Your friend says it is legal because there is a product. Here is the test regulators use, and how to apply it.
This in-depth guide covers everything you need to know about mlm vs pyramid scheme: where the legal line is. Based on verified income data and real-world case studies from our database of 138 side hustle tactics.
An MLM is legal in the US when participants are paid mainly for selling products to real customers outside the network. It crosses into a pyramid scheme when the money mainly comes from recruiting, including from purchases people make to qualify for rewards rather than because they want the product. The test comes from the FTC's 1975 Koscot decision, and selling a real product does not on its own make a company legal. Courts decide case by case: the FTC won against BurnLounge in 2014 and lost against Neora in 2023.
"It's not a pyramid scheme, there's a product"
You have probably heard that sentence. Maybe from a friend who just joined, or from a cousin at a family dinner, or from yourself, quietly, the night you signed up. You want it to be true. You want the extra income, the flexible hours, the feeling of building something of your own.
And there is still a small knot in your stomach, because the pitch talked a lot about building a team and not much about customers.
That knot deserves an answer, and the law gives a clearer one than most people expect. Regulators look past the label, whether it is MLM, network marketing or direct sales, to where the money comes from.
Question to sit with: if every person in your company stopped recruiting tomorrow, who would still be buying the product, and why?
The legal test: Koscot
The US test comes from a 1975 Federal Trade Commission decision, In re Koscot Interplanetary. As quoted in the FTC's staff guidance on MLMs, a pyramid scheme is:
"characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users."
The citation is In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975). Courts quote the same test, with very slightly different wording, through Webster v. Omnitrition, 79 F.3d 776, 781 (9th Cir. 1996).
In plain English, there are two parts:
- You pay to get in. A starter kit, a fee, or product purchases.
- You get rewards for recruiting that are not tied to selling product to the people who actually use it.
The second part does the work. In 2014 the Ninth Circuit called it "the sine qua non of a pyramid scheme", characterized by "recruitment with rewards unrelated to product sales."
The phrase "ultimate users" is where most arguments happen. A product sold to someone outside the company who wants it counts. A product bought by a participant mainly to hit a rank or a bonus may not.
What the FTC looks at in practice
The FTC's staff guidance, first published in January 2018 and revised in April 2024, explains how staff apply the test. It is staff guidance and not binding on the Commission, but it shows what investigators look for.
There is no magic percentage. "There is no percentage-based test to determine whether an MLM is a pyramid scheme. A far more comprehensive analysis is required."
Selling a real product is not a defence on its own. "An MLM can be a pyramid scheme even if it offers rewards based on retailing." And: "Having retail customers or even many retail customers is not a safe harbor."
Recruiting requirements tilt the plan. If a plan "requires a participant to recruit a certain number of participants or have multiple levels of recruits to be eligible for significant compensation, then, in practice, the plan likely will incentivize recruiting."
Buying for yourself is fine, buying to qualify is not. "Products or services that are purchased and consumed by participants to satisfy their own genuine personal demand do not themselves indicate a problematic MLM compensation structure." The problem is when participants buy "for reasons unrelated to their own actual demand."
Monthly quotas are a warning sign. "MLMs that require participants to meet monthly or quarterly purchase quotas to maintain their eligibility ... are likely incentivizing inventory loading." Inventory loading means buying product "so that a participant in the MLM can qualify for compensation ... rather than to satisfy genuine personal or retail demand."
A buyback policy does not make a plan legal. Buybacks "can benefit participants, but do not shield an unlawful pyramid scheme from law enforcement." The guidance adds that participants may not know about the refund, the process may be complicated, or getting it "may require quitting the opportunity entirely."
The FTC's consumer advice page (July 2022) puts the whole idea in one line: "If the MLM is not a pyramid scheme, it will pay you based on your sales to retail customers, without having to recruit new distributors."
The record: what courts and settlements have said
These cases show how the line has been drawn in practice. Most ended in settlements, which are agreements and not court findings, so read each one for what it actually says.
BurnLounge (Ninth Circuit, 2014)
BurnLounge sold product packages tied to its business opportunity. The Ninth Circuit affirmed in June 2014 that it "was an illegal pyramid scheme in violation of the FTCA because BurnLounge's focus was recruitment, and because the rewards it paid in the form of cash bonuses were tied to recruitment rather than the sale of merchandise." The FTC's guidance notes that once the packages were no longer tied to the business opportunity, "monthly sales of these packages plummeted by almost 98 percent". People had been buying the product to get into the opportunity.
Vemma (settled December 2016)
The FTC sued Vemma in 2015. A court ruling cited in the FTC's guidance said "evidence that distributors purchase and consume product for the purpose of qualifying for recruitment incentives is evidence of a pyramid scheme". Under the December 2016 settlement, Vemma may not pay an affiliate "unless a majority of that affiliate's revenue comes from sales to real customers rather than other distributors." The order imposed a $238 million judgment, partly suspended on payment of $470,136 and the surrender of certain real estate and business assets.
