Financial Times

Making fraud legal

By Robert L. FitzPatrick President, Pyramid Scheme Alert, US

The big bad word that is normally reserved for illegal pyramid schemes – COLLAPSE – is now referenced daily in discussions about our stock and credit markets. How could legitimate and regulated markets that are watched over by the Securities & Exchange Commission (SEC) "collapse"? Isn't the whole idea of federal regulation to prevent such a disaster? Isn't the SEC supposed to stop irresponsible or fraudulent activities that cause collapse?

If these markets really were on the brink of collapse before the federal bailout, does it mean that there are fundamental similarities between our securities markets on Wall Street that sell credit, stocks, bonds and insurance and the pyramid schemes running rampant in neighborhoods and churches that sell fruit juice, soap, and the "opportunity of a lifetime"?

There are more similarities than most people realize. Pyramid selling schemes are Main Street's own version of "Wall Street Greed." One major similarity is the effort of promoters in both fields to get fraudulent business practices legalized. Both pour millions of dollars into lobbying politicians in state legislatures. Both maintain Washington DC offices working everyday to change federal laws so they can do what many states and current federal laws and policies declare are illegal. And both – multi-level marketing, and Wall Street – have been successful in legalizing fraud or at least in preventing anti-fraud laws, written to protect the public, from being enforced.

CBS 60 Minutes recently revealed that the actual culprit behind the debacle was not the real estate decline. That was only a spark. Unknown to nearly all of us, was a multi-trillion dollar market for "derivatives" and "credit default swaps". These were "side bets" taken by huge financial institutions, using shareholder and depositor money, on the fate of the real estate market. They could place bets with pennies on the dollar. Companies could sell and buy "swaps," which were actually insurance, without having the money to pay off if the market went down. And this swap and derivative market was so big and profitable that it siphoned billions into the hands of financial industry leaders in bonuses and pay. Then when the market went down, some made billions more on their bets. Others lost, and that's when taxpayer money was suddenly needed to cover their bad bets.

Here's the thing. 60 Minutes reported that this derivative and swap market – that caused the "collapse" – used to be illegal! In fact, these same types of "bets" had caused a financial "collapse" in 1907. That disaster resulted in state and federal laws being enacted to outlaw these dangerous bets. But in the 1990s, the financial community lobbied to get them unregulated, to make the fraud legal. In 2000, they finally got a new law passed. It was called Commodity Futures Modernization Act of 2000.

Ever heard of it? Probably not. The law passed almost in secret in 2000 on the very last day of Congress before a new president took office. It was the last vote of the session. There never was a public hearing and the Senate passed it by "unanimous consent." One of its worst aspects was the infamous "Enron Loophole" that allowed unregulated energy trades. The "collapse" of Enron was only a precursor of what was to come as the result of what this law legalized.

With the new law, Wall Street went wild, as did Enron. Now, Enron is bankrupt, with top officials in jail. Thousands of shareholders and employees lost their life savings. Our stock market has subsequently dropped nearly 30%. We are now in a Recession. Uemployment and home foreclosures are at record highs. Such are the consequences of legalizing fraudulent business practices.

The parallel in multi-level marketing to the "derivatives and swaps" is the selling of the "endless chain" to lure investors and sell products. This type of scheme will always cause 90-99% of consumers to lose money. The endless chain is a classic fraud. It cannot fulfill its promise. It causes either total or continuous "collapse" in which consumers that are the "last ones in" lose their money. In "continuous collapse," 60-80% of the latest investors lose their money each year. However, the scheme is allowed to replace them and repeat the cycle over and over again.

By allowing the endless chain schemes to continue and to recruit replacements, the government effectively "bails out" the scam year after year. Without being able to recruit replacements, the scheme would totally collapse. Lack of law enforcement gives the scams the appearance of legality and viability and convinces consumers that the schemes must be viable income opportunities and those that fail really are just "losers."

While the MLM industry, unlike the financial industry, did not get its special "legalization" passed in Congress, it did get something almost as good. It muzzled law enforcement. In 2001, when President Bush was elected, after receiving millions in contributions from MLM, he appointed the attorney, Timothy Muris, as head of the FTC. Muris worked for a law firm that represented Amway. Immediately, investigations and prosecutions of MLM's stopped at the FTC.

"Collapse" could then continue among the millions of consumers who were lured by the false promises of "unlimited" income and were told the profitable expansion of salespeople was "endless."

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