A very thin line between multilevel marketing and pyramid schemes

The Manila Times/April 28, 2003
By Max de Leon

After six frustrating months working like crazy for a "networking com­pany" to earn his first million, Mark, a law­yer, realized he was chasing a mirage. It was time to quit and head back to the real world, he told himself.

Mark joined Forever Living Products Philippines Inc. (FLPPI) in October 2000, and shelled out P10,000 for the op­portunity to earn big money the fast and easy way. He was in high spirits after joining the company and even spent sleep­less nights thinking of the big bucks he was told he could earn when he was first invited to attend the company's "opportunity plan presentation." He even thought about giving up law to go full-time into "the business."

Like other FLPPI recruits, Mark found FLPPI's marketing and compensation plan very enticing, because the overrides and commissions supposedly get higher with every successful recruit, made including those of the "downlines." The term "downlines" refers to the new workhorses at the base of the recruitment pyramid 'the recruits' own recruits.

But after a few months of frustration with recruiting downlines, Mark's enthusiasm faded.

"Of course, when you invite someone, you have to pay for the fare and snacks, only to get frustrated in the end when you are rejected," says Mark. "In those times that I did the business, I couldn't get back the money I had invested."

"It was like I was buying and using the company's products that were grossly overpriced," adds Mark, who now works in a government agency.

Probably thousands more share Mark's frustrations. FLPPI, company insiders said, has drawn around 300,000 members nationwide since it was registered with the Securities and Exchange Commission on Sept. 19, 1988. Several dozens other companies have sprouted, following FLPPI's modus operandi.

Shadows of the pyramid

Originating from the United States, FLPPI is only one of many firms currently engaged in "multilevel marketing" (MLM).

Also prominent owing to the size of their membership are Powerhomes Unlimited Corp., Amway, First Quadrant, Herbalife, Sunrider Philippines, Waters Philippines and GoldQuest. MLM firms have a variety of titles for their members like "distributors," "business associates" and "sales associates."

FLPPI, Sunrider and Herbalife offer mainly food supplements; PowerHomes sells houses and lots and training in computer, networking and real-estate brokering. First Quadrant offers leather products and clothes; GoldQuest, gold coins; and Water Philippines, water purifiers.

They are referred to as MLMs, networking or network marketing firms.

But nonbelievers call them "shadow pyramiding." "These schemes really walk, talk, smell and appear to be like pyramiding," says one observer.

Jaime Olmos, Department of Trade and Industry assistant director and acting chief of the Bureau of Trade Regulation and Consumer Protection, said they are not sure how many companies are engaged in MLM schemes.

He noted that the department becomes aware of an MLM firm only when a complaint has been filed against it, because the department is required to invite the supposed erring firm for marketing presentation and questioning.

"We don't keep a list of companies engaged in MLM," says Olmos. "What we do is invite certain companies to look into their marketing plan to see whether they are legitimate or are using the pyramid scheme."

Traditionally, pyramiding involves only the investment of money in which a recruit would have to get a specific number of downlines and earn a certain percentage from the amount he invested and those that were poured in by the recruits of the recruits.

But when authorities cracked down on firms or persons involved in this illegal scheme, some "innovative" groups thought of going around the law by offering products and/or services in their scheme.

Thus began the problem of distinguishing a legitimate MLM from those into pyramiding.

Olmos says MLM in itself is legal.

"It is a marketing strategy to broaden the market base," he said. But only a thin line separates networking from the pyramid scheme.

Olmos stressed that simply by offering products and services, a networking company becomes legal and is shielded from pyramiding charges.

"We really need to check the business plan or compensation plan, because that is where we can determine if a company is a legitimate MLM or not," he said.

Recruitment is the business

Joey Sarmiento, president of Sunrider and chairman of the Direct Selling Association of the Philippines (DSAP), said MLM is a kind of direct selling or person-to-person selling that pays distributors commissions based on the sale of products and services at fair market value.

When compensation is anchored on recruitment, Sarmiento said, it becomes pyramiding, as distributors of the company will tend to concentrate on recruiting persons rather than selling products and services.

Olmos said the earnings in recruitment should only be incidental and always smaller than the commission from the sale of the products.

Sarmiento noted that the scheme would become pyramiding if those on top of the chain, often called "uplines," would continue to earn big even if they have stopped selling goods and services.

To become a distributor in a legitimate MLM, Sarmiento said, one mustn't pay huge sums of money in exchange for overpriced products and the right to recruit other persons.

Sarmiento said padding the price of the products and services is obviously meant to facilitate the payment of commissions out of the recruitment of downlines.