Herbalife (settled July 2016)
Herbalife agreed to pay $200 million to settle FTC charges. The FTC charged deceptive income claims and a compensation structure it called "unfair because it rewards distributors for recruiting others to join and purchase products in order to advance in the marketing program, rather than in response to actual retail demand." The FTC did not describe Herbalife as a pyramid scheme in the release, and no court made that finding. The settlement required that at least two-thirds of rewards be based on tracked and verified retail sales, and that at least 80% of product sales go to legitimate end users. The FTC later mailed checks to nearly 350,000 people.
AdvoCare (settled October 2019)
AdvoCare agreed to pay $150 million and be banned from multi-level marketing "to resolve Federal Trade Commission charges that the company operated an illegal pyramid scheme." According to the FTC, 72.3% of distributors earned no compensation from AdvoCare in 2016. The FTC later returned more than $149 million to more than 224,000 people.
LuLaRoe (Washington State, settled February 2021)
LuLaRoe agreed to pay $4.75 million to resolve a lawsuit by Washington's Attorney General "asserting that LuLaRoe ... was operating a pyramid scheme." The Attorney General's release says "many retailers did not receive the promised 90 percent" buyback, "and some received no refund at all." The settlement required bonuses to be based on retail sales rather than on retailers' own purchases.
Neora (the FTC lost, September 2023)
The FTC sued Neora, formerly Nerium, in federal court in Texas. After a trial, Senior US District Judge Barbara Lynn ruled in September 2023 that "the FTC has not established the second prong of the Koscot test, and concludes that Neora is not operating as an illegal pyramid scheme." Judgment went to Neora. The FTC's case page says the case is closed. This matters for balance: the law does not treat every MLM as a pyramid, and the FTC has to prove its case.
Amway, World Wide Group and LTD (proposed order, September 2026)
On September 17, 2026, the FTC and Washington State announced that Amway, World Wide Group and LTD will pay $225 million to resolve allegations. The FTC called it the largest monetary recovery it has obtained against an MLM. It alleged that "most IBOs who joined WWG or LTD after 2020 spent more money on Amway products and training than they received from Amway." Under the proposed order, IBOs "will be required to sell to others at least 70% of the products they purchase from Amway each month." The order is a proposed stipulated order that takes effect when a judge signs it.
Question to sit with: in every case above, the argument came down to who the customers really were. Who are the customers in your downline's orders?
Legal does not mean profitable
Even when a company is on the right side of the line, the FTC's own consumer page says "most people who join legitimate MLMs make little or no money. Some of them lose money."
So there are two separate questions. Is this company legal? And will it pay you? The second one is answered by the company's own numbers. Our guide to reading an MLM income disclosure statement shows you how, and is MLM worth it? puts the figures together.
A plain-English test for your own plan
You do not need a lawyer to see which way a plan leans. Pull up your compensation plan and your last three months of orders, and answer these honestly.
1. Could you earn real money with zero recruits? The FTC's consumer page says: "In a legitimate MLM program, you should be able to make money just by selling the product." If the plan only pays meaningful money once you have a team, it is built around recruiting.
2. Do you have to buy a set amount each month to stay active or qualify? That is the quota the FTC guidance links to inventory loading. Ask yourself whether you would buy that amount if there were no rank attached.
3. Does rank or a bonus require a number of recruits or "legs"? The FTC guidance says such requirements likely incentivize recruiting.
4. Who bought the product last month? Count orders from people outside the company against orders from participants, including you. You cannot apply a legal percentage here, because there is none, but the ratio tells you what is driving the business.
5. Is there a buyback, and is it real? The US Direct Selling Association's Code of Ethics requires member companies to buy back marketable inventory "within twelve (12) months from the salesperson's date of purchase at not less than 90 percent" of the original net cost when a seller leaves. Check whether your company offers this in writing. Remember the FTC's point that a buyback does not make an unlawful plan legal.
6. Are you shown cars, houses and holidays? The FTC guidance treats images of "houses, automobiles, and luxury vacations" as implied earnings claims, which must reflect what a typical participant earns.
If most of your answers point toward recruiting and qualifying purchases, read the red flags and the checklist for evaluating a company. If they point toward real customers buying a product they want, read direct sales done right for how to build on that.
Outside the US
Other countries draw a similar line, often in more detail. The UK's Digital Markets, Competition and Consumers Act 2024 bans a scheme where a consumer pays "for the opportunity to receive compensation that is derived primarily from the introduction of other consumers into the scheme rather than from the supply or consumption of products." Malaysia bans promoting a pyramid scheme under section 27B of the Direct Sales and Anti-Pyramid Scheme Act 1993 and requires direct sales companies to hold a licence. Canada's Competition Act treats a plan as pyramid selling if, among other things, participants are paid for recruitment or lack a buyback on reasonable commercial terms. The full country-by-country version, with refund rights, is in MLM laws by country.
If you think you are in one
You did nothing shameful by joining. These plans are built to be persuasive, and they usually arrive through someone you trust.
If you believe your company is paying mainly for recruiting, the FTC tells consumers to report it at ReportFraud.ftc.gov and to their state attorney general. If you want out, how to leave an MLM and recover money walks through buybacks, card disputes and cancelling autoship. If you still want your own income, and you should, start with the alternatives that have better odds or the honest guide to MLM and direct sales.
This page explains how regulators and courts have described the law. It is general information, not legal advice about any specific company or plan.