CLERK, U.S. DISTRICT COURT
DEC – 6 2002
CENTRAL DISTRICT OF CALIFORNIA
BY _____ DEPUTY
JOHN D. JACOBS, Cal. Bar #134154
JENNIFER M. BRENNAN
Federal Trade Commission
10877 Wilshire Blvd., Ste. 700
Los Angeles, CA 90024
(310) 824-4343 (voice)
(310) 824-4380 (fax)
Attorneys for Plaintiff FTC
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF CALIFORNIA
Case No. 02-9270
DECLARATION OF FTC’S EXPERT WITNESS PETER J. VANDER NAT IN SUPPORT OF PLAINTIFF’S EX PARTE APPLICATION FOR TRO AND OTHER EQUITABLE RELIEF
FEDERAL TRADE COMMISSION,
TREK ALLIANCE, INC., et al.,
ENTERED ON ICMS
DEC 20 2002
DECLARATION OF DR. PETER J. VANDER NAT
Pursuant to 28 U.S.C. Section 1746
- My name is Dr. Peter J. Vander Nat, Ph.D. I have a doctoral degree in economics from the University of Notre Dame. I am an economist employed by the Federal Trade Commission, and for approximately fourteen years I have advised the Commission on consumer protection matters. A true and correct copy of my resume is attached (Exhibit 1). Prior to this matter, I have served as the Commission’s expert witness in a number of pyramid scheme matters. Over the last three years, I have testified in federal district court regarding three pyramid cases: FTC v. Equinox International Corp. (CV-S-99-0969-JBR (RLH)) (D.NV); FTC v. Five-Star Auto Club (99-CV-1693 (CM) (S.D. NY); and FTC v. SkyBiz.Com, Inc. (01-CV-0396-EA (X)) (N.D. OK). In each of these matters I testified that the ostensible business opportunity was a pyramid scheme.
- In preparing my declaration on Trek Alliance, Inc. (“Trek” or “the company”), I have examined a variety of materials. These include Internet materials that explain the company’s program; the Trek Pay Plan; the company’s Policies and Procedures; a number of Trek Revenue Disclosure Statements; transcripts of sales presentations and training seminars given by company representatives; declarations from former Trek distributors; and certain company business records received by way of the State of Maryland.
- This declaration has three parts. In the first part, I summarize my conclusions regarding Trek Alliance. In the second part, I describe in general terms the main elements of a pyramid scheme, including the considerable harm caused by such schemes. In the third part, I apply the criteria regarding pyramid schemes to Trek and I give the analysis on which my conclusions are based. There are also vigorous appendices, including one regarding the mathematics of pyramids.
Part I: Summary of Conclusions
- Trek Alliance presents itself as a multi-level marketing program (MLM) by which its distributors can obtain substantial earnings. In the company’s Policies and Procedures, Trek emphasizes the role of retail sales and states:
Trek’s sales and marketing program is based upon retail sales to the ultimate consumer. Every aspects of the program is designed to assist our Independent Representatives in the marketing of fine products and services to the general consuming public.
In reality, retail sales do not play any significant role in Trek’s program. Although the company has certain rules regarding retail requirements (the “6 retail sales rule” and “70% rule” explained below), it is very likely that Trek does not enforce these rules; moreover, even if they were enforced, these rules would not lead to any significant retail sales. I believe the level of retail activity is exemplified by certain data received from the State of Maryland which show that, relative to all Trek product sold in Maryland (approximately $1.8 million in total), recorded retail sales to the general public amounted to less than 2%. For reasons explained below, retail activity (whether in Maryland or in another state) is not likely to be significantly greater than the amount for which Trek has records.
- Instead of an emphasis on retailing, Trek gives its distributors a Pay Plan under which the various positions and the related earnings hinge critically on the ongoing recruitment of new distributors. Under several optimal scenarios in which the distributors do exactly what is needed to obtain the rewards proposed by the Pay Plan, approximately 98.8% to 99.6% fail to achieve any earnings. These results come from the very structure of the Pay Plan. It is also shown from earnings data that the vast majority of distributors do not, in fact, obtain any earnings from the Pay Plan. And for the majority of distributors who do not obtain some earnings, approximately 90% of these do not receive sufficient earnings from the Pay Plan to recoup regular monthly business expenses that they incur in actively pursuing Trek’s program.
