Section 327 of the California Penal Code was one of the earliest state statutes concerning MLM-style pyramid schemes.    The statute prohibits “endless chains”, which are defined as schemes where participants pay for the chance to receive compensation when new participants join the scheme.    Payments based on sales to persons who are not participants (i.e., bona fide retail sales) are not considered illicit “compensation.”  Section 327 imposes criminal penalties (up to three years in prison) for anyone who “contrives, prepares, sets up, proposes or operates” an endless chain scheme.

Section 1689.2 of the California Civil Code provides that any participant in an endless chain scheme can sue to rescind the contract and recover their net losses, plus attorneys fees.

California Penal Code Section 327. Endless chain

Every person who contrives, prepares, sets up, proposes, or operates any endless chain is guilty of a public offense, and is punishable by imprisonment in the county jail not exceeding one year or in state prison for 16 months, two, or three years.  As used in this section, an “endless chain” means any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant. Compensation, as used in this section, does not mean or include payment based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

History: Amended by Stats. 1989, Ch. 436, Sec. 2

California Civil Code Section 1689.2. Party in endless chain scheme

A participant in an endless chain scheme, as defined in Section 327 of the Penal Code, may rescind the contract upon which the scheme is based, and may recover all consideration paid pursuant to the scheme, less any amounts paid or consideration provided to the participant pursuant to the scheme. In addition, the court may, upon motion, award reasonable attorney’s fees to a prevailing plaintiff.

History: Added by Stats. 1989, Ch. 436, Sec. 1.