Direct selling or pyramiding?

The direct-selling industry became visible in the Philippines in the 1970s.

Counting only the distributors of the 26 members of the Direct Selling Association of the Philippines, Sarmiento said more than two million Filipinos are engaged in MLM and direct selling nationwide.

Their total sales figure for 2000 was $298 million (P15 billion). In 2001, total sales reached $500 million (P26 billion).

The Philippines ranks fourth in Southeast Asia in sales and first in the number of people in direct selling with Indonesia, followed by Thailand and Malaysia. Worldwide the industry had total sales of more than $78 billion in 2001, and was powered by some 44.6 million salespeople.

And even with pyramiding schemes hogging the headlines, Sarmiento said the networking industry in the country continues to grow, although not as much as they expected.

"The figures are not declining, although they are not growing as fast, because of the proliferation of pyramiding schemes that give the industry a bad image," he said.

Sarmiento said estimates in the sales for 2002, showed the industry grew by only about 10 to 20 percent compared with the 67-percent increase from 2000 to 2001.

Doomed to fail?

MLMs work by geometric expansion, whereby a recruit must in turn recruit a certain number of people. So, if selling the product is a mere sideshow to the real profit-making anchored on recruitment, an MLM firm is bound to collapse at a certain level due to saturation.

If, for example, a recruit'in order to earn his commission'must recruit 10 other people, at a depth of three levels, there would be 1,000 persons under his pyramid. At a depth of six levels, that number would swell to one million.

Considering the limited number of people who can afford and are willing to buy and use a particular product, saturation is inevitable and fast. This makes only those on top of the chain happy while those below are doomed to lose money.

To compound the situation, in MLMs the product is not the real reason people are enticed to join. The product offered is merely the excuse to legitimize the real and probably illegal moneymaking scam.

The strong attraction of greed

"What are your dreams in life?"

If you hear this question asked by the speaker in a seminar, followed by an enumeration of answers that include big incomes, a new house and lot and expensive cars, financial freedom and huge bank accounts while working part-time, chances are you are attending a "business opportunity presentation" of a networking company.

Marketing presentations of most shadowy "multilevel marketing" groups or MLMs often start by appealing to the materialism and greed of the prospective recruits present in the seminar. While this style may turn some people off, it also conditions the minds of the prospects to be part of the "get-rich-quick" scheme that is to be introduced to them. As people say, unbridled greed suspends good judgment.

Mark, a recruit from Forever Living Products Philippines Inc. (FLPPI), said this is the part where seminar participants "get high"'the same part that gave him sleepless nights.

After this, the speaker would discuss briefly the products and/or services being offered by the company and justify why the company charges an entry fee that is obviously overpriced.

Then the speaker would map out the company's marketing plan, which includes the system on how to recruit "downlines" and how much would be earned for every successful recruitment effort.

Afterward the speaker would give more teasers on how big some of their distributors are earning and the luxurious lives they live through the company.

At the end of the presentation, prospective recruits are divided into small groups by those who invited them. Here, particular questions would be answered. Also, the prospects would be shown sam­ples of the huge amount of weekly checks re­ceived by old distributors of the company.

"Some of our busi­ness associates are now earning P350,000 a week," Carmela Carva­jal, a marketing presentation speaker of First Quadrant, recently told some 50 persons cramped in a small seminar room of the company in Greenhills, San Juan.

Overpricing

First Quadrant, which has attracted more than 80,000 "business associates," is owned by the family of Laureano Guevarra, the acknowledged founder of the Philippine shoe industry. Julie Rose Defensor, wife of the housing czar Michael Defensor, is the company's corporate secretary.

It charges its new distributor P8,880 as entry fee.

Carvajal said the amount would entitle the company's new business associate to P2,000 shopping privilege on its products, an accident insurance, 50-percent discount on all its products, a business kit and the right to recruit other distributors.

She said First Quadrant uses the binary system in its recruitment in which a distributor can only have two direct recruits that would be situated on the right and left of his pyramid as first level of his downlines. The first two recruits would be the start of his groups A and B. For every successful recruit, the business associate gets P1,000 and an additional P1,500 for every pair of recruits. Besides this, the distributor will also get a 5-percent rebate on every purchase made by his downlines.

The company, Carvajal said, does not impose a sales quota on its distributors. "If you don't want to sell the products, it's OK," she said. "A lot of our business associates do that, but they still get their checks weekly."

Julie, a ranking government employee based in Davao, said she was lured into the company by her best friend in August 2002, but never got to recruit anybody or sell its product because, according to her, the products are too expensive for their quality.

