By Stacie Bosley
September 29, 2017 at 5:00 am ET
Rep. Marsha Blackburn (R-Tenn.) recently made a case for the Anti-Pyramid Promotional Scheme Act, which she introduced in the House, citing her positive experience with direct selling as a college student and her desire to support entrepreneurship and legitimate opportunities in the marketplace.
But how does one reconcile this personal narrative and trade group support with the opposing perspectives of a Federal Trade Commission member, national consumer groups, a direct selling executive, and other experts who all argue that this proposed legislation increases consumer exposure to pyramid scheme fraud?
As is often the case, the devil is in the details. An illustration can help to clarify the implications of this proposed legislation.
Imagine that you approach a city block that is filled with hot dog carts — enough that there are only a few customers at each cart during the busy lunchtime rush. You expect to see frustration and worry in the eyes of the vendor you approach, but instead find a hopeful and excited expression. This scenario repeats itself, until one day you return to find no carts remaining.
You cross paths with your favorite vendor, who carries an expression of defeat and frustration. He now realizes he was a victim of fraud – a form of fraud that was recently legalized by the U.S. government, so he has no way to recover the thousands he spent on the venture. Worse yet, he recruited friends and family into this scheme, so relationships are strained and they are not sure how to dig out of their collective financial hole.
How did this come to be? The hot dog cart company in question is built on the following rules: to earn compensation from the company the hot dog vendor must (1) buy a minimum amount of hot dogs and supplies and (2) sell hot dogs to customers or recruit new cart operators or both. The vendor makes pennies for each hot dog sold to customers like you but makes much more from recruiting additional hot dog cart operators.
The result? A market crowded with cart operators who buy hot dogs for the purpose of reaping promised rewards, likely eating a lot of hot dogs along the way. Yes, hot dogs are being purchased, but these vendor purchases have little to do with actual consumer demand for the product.
It is not difficult to intuitively grasp the problems with this structure as it so clearly conflicts with our understanding of legitimate retail systems. We understand that there is not an infinite demand for hot dogs. It is not logical to incentivize endless recruitment of vendors, especially within a finite geographical region.
Each vendor should be focused, first and foremost, on selling hot dogs to those who are not operating a cart. If not, the structure simply passes money from newly recruited vendors to those up the food chain, dooming the vast majority to losses as recruitment of new vendors becomes more difficult in an exponentially growing network of sellers. In short, this is an illegal pyramid scheme, disguised as a retail business.
While the hot dog cart scenario above might set off warning bells for nearly everyone, most frauds of this nature are less apparent (i.e., no obvious line of carts on a single block). Persuasion, hope and trust frequently override skepticism. Victim silence makes prevention and detection difficult. Of all of the fraud types monitored by the Federal Trade Commission, pyramid scheme victims are the least likely to report their experience to authorities, making prevention and enforcement all the more important.
These schemes target vulnerable individuals and communities with the promise that hard work and ingenuity — not chance, greed or luck — will allow them to achieve the American Dream. In so doing, it diminishes their ability to truly pursue upward mobility.
Rep. Blackburn writes, “I was not a victim when I sold books for Southwestern, and my customers were not victims when they bought books from me.” But her bill, H.R. 3409, does not protect companies that sell books, hot dogs or other products and services to actual retail customers — it protects scams like the hot dog cart company illustrated above. Her personal experience of the past fails to fit the legislation she sponsors in the present.
The FTC has closed many direct selling companies for creating pyramid scheme victims, not for satisfying demonstrated consumer demand. Those companies would still be operating if H.R. 3409 were the law of the land.
This act is not a pathway to protect legitimate commerce, entrepreneurship, and opportunity – it serves to protect the scams that the bill’s proponents condemn and does little to promote or support legitimate direct selling. Tell your representatives and House leadership to reject H.R. 3409.
Stacie Bosley is an associate professor of economics at Hamline University who studies consumer fraud and direct selling.
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