What Is a Pyramid Scheme?

:
Distinguishing the Term
from Legitimate Multi-level
Marketing Practices
BY HAROLD FURCHTGOTT-ROTH
Director, Center for the Economics of the Internet, Hudson Institute

KIRK ARNER
Legal Fellow, Center for the Economics of the Internet, Hudson Institute

June 2020

This essay is part of a series exploring the importance of
allowing flexible business models in the American economy.
“Pyramid scheme” sounds sinister. The term is used so
routinely and casually that it is easy to imagine it has long been
codified as illegal in the United States. It turns out, however,
that the concept is a rather recent American legal construct
that has yet to be codified in federal statutes.
To many people, “pyramid” evokes marvelous images of an
ancient and bygone era. The Great Pyramid of Giza was one
of the Seven Wonders of the Ancient World. The ancient
Aztecs also had pyramids—works of profound engineering
and beauty.
After maintaining a positive and wondrous connotation for
millennia, “pyramid” acquired a decidedly negative financial
meaning in early twentieth-century America. The Oxford
English Dictionary credits the American Samuel Reinsch with
its first usage.1
In his Readings on American Government, published in
1909, Reinsch uses the term “pyramid” to discuss “an illicit,
unstable financial scheme.” Later, in 1920, the Oakland
Tribune described Charles Ponzi’s infamous scheme as a
“pyramid.”
The OED also credits Americans with originating the term
“pyramid scheme,” which first appeared in the Oakland

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Tribune in 1949. It gives three examples of the use of “pyramid
scheme,” each of which involves financial transactions.
Perhaps surprisingly then, the term “pyramid scheme” does
not appear in the U.S. Code. The term appears only four
times in the Code of Federal Regulations, exclusively in
reference to the illegal sale of government bonds. There is no
2
federal statutory definition or regulatory definition of “pyramid
scheme,” and efforts to write a statutory definition have not
passed Congress.
Nevertheless, the term has such evocative and pejorative
connotations that it is frequently used as a term of art in
federal complaints, including under Section 5 of the Federal
Trade Commission Act and under securities law. Recent
examples include FTC cases against AdvoCare and Neora
3
(formerly Nerium).4 According to the Association of Certified
Fraud Examiners, the FTC shuts down approximately ten
pyramid schemes annually.5
Despite the lack of a standard definition, various federal
agencies have web pages warning consumers about the
differences between illegal pyramid schemes and legitimate
multilevel marketing businesses. The table below presents
various informal indicia of pyramid schemes, as determined
by the Securities and Exchange Commission, the FTC, and
the FBI.
Although these are not formal legal definitions, it is surprising
how little overlap there is across federal agencies, whose
only point of agreement is that pyramid schemes emphasize
recruitment. Moreover, these indicators provide little clarity to

Federal agencies’ warning signs of pyramid schemes

  SEC FTC FBI

No geniune product or service X

Promises of high returns in a short period X X

Easy money or passive income X

No demonstrated revenue from retail sales X

Buy-in required X

Complex commission structure X

Emphasis on recruiting X X X

Promoters play on emotions or use high-pressure sales tactics X

Distributors buy more products than they want to use or can resell X

SEC See https://www.sec.gov/oiea/investor-alerts-bulletins/investor-alerts-ia_pyramidhtm.html

FTC See https://www.consumer.ftc.gov/articles/0065-multi-level-marketing-businesses-and-pyramid-schemes
FBI See https://www.fbi.gov/scams-and-safety/common-fraud-schemes/pyramid-schemes

