An Economic Analysis of the Criteria Used to Distinguish Direct Sellers from Pyramid Schemes

21 October 2015
By Dr. Chetan Sanghvi, Dr. Timothy Watts, Jennifer Cascone-Fauver, et al

NERA was retained by the Direct Selling Association to conduct an economic analysis of the criteria used to distinguish a legitimate business enterprise from a fraudulent pyramid scheme, especially with regard to the economic implications of certain court rulings, publications, public statements, and court testimony of other experts, including Drs. Peter J. Vander Nat and William W. Keep. The authors examine expert economic testimony and decisions in certain litigated matters at a level abstracted from the specific allegations; they do not opine on the merits of the litigants’ positions in those matters.

In sum, the authors find that the economic and logical reasoning relied upon in the testimony and statements referenced above does not provide a reliable basis for determining whether an enterprise is a pyramid scheme. In particular, approaches popularized by Vander Nat and Keep that summarily reject the legitimacy of “internal consumption” and draw unsupportable inferences from the rate at which individuals quit direct selling are shown to utilize faulty logic to postulate criteria that are unrelated to the primary hallmark of pyramid schemes. Such approaches are prone to generating false positives.

This report does not purport to have the final say on this subject. Rather, the authors seek to exposit and demystify some of the byzantine discussions and the failures of logic and economics that have characterized prior evaluations of public policy toward pyramid schemes. The report examines the costs and benefits of different approaches to fraud detection to facilitate a meaningful, substantive dialogue regarding the socially optimal approach to consumer fraud law enforcement as it pertains to direct selling and pyramid schemes.