"For my P2,000 I only got a pair of sandals [with the brand name Doyee] worth P1,700 and a pair of slippers worth more than P300. Nag-abono pa nga ako [I even added some amount to it]," she told The Times when she recently visited her sister in Manila.

The same overpricing of products is the usual complaint of distributors of FLPPI. The company charges P12,000 as entry fee to a member so he could get the right to recruit other people and enjoy a 30-percent discount on the company's products. He could also retail the products at a 43-percent profit.

For the P12,000 (it was recently reduced from P14,550) the new recruit will be given a "combo pack" consisting of 27 of the company's products that range from health goods to shampoo and cosmetics. Some of the products are an eight-ounce Aloe Jojoba Shampoo with a retail price of P541, a 100-tablet bottle of the Absorbent C worth P715, Aloe Liquid Soap P618, and Forever Bee Honey P959.

A combo pack is equivalent to two case credits (cc) and would elevate the new distributor to the assistant supervisor level. Should he reach 25 cc, he would be promoted to supervisor, 75 cc to assistant manager and 120 cc to manager. The one on top of the chain gets corresponding compensation, commissions and rebates from the sale and recruits of his downlines. But, of course, as Mark said, this is easier said than done.

"The ladder to promotion is very hard to scale, because you need to spend a lot of time and money to reach higher levels. While you go up, the sales quota you need to maintain for you to get your commissions also goes up so that it becomes near impossible to meet, because the products are too expensive," Mark said.

Recruits solve all problems

FLPPI is known in the networking circle as either owned or controlled by the family of National Security Adviser Roilo Golez, the company's founding managing director. His wife, Natalia, now holds that position. In its Securities and Exchange Commission registration, Golez was not listed as one of the company's incorporators.

To earn big in the company, distributors are being told to recruit more and more people as shown in one of their motivational materials entitled "Attack! Attack!" which also has a slogan "recruits solve all problems of the business."

FLPPI uses a system where a member can get as many direct recruits as he can. Originally, an upline automatically gets 30 percent of the entry fee of his direct recruits plus 5-percent rebates. But in July 2000, the company decided to scrap the 30-percent ready commission in order to lower the price of the entry fee.

In the case of Powerhomes Unlimited Corp., distributors whom they call marketing and real-estate sales associates (MSAs) shell out $298 to buy its products and services and the right to recruit downlines.

In one of the articles posted on its website, Powerhomes claimed that its principal product is house, with its marketing training package consisting of basic real-estate brokering, leverage marketing and computer literacy as add-ons.

The company thought up the socialized power-pairing system (SPPS) "where an MSA can only be allowed to get two customers/enrollees that he/she attaches directly under the left and right side of his/her specific monitoring center to form a pair of direct customer base."

The cycle will be duplicated by succeeding customer/enrollees. For every pair of recruits, the MSA receives a fee of $73.60.

In both Powerhomes and First Quadrant, the persons on top or the uplines, although limited to only two direct downlines, can spill over their excess recruits to their downlines who have not recruited somebody yet. With this, the matrix will continue to expand and the earnings go on flowing.

This is also why a person who stopped selling and recruiting can still earn, because he will be automatically entitled to specific commissions from the spillovers and those who will be recruited by them.

Legitimate networking

Joey Sarmiento, chairman of the Direct Selling Association of the Philippines, said that in his company, Sunrider Philippines, distributors get no payment from the recruitment they make, but only on sales.

So even if a distributor recruited so many downlines, but registered no sales, Sarmiento said he will not get paid.

"This is because in a legitimate MLM, the intention is really to sell your products. You recruit somebody to help you sell the products and not because you will get a certain amount from his registration fee."

Jaime Olmos, assistant director of the Department of Trade and Industry, said that in MLM one will get a big income if one strives hard in selling the products of the company.

"But in pyramiding, you can just concentrate on recruiting people and soon you will be able buy your Isuzu Trooper," Olmos said. "You no longer have to sell'just recruit and recruit."

With the earnings of most MLMs anchored on recruitment, distri­butors often get pushy and deceptive when getting people signed up as they make extraordinary claims on the products and the earning potentials.

Sarmiento said this happens because MLM companies have no direct control over their independent distributors on the manner they sell the product and the business opportunity.

But Olmos said in this, both the distributor and the company can be held liable for violating Article 50 of the Consumer Act of the Philippines which states, "An act or practice shall be deemed deceptive whenever the producer, manu­facturer, supplier or seller, through concealment, false representation or fraudulent manipulation, induces a consumer to enter into a sales or lease transaction of any consumer product or service."

