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Network marketing is in the midst of a rapidly advancing Orwellian era. It’s been slow to develop, starting in 1996 when the Ninth Circuit Court of Appeals issued its decision in Webster v. Omnitrition, but it’s snowballed in the past two years. Today the snowball grew exponentially with the announcement that the Federal Trade Commission and Herbalife have reached a settlement agreement.
Watch for detailed updates and analysis on the settlement. We’ll break it down into many little pieces to determine how it will impact your business. But today we just have time for a broad sweep so I’m just going to address some critical topics.
The obvious first question is: “Does this settlement affect my business?” It’s certainly an important question. After all, the FTC was investigating Herbalife and analyzing Herbalife’s program, so why should it apply to any other company? The answer is two-fold. There’s the technically correct answer, and the real-world practical answer. The technically correct answer is that the FTC settlement with Herbalife has no binding impact on any other network marketing business. The real-world answer is quite different. The changes that Herbalife must implement offer a clear roadmap to the standards that the FTC expects all direct sellers to conform, and those are the standards that it will pursue in future cases against direct sellers.
There’s no law that requires direct selling companies to adhere to all of requirements in the Herbalife settlement. But those who stick their head in the sand and ignore the messages in the Herbalife settlement agreement do so at great peril. By now you’re certainly wondering what the settlement agreement requires. Here’s a high level summary of the most critical issues that will impact every network marketing program:
I went to a Grateful Dead concert in 1976. The band was at the height of cool at the time as they represented the counter-culture movement from the Haight-Ashbury district of San Francisco. Although I had been to a number of concerts before seeing the Dead, this concert was different because it was the first (and to this day the only) concert where I witnessed security personnel hauling stoned audience members out throughout the show like it was a revolving door, and I saw medical personnel take at least six overdosed people out on stretchers.
This was obviously a common occurrence at Dead concerts. I vividly recall that right after their first number (Truckin’), Jerry Garcia (lead singer for those of you not old enough to have a touch of grey) announced “Hey people, have a great time, but don’t do any stupid sh**!” Such profound wisdom in such a simple statement!
I don’t think Jerry Garcia’s admonition resonated with the audience that night (shocking, right?), but it should resonate loudly with direct sellers. I look back on the FTC’s last four pyramid actions, Vemma, Fortune Hi-Tech, Burnlounge and Trek Alliance, and in each case we can point to stupid things that that landed the defendants in the FTC’s cross-hairs. We can (and will) closely analyze compensation plans, compliance and marketing nuances that the FTC charges render MLMs pyramid schemes. But there’s a place for analysis, and a place for common sense. Let’s put common sense first, because it’s unquestionably the first and best defense against finding your business in the line of regulatory fire.
The U.S. District Court in Arizona just released its order on the Vemma TRO/asset freeze and receivership. Here’s the quick summary, but the analysis has many angles and moving parts that invite much analysis and interpretation.
- The Temporary Restraining Order. The court found that there is a substantial likelihood that Vemma was running a pyramid scheme. However, the court also found that there were parts of Vemma’s business that were being operated legitimately. Therefore, the court amended the TRO and allowed Vemma to continue to operate those parts of its business that were being run legitimately, but enjoined Vemma from engaging in those practices that it viewed as illegal. As it relates to Vemma’s sales and compensation program, the court enjoined Vemma from incentivizing distributors to buy products to become eligible, or maintain eligibility, for compensation rather than for resale or personal use. (Emphasis added – this is HUGE!). This is seemingly contradicted by another statement in which the court prohibits Vemma from paying compensation related to the sale of products unless the majority of compensation is derived from sales to buyers who are not members of the Marketing Program. (Emphasis added).
- Vemma remains enjoined from paying commissions on the sale of Affiliate Packs and on the sale of products to distributors if such sales accumulate sales volume that qualifies the purchasing distributor for compensation. This provision directly impacts Vemma’s autoship program; we will analyze this in much greater detail in upcoming analyses.