- I have considered a base of some 22,281 Trek distributors (since inception, all those who joined by the close of year 2001). Upon applying conservative assumptions about business expenses and upon also including all who had earned nothing from the Pay Plan, I estimate that in all likelihood more than 96% of Trek distributors experienced business failure. For those who joined during 2001 (nearly 6,100 distributors), I estimate that more than 99% experienced failure. From all of the above considerations, I conclude Trek Alliance is a pyramid scheme.
Part II: The General Elements of a Pyramid Scheme
- In generic form, a pyramid scheme is an organization in which the members obtain their monetary benefits primarily from the recruitment of new members rather than selling goods and services to the public. The main benefit of membership is the right to recruit others and to receive monetary compensation for doing so. The program may involve the sale/purchase of certain goods or services to the public or to the members of the organization. Frequently, the members themselves may consume some product or service that the organization offers. These may range from items that are commonly available and frequently purchased -such as everyday household items, nutritional supplements, personal care products- to items new to the market such as internet access devices for television sets. Sometimes, the product or service may be consumed independently from recruitment; other times the good or service can only be received in direct connection with the recruitment of others. But whatever the particular details, in compari-son to alternative ways of obtaining the product or service, the benefits from the organization’s provision of the product or service range from small to none; at the same time, people obtain most of the monetary benefits of membership by recruiting others into the organization.
- A pyramid scheme in its most extreme form is one in which there is no product or service. The organization is essentially a chain letter that is funded entirely by ongoing membership payments. People are motivated to join and to make the required payments because they are promised a certain part of the payments by those who join later on. If enough people continue to join, a given member could recoup his or her initial payment (or the ongoing monthly payments) and also generate additional returns. Of course, it is this latter circumstance that all members are hoping to attain. But the required numbers of new members cannot, in fact, be recruited on a perpetual basis; hence, at some point the scheme collapses.
- The particular formula that compensates people for obtaining new recruits may vary from one pyramid scheme to another, but all have a common thread. Some type of “downline” with an associated compensation schedule is established for all members. As new recruits are drawn into the organization and are placed into various downlines, those who are already members generally move to higher levels where they may qualify for greater compensation. Like any chain letter, a pyramid scheme is just a mechanism to transfer funds from one person to another. Those at lower levels of the organization pay certain amounts to those at higher levels. As noted earlier, a person is motivated to make these payments in the hope of making a profit later on. Oftentimes, the compensation schedule reveals that a given participant must generate a certain number of recruits in order to recoup -by receiving a cut of the new membership fees- the person’s own membership payment(s). As the recruits do their own recruiting in turn, a given person may be fortunate enough that his or her downline is filled with growing numbers of people, and the total compensation received might go well beyond the person’s own membership payment(s). In contrast, there is a clear down side as well: the lower one’s level in the structure, the less is the compensation. Although it may seem obvious to say so, there is always some set of people at or near the bottom. As explained further below, over time these levels have magnitudes that grow very rapidly and, in fact, comprise the vast majority of the participants. Also, those at or near the bottom inevitably lose their money.
- The harm caused by a pyramid scheme may be summed up as follows: since most of the proposed rewards are tied to recruitment, a situation is created in which the monetary benefits set forth by the company cannot come true for the vast majority of participants (while all members pay money for the ostensible benefits of membership). The benefits are premised on the ongoing ability to recruit new members, while this premise is always false. Growth is limited by the fact that the number of people willing and able to invest in any given business venture are fewer in number than the general population. Also, regardless of the definition of “general population” (i.e. region, country, or international domain), the population remains finite; thus, at some point, new recruitment possibilities cease. Yet, for as long as a successful recruitment pattern is maintained, the number of people who are near the base of the pyramid often grows at an exponential rate, and the people who are at or near the base usually comprise the vast majority of the participants. (The names of those who are at or near the bottom will change, but the relative proportion of people at or near the bottom does not change for as long as a successful recruitment pattern is maintained). Eventually, when new enrollment stops, the people at or near the base of the pyramid cannot qualify for the rewards precisely because their downlines are either empty or have insufficient numbers of recruits.
 I refer to respective optimal scenarios for becoming either a Bronze Director or a Bronze Coordinator (as Trek defines these positions in the Pay Plan). These positions are among the lower bonus positions that Trek describes as being at the heart of the compensation plan.
 These data come from the State of Maryland and also from nation-wide Trek distributor earnings that are derivable from company materials.
 This feature describes one important type of compensation plan; another type of compensation (discussed below) hinges on “sales volume” that is generated in the act of recruitment.