Bill aims to make pyramiding a heinous crime

If Rep. Harry Angping (3rd District, Manila) would have his way, pyramiding will soon be a heinous crime.

"We want the extreme punishment for this crime. It should be either death or life imprisonment," Angping told The Manila Times after the House of Representatives adopted House Bill 5601 before the Holy Week.

The bill, "Pyramid Sales Ban Act," seeks to amend several portions of RA 7394, or the Consumer Act of the Philippines, because Angping said, it is now obsolete.

From the penalty of a mere P500 to P10,000 and one-year imprisonment for involvement in pyramiding scheme under Section 60 of RA 7394, the bill would make the offense'if committed against three or more individuals'an automatic "act of economic sabotage and shall be considered a nonbailable offense."

Angping said several billions of pesos are being lost to pyramiding schemes, which could have been used to fuel the economy if put in a bank and circulated through legitimate lending.

The crime, he said, should be made a non-bailable offense because pyramiding operators can easily change company names and restart an illegal business if allowed provisional liberty.

Also, Angping said, it is but appropriate to make pyramiding a heinous crime because victims here are often gypped of their lifetime savings.

"You rob a person of his lifetime savings. That is as good as killing him," Angping said.

Broader definition

Besides the provisions on the penalty, House Bill 5601 also seeks to amend the definition of "pyramid sales scheme" under the Consumer Act to make it broader and clearer.

Article 2(K) of The Consumer Act defines pyramiding sales scheme as sales devices whereby a person, on the condition that he makes an investment, is granted by the manufacturer or his representative a right to recruit for profit one or more additional persons who will also be granted such right to recruit on condition of making a similar investment.

In this definition, the profits of the persons using such a plan are derived primarily from the recruitment of other persons into the plan rather than from the sale of consumer products, services and credit.

House Bill 5601 adopted the definition but added that pyramiding could also mean that a "substantial amount" is derived as profits from recruitment rather than from the sale of the product.

The bill also adopted the detailed definition of pyramid sales scheme under the Department of Trade and Industry Administrative Order 08, the rules enforcing Article 53 of the Consumer Act.

Article 53, the existing law that bans pyramid sales schemes, forbids the use of chain distribution plans or pyramid sales schemes in the sale of consumer products.

Although the department's administrative order broadens the definition of the pyramid scheme, its punishment'because of its administrative nature'is limited only to the issuance of a cease and desist order against operators of a pyramid scheme and penalties of P500 to P300,000 fine and additional P1,000 for each day of continuing violation.

The criminal proceedings that can be taken under the administrative order also fall under Section 6 of the Consumer Act.

But the administrative order made good in giving a detailed definition of the pyramid scheme that Angping adopted in his bill.

Pyramiding defined

Section 2.2 of the department's administrative order says that without limiting the coverage of the term "chain distribution plan or pyramid sales scheme," business sales or marketing plan or scheme is considered a chain distribution plan or pyramid sales scheme if it has two major features.

First, a promoter persuades recruits to buy products, services, credit, title or rank whereby the recruits can receive income primarily from the mere introduction, recruitment or sponsorship of other participants into the scheme rather than from the marketing and sale of products.

And second, it is pyramiding when the profits of the persons using them are derived primarily from the recruitment of other persons into the plan or scheme rather than from the sale of consumer products and services. Its attributes include the following:

1. Revenues or income are derived from participants' entry fees.
2. In order to earn income, participants must sponsor a fixed number of other participants, each of whom must in turn sponsor a fixed number of participants as in a plan compensating participants balancing the number of recruits that the number of sales volume.
3. A participant's income is derived primarily from his slot or position within the organization as determined by the time, date and order of participation.
4. Participants are not allowed to return marketable and unused products for refund within a reasonable period of time or the conditions for such product return are contrary to the provisions of the Consumer Act and/or its implementing rules (DAO No. 2 s. of 1993).
5. There is no fair market value for the goods received (fair market value is a price determined by an open market system. An indicator would be that consumers would still be willing to buy a product at its quoted price without participating in the compensation plan).

Networking covered

But what made Angping's bill more important is that it included the definitions of a legitimate multilevel marketing (MLM) plan that are not present in both the Consumer Act and the DTI administrative order.