- The Asset Freeze. Vemma’s assets and the personal assets of the defendants are unfrozen. The court found that the FTC did not present sufficient evidence that the assets were at risk of being dissipated.
- The Receivership. The court found that because Vemma is prohibited from engaging in illegal practices, it was unnecessary to have the business run by the receiver. However, the court recognized that Vemma had engaged in numerous illegal actions, so it re-cast the receiver as a court appointed monitor to oversee the defendants’ management and operation of the business. This is a significant step as it puts Vemma’s management back in charge of the company. Of course, the problem is that the company is a mere shell of its former self since the receiver fired most of its employees.
We’re expecting the court’s decision today in the Vemma action on whether the Federal Trade Commission’s temporary restraining order will be lifted, modified, or remain in place in the form of an injunction. There are MANY lessons to be learned from the FTC’s action, and we will be addressing them one-by-one in the coming weeks, so stay tuned. (Note: The order from the hearing is here.)
But as we wait for the immediate outcome, one thing of which we can be certain is that if the court completely lifts the TRO (highly unlikely), Vemma as we know it is done. The FTC’s favorite receiver did such a hatchet-job on the company that he killed it long before Vemma saw the light of the court room. Employees were dismissed within days after the raid, and while Vemma certainly had a cadre of loyal distributors, many more have departed given the specter of the FTC’s action.
Every network marketing company, whether MLM, party plan or hybrid, is fine-tuning their marketing strategy trying to crack the magic nut that is social media. Whether it’s posting a polished Facebook Fan Page or an ad hoc tweet, everyone is getting into the act. But it’s independent distributors who are leading the charge; they have adapted it as their favored communication medium to broadcast their message.
Social media is indeed a communications phenomenon, and there’s simply no stopping it. Unquestionably it can quickly create the much desired “buzz” that every company desires. But direct sellers MUST understand that they are responsible for all the social chatter that goes on. The FTC has made it clear in its testimonials and endorsements guidelines that it will hold a business responsible for statements and representations made by anyone with a “material connection” to a company. Guess what – your distributors definitely have a material connection to your company, and you are responsible for what they are saying!
In January the FTC is filed a lawsuit against Fortune HiTech Marketing (FHTM) alleging that it is a pyramid scheme and that it engaged in false and deceptive practices. As evidence against FHTM, the FTC presented statements and presentations that FHTM’s independent distributors posted on social networks. Among the posts cited by the FTC are:
- A tweet wherein an FHTM distributor allegedly states: “bring ur friends & learn how 2 make $100K a YR.”
- Photos of a check presentation ceremony;
- Distributor photo’s of their commission checks;
- A top-level FHTM distributor claimed on Twitter that he made more than $5 million through FHTM.
It’s very clear that the FTC is monitoring and gathering evidence from social media outlets, and direct sellers MUST take this message to heart. Understand that social media is indeed a communications phenomenon, but you must not let it go unchecked. Your company is responsible for the statements that your sales force posts, so be clear with your field about the rules they must follow. But that’s not enough. In addition, as part of your regular compliance efforts it’s critical that also actively monitor social media posts made by your sales force and take proper measures when improper posts are discovered. After all, the FTC is watching …
For years Montana has required that multilevel distribution companies (MLMs) submit an annual filing with the Securities Division of the Montana State Auditor’s office. The filing was a “notice” filing that provided Montana with the information it felt it needed to identify persons and entities operating MLM businesses in Montana, and further gave the state the tools it believed necessary to investigate MLMs that it believed were problematic.
This May Montana revised its filing statute. It is no longer just a “notice” filing. Rather, Montana law now provides that it is “unlawful” to conduct an MLM business in Montana unless the business files an annual registration. However, there is one very notable exception to the new law; businesses that are members of the Direct Selling Association (DSA) are exempt from registering.
