Spencer M. Reese(1)
I was in St. Louis last April visiting relatives. As any native St. Louisan will tell you,
it is a civic duty to go to at least one Cardinal baseball game if you are in town during a home
series. After all, St. Louis is a baseball town, and to miss a game is akin to denying your
heritage. Not wanting to reject my birthright, I found myself in the bleachers at Busch
Stadium for the first game in a series against Houston. I was anxious to see how the Red
Birds looked as spring training had recently ended and it was time for the players to earn their
diminutive seven figure salaries.
A few minutes before the game started, an old college classmate whom I had not seen
for at least 20 years sat down next to me. It was good to see him and to catch up on old
times. The topic of conversation was as would be expected for people who have not seen one
another for some time - baseball, old friends, baseball, who is doing what, where are they
now, baseball, all standard fare. Then came the seventh inning stretch.
As the teams left the field, my old classmate said to me - "You know, I have always
respected your business judgment. I'm working my own business, and I'd like to run some
ideas by you and get your opinion." I quickly flagged the beer vendor.
"Have you ever heard of multi-level marketing?" he asked. "I'm vaguely familiar with
it" I responded (as I always enjoy hearing distributors pitch companies and their products, this
door wide-open answer has become only slightly less automatic than breathing). He then
broke into a frenetic discourse on the evils of corporate America, job insecurity, and how
anyone who does not own his or her own business is doomed to indentured servitude for the
rest of their lives. But he had the answer.
"This program is unlike all the rest!" he exclaimed. "You buy your products, enroll
people as distributors, and get a commission off of what they buy and sell." "Novel and
provoking concept" I replied. "Yeah, but that's just the tip of the iceberg. You see, in this
program, not only do you get a commission from your downline's purchases, you can also
sign them up to take the company's $500.00 training course. The training is a separate fee,
and you get a commission for each person you train, and also get an override bonus for every
training course sold to your downline through five levels." He then spent the next inning
describing the importance and details of getting people enrolled in the training program.
When he stopped for air, I asked what products or services the company was selling,
as this had not been mentioned (just a minor marketing oversight). "Widgets" he replied.
"Tell me about the widgets, are they any good?" I asked. His response was predictable:
"They're just widgets, don't get hung up on them. I focus on promoting the training
program, not on the widgets, because that is where the money is." You mean you are getting
paid for selling training programs that train people how to sell widgets, but the sale of widgets
is of secondary importance to the sale of training programs?" EXACTLY! he exclaimed, as
though I had just received a divine revelation. I stated that seemed backwards to me. After
all, baseball players don't command mega-buck salaries for their efforts in training camp.
They earn their salaries based on their results during the playing season. "Shouldn't you get
paid based on your sales results rather than your efforts simply to enroll people in a training
program?" I asked. "This isn't baseball - this is multilevel marketing. The training is the
product!" he proclaimed.
How Did this Happen?
Several very visible companies have successfully incorporated training bonus
programs into their plans. They are typically presented as a second compensation structure
dedicated to training. As a result of these few companies' success with training bonus
programs, the MLM industry is seeing a proliferation of training programs overlaid on
traditional marketing plans. I frequently hear clients say - "Well, ABC company does it, and
they are such a big company it must be legal."
This raises a timely topic - what legal problems are associated with override bonuses
on training programs? Training programs have not been the central focus of regulators'
attacks on MLM companies, but that does not mean a training-based compensation plan is
without risks. In the March 1997 permanent injunction that a California court entered against
Destiny Telecomm, the court specifically enjoined Destiny from paying commissions based
on training programs. The injunctions expressly states:
Defendants are hereby permanently restrained and enjoined
from directly or indirectly paying commissions on sales aids,
such as video tapes, flip charts, sales kits, magazines or other
items or materials which can be used to recruit or train
distributors or for the purchase of training classes.
The injunction prohibiting Destiny from paying commissions on sales has largely been
lost by the public because the 1.6 million dollar civil penalty provisions have captured the
media and public attention. Nevertheless, it is a significant aspect of the court's order, and
one which the MLM industry should take note. This is particularly true since, as training-based compensation is becoming increasingly popular, the likelihood that the industry will see
an increase in regulatory action is a very safe bet.
What is the Problem?
