Is financial MLM a Ponzi 2.0? And what fintech can do about it.
The start of the year is usually tough with your bank account turning red. Luckily, there are a few easy ways to earn some quick bucks online. Or, wait? In the current context many are tempted by easy money. New schemes and companies are leveraging social media networks to misuse the gullibility and low financial knowledge of consumers, mainly youngsters, by promising them financial independence. Can regulators enforce tighter scrutiny over these new business forms, or can the financial and fintech industry resolve the issue by itself?
With weakened prospects caused by the (economic) consequences of the pandemic, people turn to online jobs. Making money online seems to be the new trend — gig-workers or Turkers are just a few examples of how to round up your monthly income.
Side-jobs aren’t a thing from the present though. Decades before the internet, suburban women would gather around tea and cookies to host famous Tupperware Home Parties. The plastic container brand asked clients to host meetings where they could act as brand ambassadors — and earn a piece of the sale.
What soon followed was a new form of sales and marketing called multi-level marketing (MLM), or network marketing, involving tens of millions of consumers. Today, in part due to an increasing participation of self-employed people around the world, the industry is valued at over $167 billion.
But opportunities come with risks, and what seems too good to be true usually is.
The problem isn’t with the network marketing business model, but with those that have used this technique to promote dubious (financial) products.
The wide reach of social media networks and videoconferencing — and more recently the sad restrictions of social distancing — has pushed referral schemes to move outside of the typical housewives’ living rooms and take over youngsters’ incredulity online.
Thereby, rendering the line between legal forms of network marketing and fraudulent programs a point of controversy, confusion, and inquiry in many countries as well as an opportunity for anti-fraud fintech’s to step up.
Customers that enter MLM’s have overall low levels of financial literacy.
Beware of the (digital) Tupperware
Not everyone is a keen defender of MLM’s. Critics often compare them to pyramid or Ponzi schemes — a form of fraud that lures investors and pays profits to earlier investors with funds from the more recent investors -, although they themselves reject this idea.
In fact, the latest industry numbers claim that in the U.S. multi-level marketing companies brought in an estimated $34.9 billion in revenue, thanks to the more than 18 million people involved.
But things have changed as new MLM’s have started to go off-road.
· On the one hand, the target audience has shifted from steady, full-time employees to more vulnerable citizens such as stay-at-home moms, college grads with student debt and overall youngsters looking for a way to make income.
· On the other hand, the underlying asset — the product — has moved away from a tangible product to more complex financial products or trading techniques.
As a result, financial gains from joining network marketing companies are found to be limited, if not null.
A 2018 survey showed that only 25 percent of those participating in a MLM job made a profit, while the U.S. Consumer Awareness Institute found that 99% of MLM participants either don’t make money at all or actually lose it.
Thanks to network effects and peer recommendation, MLM companies however encounter widespread success. By deliberately circumventing traditional channels and existing (financial) institutions, they manage to reach large audiences in short amounts of time. And because clients leverage their close circles, success rates for perpetuating the chain are high.
Academics concluded that personal scrutiny lessens when we trust someone suggesting that religious or ethnical communities provide highly trusted social networks for recruitment.
The U.S. financial authorities found that community-based fraud — also known as “affinity fraud”- often targets people with common ties based on ethnicity, nationality, religion, sexual orientation, military service and age.
What’s more, customers that enter MLM’s have overall low levels of financial literacy. They are usually dissatisfied with their present economic condition but highly optimistic about opportunities MLM gains represent.
Behavioral theorists have shown that investment decisions for these strategies are positively influenced by biases such as optimism, confirmation or overconfidence.
A Jamaican study found that investors’ exposure to such investments is driven by a complex interaction of factors related both to gullibility and heightened risk tolerance. They are therefore willing to risk high levels of exposure to such schemes so as not to be left behind.
Although most network marketing firms are operating within the authorized frameworks, a fraction ventures into more hazardous waters — causing a dilemma for policymakers. U.S. authorities uncovered sixty alleged Ponzi schemes last year with a total $3.25 billion in investor funds, the highest amount since around the time of the Great Recession.
By deliberately targeting gullible youngsters thanks to financial independence headlines, claims of scams, frauds and money losses have skyrocketed.
A fire festival
So, what do MLM companies try to achieve? Well, judging from the sales textbook it encourages existing distributors to recruit new distributors who are paid a percentage of their recruits’ sales. But down the line, it isn’t so much about the actual products or services, but rather the emphasis these companies put on the financial independence it can lead to: FIRE.
The up-and-coming fire-movement — standing for Financial Independence and Retire Early — devotes people to extreme forms of money saving. Some even aspire to quit their jobs in their 30’s, or at least have the freedom to achieve a greater work/life balance.
Especially during economic downturns, fire-adherents proclaim their philosophy positions them to be among the most financially prepared to weather the shocks.
Promoted by flashy Instagram posts, financial independence concepts rapidly seduce youth. Surfing on this growing trend, network marketing firms and other online financial advisors (mis)use this slogan to recruit their support base.
