LuLaRoe Lawsuit: Pyramid Scheme

If you’ve ever done any research about network marketing companies or multilevel marketing companies, you’ve surely come across the phrase “pyramid scheme.” Pyramid schemes are illegal in the United States, while true network marketing and multilevel marketing companies are legal.

What’s the difference?

In a multilevel marketing or network marketing plan, those who sell or promote the company must sell a product. In a pyramid scheme, the individual earns money just for bringing someone else into the program. There is no requirement that they sell.

CaseBerry, Hayton, & Scheffer v. LuLaRoe, United States District Court, Central District of California, Case Number: 5:17-cv-02176.

Who should pay attention to this case?: All LuLaRoe retailers who signed on 2013 and later, former and current.

Case allegations:  LuLaRoe is an endless chain scheme in violation of California law, several counts of RICO (Racketeer Influenced and Corrupt Organizations – This is a federal statute which focuses on all aspects of a business system to include wire and mail fraud and alleges that there was an unlawful criminal enterprise), Unfair and Deceptive Practices, and False Advertising.

Pyramid schemes are “[s]uch contrivances. . . 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 sale of the product to ultimate users.”

The satisfaction of the second element of the Koscot test is the sine qua non of a pyramid scheme: “As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.”

Is LuLaRoe a pyramid scheme?

Short answer: Possibly, at least initially.

The question that must be answered is how Retailers make money. Retailers earn money in two ways: Selling the clothing they purchase from LuLaRoe and bonuses based on their downlines.

Until 2017, the bonus plan for LuLaRoe Retailers was based on the purchases made by the Retailer’s downline, not their product sales. A Sponsor could earn 5% of their personally sponsored Retailer’s orders as long as they also ordered 175 pieces. A Trainer could earn that plus 3% of their downlines’ downlines as long as they ordered 250 pieces per month. Coaches and Mentors had different plans, but all were based on Retailer purchases, not sales.

Obviously this scheme works out well for LuLaRoe. From the top down, Retailers were pushing other Retailers to place orders with LuLaRoe, whether they’re selling it or not. Requiring uplines to purchase to earn a bonus ensures that LuLaRoe will continue to profit off their enterprise. It matters not at all to them that the product actually sells. Team leaders were using incentives like iPads and designer handbags to encourage their downlines to buy more and more inventory. Not only that, LuLaRoe leadership pushed that in order to be successful, Retailers had to have the latest prints.

Someone must have notified LuLaRoe that they were running a pyramid scheme, so all Retailers were notified that the compensation plan would change in 2017. Rather than achieving bonuses based on orders placed with the company, they would earn bonuses based on the sales of their sponsees, as long as they sold a certain number of pieces with an average price per item of $30.

LuLaRoe tried to paint themselves as benevolent by stating that they would start paying based on the new compensation plan right away, even thought it would essentially amount to a double bonus because Retailers had already been paid a bonus based on orders. What they didn’t say is that they basically had to or they’d be admitting to having operated a pyramid scheme.

The compensation plan represented a massive shift in how Retailers are compensated. Making money became more difficult as Retailers now could only earn bonuses when products sold. Some Sponsors were no longer even Sponsors because LuLaRoe changed the qualifying threshold for Sponsorship – Retailers had to have at least 10 Pop-ups and $10,000 in retail sales before they could earn bonuses as a Sponsor.

The change in the compensation plan also affected how Retailers priced their products. LuLaRoe already had a requirement in place that prohibited Retailers from advertising below their Minimum Advertised Price, but Retailers were still free to choose their prices. Requiring an average product price of $30 meant Retailers had to either change what they carry or stick to the Minimum Advertised Price.

Why is that? Let’s look at a Retailer who focuses on leggings and tops – the heart of the LuLaRoe business. The Minimum Advertised Price for adult leggings is $25 and for most of their classic tops is $35. If sold together all the time, the pair average is $30. But what if people are buying one top and several pairs of leggings to match each top? The Retailer isn’t hitting that $30 average. Regardless how you look at it, LuLaRoe positioned themselves to continue earning large sums of money while their Retailers are left to fight each other. This is exactly the kind of thing the laws are designed to prevent.