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The Federal Trade Commission has updated its online advertising disclosure guidelines to reiterate that just because the media are new or rapidly changing does not mean that the law and FTC regulations do not apply. “.com Disclosures: How to Make Effective Disclosures in Digital Advertising,” makes it clear that online advertising, whether desktop or mobile, large screen or small, must include “clear and conspicuous” disclosures, regardless of the space allotted by the medium.
The new guidelines explain the benchmark succinctly: if an advertisement without a disclosure would be deceptive or unfair, or would otherwise violate an FTC rule, and the disclosure cannot be made “clearly and conspicuously” regardless of the device or the platform, you should not run the ad.
So your company has great products (or services). You’ve searched for the best of the best and you regularly lay out a significant chunk of change for R&D and inventory. You take great pride in what you offer and try to take the message to the sales force about the benefits of your products. To you, the benefits and value are obvious. But is this why your distributors buy the products? This seemingly simple question has considerable ramifications from both marketing and legal perspectives.
Unfortunately, the product message can be overwhelmed by the hoopla and hype surrounding the riches that will flow from being a distributor (I use the phrase “hoopla and hype,” but feel free to insert your favorite colorful phrase of choice!). If the real message is that one should purchase the products because they are the gateway to participating in the compensation plan, then what is actually being “sold” is the income opportunity rather than a bona fide product or service. The truth is, if people are really buying the products simply to access the compensation plan, you would be better off saving your money and selling “pixie dust” rather than spending a fortune on product development and inventory.
Of course, the reality is that most direct selling businesses offer high-quality merchandise that confers excellent consumer benefits. However, their compensation plans are designed so distributors’ monthly auto-ship orders satisfy distributors’ personal volume quotas, thereby keeping them “active” in the compensation plan for the month. Therefore, the products serve dual purposes by: (1) providing superior product benefits; and (2) protecting compensation plan qualification. But as indicated, the first of these benefits can become overwhelmed by the hype surrounding the compensation plan. If the real sales pitch is about earning riches, the product purchases are vulnerable to attack as “participation fees” incidental to earning compensation. The Federal Trade Commission expressed this position in its 2004 Staff Advisory Opinion – Pyramid Scheme Analysis by stating:
The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.
In the FTC’s recent case against Fortune Hi-Tech Marketing, Inc., the FTC argues that the defendant’s products were simply a proxy for participating in the company’s compensation plan. In the Commission’s Memorandum in Support of its Ex Parte Motion for a Temporary Restraining order with Asset Freeze, Appointment of a Receiver, Other Equitable Relief, and an Order to Show Cause Why a Preliminary Injunction Should Not Issue (wow – what a mouthful!!!), in reference to the defendant’s product and service package bundles, the FTC states: “It is very unlikely that representatives would ever purchase any of these products and services except to remain “qualified” for recruitment bonuses.”
This returns us to the original question: “Why are your distributors buying your products?” The answer of course, is that there are usually multiple reasons. History teaches us that distributors oftentimes focus on the money that can be made under a compensation plan as their primary recruiting and selling mechanism. If the product purchases are presented as the means to accessing or remaining active in the compensation plan, the FTC will use this as evidence that the product purchases are primarily participation fees and not bona fide product sales to end-user consumers.
If the FTC wants to bring an action against your company alleging it is a pyramid scheme, this analysis will form one of the cornerstones of its argument. The message to you as corporate executives is that you must ensure that the financial message does not become the principal selling point behind your products. Rather, the product features, benefits and/or value must be the primary reason why distributors buy your products. This of course leads back to offering products with great quality and value, and of course effective non-financial marketing techniques.
Some of you may have heard of the recent enforcement action taken by the Montana Securities Commissioner against a start-up MLM program known as “Funky Shark”. Funky Shark was a penny auction MLM program based in Bozeman, Montana that began operations in the Fall of 2012, but never actually launched its auction website before being shut down.
In an effort to raise capital to support the launch of the new venture, the company recruited distributors to participate in its Founders Program. In exchange for a non-refundable payment of $1,000, “Founders” were entitled to receive a share of the profits generated by the company’s penny auction program. In addition, they earned bonuses for every new distributor that they recruited.
Before Funky Shark could launch its penny auction website, the Montana Securities Commissioner filed a lawsuit against it and its owners and obtained a Temporary Restraining Order (“TRO”).
Yes, you just may have to—and in states other than where your business is located.
Most entrepreneurs and business people understand that if they have a business location, employees, or business assets or property in a state, they will be required to collect sales taxes on the sales made to the residents of that state—provided the product or service that they are selling is subject to sales tax. Unfortunately, there seems to be a rather pervasive belief among new-comers to the direct selling industry that direct selling companies do not need to collect and remit sales taxes in those states in which they have no business locations, employees, assets or property, but are doing business through their distributors. At least half of the new start-up direct selling companies that we meet with seem to be under this mistaken impression.