In 2018, a famous American Instagram influencer managed to extort over $1.5 million from her followers thanks to a fraudulent checking scheme.
Even listed network businesses have been investigated by regulators over alleged pyramid constructions.
TikTok and other social media platforms have experienced an influx of scammers that use their app to hawk multi-level marketing schemes to part users from their money, mainly minors aged 14 and younger.
Because MLM’s thrive mostly online, the various lockdowns created a golden opportunity to increase their reach. By deliberately targeting mostly gullible youngsters with low levels of financial literacy thanks to financial independence headlines, claims of scams, frauds and money losses have skyrocketed over the past year.
The SEC found that there has been a significant uptick (a 70% jump in Q4 2020 compared to the same period in 2019) in consumer complaints involving investment fraud during the Covid pandemic including Ponzi schemes, fake stock promotions and community-based financial scams.
A similar warning was issued by the UK’s financial watchdog.
As a response social media companies have sharpened their general terms and conditions banning all types of multi-level marketing activities.
While “spending less and saving more” sounds like music to any policy advisor’s ear from a financial education perspective, the way these so-called ‘Instagram traders’ are waving the financial independence card is mostly worrying.
To the extent that consumers can face serious fraud consequences and pose a risk to the wider economic system.
Financial industry players are stepping up to unveil the dangers of MLM activities.
Fintech freedom fighters
An increased level of (attempted) fraud is not unusual during a downturn — the current pandemic is no different.
Complaints data shows that the economic uncertainty has led to a sharp rise in cybercrime, fraud, and money laundering.
Additionally, a study found that around 70 of adults said they believed the pandemic was causing an uptick in fraud attacks.
But more and more MLM’s now focus on selling trading courses and financial assets such as foreign exchange trading, crypto’s or life insurance. With MLM techniques navigating into the financial services industry, the controversy and scrutiny is reaching a whole new level.
Sounds like a toxic cocktail? Probably is.
Financial industry players — both traditional and new — are thankfully stepping up to unveil the dangerous consequences MLM activities can have.
Since 2008, financial institutions have been targeted with regulations intended to safeguard financial systems and customers. But with recent anti-money laundering scandals making headlines, big banks are under a magnifying glass (regulators imposed bigger fines for anti-money laundering failures in the first half of last year than they did in the whole of 2019).
While this usually is bad news for most people it is an opportunity for solutions specialized in financial crime. Financial institutions are massively investing in their compliance innovation and customer due diligence procedures.
Similarly, tracking transactions, connecting data, and leveraging technology is opening new possibilities for fintech players in the fight against scams. Niche fintech providers have seen important funding rounds last year in their mission to automate suspicious activity investigation, use machine learning to spot anomalies in people’s banking transactions, avoid suspicious cryptocurrency exchanges or implement adaptive decisioning methods.
Another reason why financial MLM firms can trick first-time investors, is because trading — any kind of trading — is simply hard. That is why fintech companies have for a few years now disrupted the trading segment, underpinned by the boom of stock trading apps — a trend set to continue in 2021.
With their apps they try to gear amateur traders towards education-focused trading and investing. Some do so by capping and diversifying the number of trades users can do each day, by transferring to thematic-based trading approach, or simply by providing academic trading services to help the everyday Joe trade responsibly.
A combined policy approach will hopefully encourage the joy of missing out on what usually seems too good to be true.
From FOMO to JOMO
Although the multi-level marketing industry has a negative image and is under increasing scrutiny by regulatory agencies, claims that MLM organizations are inherently pyramid schemes and unethical are misplaced. Many are at best, financially risky.
By filling the employment void and praising their financial gains, MLM-ambassadors are exploiting a fear of missing out on a golden opportunity. Unfortunately, they also exploit the already fragile financial situation of many (un)employed — and unaware — citizens around the world.
Even financial market players raise questions about the industry’s realistic longevity. Over the past year analysts and stock brokers progressively distanced themselves from network marketing firms as the aggregate equity of a dozen publicly-traded MLM’s lost over a third of its value.
Authorities are looking at ways to contain the promotion of financial products through social media. However, they have a hard time banning these techniques, as many financial MLM’s do not sell any products but rather focus on recruiting others to the chain.
The EU has recently put forward proposals for new legislation designed to make online platforms more responsible for the content posted on them, while the Financial Action Task Force has taken up modernizing information sharing on global money laundering as a focus for 2021.
To ensure consumers are well prepared to distinguish legitimate financial advice from scams and not be tricked into risky side jobs, both the industry and policymakers need to look at the issue.
· From fintech and finance providers we can expect stronger tools to monitor suspicious activity, and better provision of financially safe (educational) investment applications.
· From policymakers we should expect a better understanding of the risks involved and their rapid dissemination online, as well as further research into the victims. Efforts that increase awareness of past victimization and reduce the stigma of reporting, both formally and informally, will yield positive externalities for consumers-at-large.
Combined, this will hopefully better equip consumers to understand the risks of financial MLM’s, and perhaps, the joy of missing out on what usually seems too good to be true.