Section 4 of HB 5601 clearly defines "permissible sales practices" for MLM, including:

1. A low entry barrier such as minimal processing fee or reasonable sales kit demonstration materials, sold at cost as prospects sign up as distributor.
2. A low exit barrier by way of a "buy-back" policy (at a reasonable rate of the price paid) whereby the firm will rebuy within 90 days from last purchase, the unsold, unopened, unused, unexpired, undamaged and salable inventory held by distributors resigning from or terminating their contracts with the company.
3. An indispensable need for regular retail requirements for the distributor to earn continuously. There is no offer in income by simply recruiting and products are sold at fair market value.
4. An obligation for distributors to sell at least 70 percent of their previously acquired inventory before they are allowed to make a repurchase. There is absolutely no inducement for inventory loading.

Senate takes the cue

Senators Robert Jaworski and Noli de Castro also filed separate bills on the matter, which are also consistent with the definitions of administrative order of the pyramid sales scheme.

The two bills also defined a legitimate MLM plan.

Angping and the cosponsors of HB 5601 are hoping that the Senate would just adopt the bill and add some provisions of the bills of Jaworski and de Castro to make sure there would be no loopholes in the new law that will be passed.

The important part of the two Senate bills is their preventive aspect.

De Castro and Jaworski stated in their bills that the marketing plans of MLMs should be filed first with the DTI for review if they are legitimate before the actual operation or implementation.

The two senators also tasked the DTI to guard against the following factors in an MLM plan that give the presumption of a pyramid scheme: prohibitive entry requirements of headhunting fees, undisclosed drawback policies, front inventory loading, profits primarily derived from recruitment, unjustified claims of unusually large returns on investments or get-rich-quick promises, absence of a real market for a product and other similar pyramiding schemes as hereinafter defined by law.

The DTI was also given jurisdiction over charges of the use of pyramid sales schemes.

But in the version of de Castro, the penalty was increased to P1 million to P5 million fine and imprisonment of 12 to 20 years without the benefit of bail.

In the two bills, pyramiding entities are also ordered to return participants' "any and all considerations given, with interest charges at a rate to be computed from the time such payments were made."

Mediation proceedings

Just recently, the DTI invited 27 MLM firms suspected of engaging in the pyramid sales scheme.

Right now, Powerhomes Unlimited Corp., Lifelink Multi-Card, Inc. and Tie-With-Us Enterprise are mediating with the DTI.

Evidence of pyramiding was not substantially established against the following companies, which presented their plan: Phil. Rich Int'l. Marketing Co., ADL Marketing Phils., Inc., Inosphil Corp., CPY Loan and Credit Corp., PriManila Plans, Inc., Sophi Martin Phils. and Kabuhi Int'l. Marketing Network, Inc.

Also, the DTI said the following companies are still under evaluation after their business plan presentation: Grand Post Int'l., Inc., Net Taipan Corp., First Quadrant and Dream Team Pre-Paid Club.

The summons sent to the following companies for marketing presentation were returned due to change in business address: Ikingkong, Capitol Int'l Services, GEJOBACO Assoc., Inc., Rainbow Technologies, Inc., Sure Car, LGY Lending/Network and Financial Assistance, Ugnayan Phils. Marketing Systems, Entrepreneurs Club Int'l Marketing Corp., Cymbionic Inc. and Rise E-Commerce.

DTI Assistant Director Jaime Olmos said there has been no case law in the country yet where an MLM firm was found guilty of using the pyramid sales scheme, although the department is hoping there would be one soon.

He said Forever Living Products Phils., Inc. was not invited for business plan presentation, because it is a member of the Direct Selling Association of the Philippines (DSAP).

But DSAP President Joey Sarmiento made it clear that being a member of the organization does not shield a company from any investigation.

He admitted, however, that the DTI recognizes the organization because it is a resource group of the department in pyramiding investigations.

This is why, Sarmiento said, the DSAP came up with an eight-point framework, which it uses in screening applicants for membership in the group.

Sarmiento said the framework is consistent with the DTI administrative order on definitions of a pyramiding scheme and serves as the test in evaluating an applicant's marketing plan.

Guarding against naiveté and greed

Besides this, Sarmiento said DSAP is embarking on a campaign to rid the industry of companies using MLM as a front for pyramiding. It includes a massive information drive and consumer education.

"We want to make sure that we are weeding out pyramiding scams because it gives the industry a bad name," Sarmiento said.

On the government's side, de Castro said recourses must be taken to avert "such instances of fraud which victimize not only our unsuspecting consumers but the reputation and integrity of our marketplaces as well."

But even on their own, Chingkee Tan of the Millionaires in Business said consumers could easily avoid being victimized by pyramiding schemes by simply guarding themselves against two things' naiveté and greed.