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consumers because “recruitment” is normally associated with
jobs and regarded as a legitimate business activity.
Nor are the other indicators unambiguously and uniquely
related to pyramid schemes. “Promises of high returns in
a short period of time” are common for many legitimate
business opportunities, whether the claims are substantive
or mere puffery. So too are promises of “easy money or
passive income”; indeed, long-term personal investing is a
largely passive endeavor. “No demonstrated revenue from
retail sales” is not a reasonable indication of a pyramid
scheme, or else every business in the United States without
retail sales might qualify. Many legitimate businesses, such
as franchises, require “buy-ins,” and others, such as real
estate, retail clothing, and insurance agencies, have “complex
commission structures.” Patrons of used car dealerships
understand the prevalence of “high-pressure sales tactics” in
legitimate businesses all too well. And consumers purchasing
“more products than they want to use” is perhaps puzzling,
but hardly unambiguous evidence of a pyramid scheme.
Moreover, many pyramid schemes involve purely financial
transactions in which there is no purchase of “products”
whatsoever.
Ultimately, the federal agencies’ lists of supposed pyramid
scheme indicators do not allow us to distinguish a pyramid
scheme from a legitimate business activity on the federal level.
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THE CONCEPT OF A “PYRAMID
SCHEME” IS A RECENT AMERICAN
LEGAL CONSTRUCT THAT HAS
YET TO BE CODIFIED IN FEDERAL
STATUTES.
Many states, including California6 and New York,7 also have
similar lists, bound up, respectively, in endless chain and chain
distributorship laws. These lists are equally insufficient. That
said, many states have been aggressively moving to update
their pyramid scheme laws in recent years by enacting strong
definitions and banning the schemes.
No doubt, some fraudulent business plans warrant
government scrutiny, but current federal efforts to define
some business practices as pyramid schemes do not clearly
distinguish between harmful and wholesome businesses.
Ancient pyramids, built to withstand adverse elements,
have lasted millennia. In contrast, pyramid schemes do not
withstand the slightest scrutiny. They are little more than a
house of cards, quickly falling apart and hurting those who
have “invested” in them.
WHAT IS A PYRAMID SCHEME?: DISTINGUISHING
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Endnotes

1 Oxford English Dictionary, https://oed.com/view/Entry/155386?redirectedFrom=pyramid+scheme#eid112152329.

2 Search results for “pyramid scheme,” Govinfo, https://tinyurl.com/sa97ljx.

3 Plaintiff’s Complaint for Permanent Injunction and Other Equitable Relief, Federal Trade Commission v. AdvoCare et al., No. 4:19-cv-00715
(E.D. Texas 2019), available at https://www.ftc.gov/system/files/documents/cases/advocare_complaint_0.pdf.

4 Complaint for Permanent Injunction and Other Equitable Relief, Federal Trade Commission v. Neora et al., No. 3:19-cv-19699 (D.N.J. 2019),
available at https://www.ftc.gov/system/files/documents/cases/1623099_nerium_complaint_11-1-19.pdf.

5 “Ponzi Schemes,” Association of Certified Fraud Examiners, https://www.acfe.com/ponzi-schemes.aspx.

6 “Pyramid Schemes / Multi-Level Marketing,” State of California Department of Justice, Xavier Becerra, Attorney General, https://oag.ca.gov/
consumers/general/pyramid_schemes.

7 “Don’t Get Caught in a Pyramid Scheme,” New York State Office of the Attorney General, Letitia James, NY Attorney General, https://ag.ny.
gov/consumer-frauds/pyramid-schemes.

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About the Authors
Harold Furchtgott-Roth
Director, Center for the Economics of the Internet
Harold Furchtgott-Roth is a senior fellow and director of the Center for the Economics of the Internet at Hudson Institute. He
founded Furchtgott-Roth Economic Enterprises in 2003 and frequently comments on issues related to the communications sector
of the economy. From 2001 to 2003, he was a visiting fellow at the American Enterprise Institute where he published A Tough Act
to Follow, chronicling the difficulties implementing the Telecommunications Act of 1996.

From 1997 through 2001, Mr. Furchtgott-Roth served as a commissioner of the Federal Communications Commission. In that
capacity, he served on the Joint Board on Universal Service. Before his appointment to the FCC, he was chief economist for the
House Committee on Commerce and a principal staff member on the Telecommunications Act of 1996. Earlier in his career, he
was a senior economist with Economists Incorporated and a research analyst with the Center for Naval Analyses. Mr. Furchtgott-
Roth is the coauthor of three books: Cable TV: Regulation or Competition, with R.W. Crandall; Economics of A Disaster: The
Exxon Valdez Oil Spill, with B.M. Owen et al; and International Trade in Computer Software, with S.E. Siwek.

Kirk Arner
Legal Fellow, Center for the Economics of the Internet
Kirk R. Arner is a legal fellow at Hudson’s Center for the Economics of the Internet. He studies and writes about the intersection
of technology and policy, with a particular focus on telecommunications regulation and antitrust. Prior to joining Hudson, Kirk
was a member of the Attorney Honors program at the Federal Communications Commission, where he worked in the Wireless
Telecommunications Bureau. Kirk earned his J.D. from the Antonin Scalia Law School at George Mason University and his B.A. in
Philosophy, Politics, & Economics (PPE) from the University of Pennsylvania.

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