So what are the risks associated with training programs? First and foremost,
companies need to recognize that marketing plans must be driven by the sale of products or
services rather than the sale of training programs. Paying commissions based on enrollments
into a training program can easily be viewed as a head-hunting operation that compensates
participants for signing up new participants. This is simply the operation of an illegal
My baseball game experience perfectly illustrates how a training program can turn an
otherwise legitimate MLM program into a pyramid. The emphasis is placed on signing people
up into the training program and not on the sale of widgets to end consumers. A company
can make the best widget in the world, but if its sales force emphasizes enrolling people into
the training program rather than selling the product, the program will come under regulatory
attack as a pyramid.
Commissions should be generated from the sale of goods and services to end
consumers. A common regulatory approach defines "end consumers" as individuals who are
not participants in the company's compensation plan, and who are not purchasing in order to
participate in the compensation plan. What this boils down to is that retail sales, rather than
sales to distributors, must constitute the foundation of an MLM program.(2)
Herein lies a
second dilemma for compensation based training programs. Except in rare circumstances,
the only individuals who will sign up for the training program are the company's own
distributor force. There is simply no reason for someone who is not an ABC distributor to
pay $500.00 to learn how to sell ABC widgets under the ABC marketing plan.
So where are the retail sales? I have heard companies proclaim that their training
programs are so good that any sales person in any industry can use it. They claim that once
word gets out about how good it is, non-distributors will flock to the training sessions. If in
fact such predictions prove to be true, any regulator would be satisfied. If non-distributors
are willing to shell out $500.00 for a superlative sales training course, it clearly has intrinsic
value separate from the compensation structure. But guess what? That is not reality. When
the sales figures are tallied, you will be hard pressed to find any non-ABC company
distributors on the ABC company training program enrollment lists.
Any company that pays out more in commissions based on the sale of training
programs rather than the sale of its goods and services needs to step back and analyze what
it is really selling. If the sales force is emphasizing the training program over the company's
products and services, the company is selling an income opportunity. If this is the case, the
company must refocus its marketing strategy and compensation structure. The emphasis
simply must be on the sale of products and services to the end user rather than the sale of
Some companies emphasize to their distributors that if they want to learn how to
manage and operate their independent business, they must enroll in the "optional" training
program. In reality, this is the only way for distributors to learn the program because
companies taking this approach often lack a policy requiring upline distributors to work with
their downline. This is a mistake, for if upline distributors take no role in managing and
training their respective sales organizations, the risk that the program will be scrutinized as
a security or lottery are greatly increased. If they do not work with their downline
organizations, the upline are receiving income primarily from the efforts of others, or as a
matter of simple luck. These are the cornerstone elements of a finding that a program
constitutes an unregistered security or an illegal lottery. It is therefore critical that a training
program does not usurp the training and management functions that should be performed by
My classmate was correct when he said baseball is different from multilevel marketing.
In baseball it's three strikes and out. In MLM, one strike can get the company fined and
ejected from the game. Therefore, companies must remember that they are in the business
of selling goods and services to end consumers, not training programs. If the company insists
on implementing a training bonus program, the products and services simply must be the star
of the team. Training bonuses, on the other hand, should at the very most play the role of a
1. Spencer Reese is a partner in the law firm of Grimes & Reese. He is a graduate of the
Washington University School of Law and is a member of the Idaho, Missouri and Colorado
bars. He was formerly in-house counsel for Melaleuca, Inc., a multilevel marketing company
with sales in excess of $260 million. Mr. Reese's current practice includes representing and
advising multilevel marketing companies on all aspects of their business, including consumer
protection, advertising law, litigation, contracts, marketing plan design, regulatory
compliance, trademark law, FDA law, policy development and distributor compliance.
Grimes & Reese is a supplier-member to the Direct Selling Association and the Professional
Association of Network Marketers. Visit the firm's website at www.mlmlaw.com. Mr.
Reese can be contacted at (208) 522-2600.
2. The retail sales debate is fiercely contested between regulatory authorities and MLM
industry members. Most regulators recognize that while retail sales must drive the program,
some degree of personal consumption by distributors is appropriate. The acceptable personal
consumption levels, however, are often arbitrarily established and are typically far less than
what most companies believe is necessary to protect against inventory loading.
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