The new statute provides that the Securities Department will provide a form that shall be used for filing. I spoke with Lynn Egan, Montana’s Deputy Commissioner of Securities, and she indicated that they were working on a form that should be available in approximately the middle of June. Once it is available, the state will provide it to those companies that have filed their annual notices. In the meantime, Ms. Egan said MLM companies should continue to use the existing form (Form MLD-1).
All direct selling companies should take this registration requirement to heart. In the past Montana has been serious about its notice filing obligations. The new law has more teeth, so all direct sellers that utilize a multilevel compensation plan should ensure to submit their annual registration to Montana.
Various bloggers and analysts were abuzz last week reporting that Fortune HiTech Marketing (“FHTM”), which is being sued as an illegal pyramid scheme by the Federal Trade Commission and the states of North Carolina, Illinois, and Kentucky, was successful in its motion to have the case moved from the U.S. District Court in Illinois to the U.S. District Court in Kentucky. This may not seem like a big deal. After all, the case was not dismissed; it was just moved from one federal court to another. But in this situation it is a big deal, and it’s good for FHTM.
Since 1996 the FTC has claimed that MLM compensation must be derived from sales to retail customers rather than sales to the company’s own distributors. That position stems from a case decided by the Ninth Circuit Court of Appeals called Webster vs. Omnitrition. (Note that the FTC argues this position before the courts, but when talking to industry stake-holders, it does not assert such a firm position). In response to the Omnitrition decision, some states have enacted MLM laws that make it clear that an MLM company’s sales to its own distributors, and the payment of commissions on those sales, can indeed be legitimate sales to end-users.
Illinois is not one of the states that specifically identifies sales to an MLM company’s sales force as a proper basis for paying compensation. However, Kentucky law does specifically recognize that sales to a company’s distributors can be a proper source for paying compensation, and is contrary to the FTC’s interpretation of the Omnitrition case. This contrast in state law makes Kentucky a much more favorable forum for FHTM than Illinois.
The FTC will certainly argue that no state law applies in its case against FHTM. Rather, it will claim that prior decisions rendered by the Federal courts govern. The Commission must take this position because the foundation of its go-to expert witness’ opinion relies on the position that all sales to a company’s own sales force do not qualify as bona fide product sales to end-users. But now that the case is in Kentucky, even though it is in a Federal Court rather than a Kentucky State Court, the Court may be more receptive to an argument supported by Kentucky law that the company’s sales to its own sales force can indeed be classified as bona fide end-user sales and not a disguised head-hunting or participation fee. If the Court does take this approach, either wholly or in part, it will undermine the foundation of the FTC’s expert witness’ analysis and make it more difficult for the FTC to prove its case.
Consequently, the order granting FHTM’s change of venue request may have an impact that is far more significant than simply shuffling the case from one federal court to another. An interesting point is that neither the briefs filed by the FTC nor by FHTM point out the impact of Kentucky law. They fail to do so because whether one state’s law is better than another for a party is not a proper consideration in a motion to change venue, so the court would not have considered it had the issue been raised. But rest assured – both sides recognized the significance of moving the case to Kentucky.
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.
Should company owners and managers hold genealogy positions? Here are seven reasons why it may not be wise:
- The financial benefit for owners to hold a genealogy position is a fallacy.
- Owners holding genealogy positions can inhibit an IPO.
- Minority shareholder rights may be violated.
- You may be unwittingly selling a security.
- Ownership of genealogy positions by owners can lead to an inequitable distribution of income.
- Ownership of genealogy positions can lead to conflicts of interest.
- Termination of a business relationship is made more difficult if management holds a genealogy position.
But the challenges associated with management holding a position in the genealogy can be overcome with proper planning and execution.
So if you are starting an MLM and are considering taking a position in the genealogy, read the latest addition to our MLM Startup Series that discusses these points and how to cope with them in more detail.
Just over a year ago, Avon Products suspended four executives as the company investigated questionable payments to officials in various international markets. Last week, Avon disclosed in a Securities and Exchange Commission filing that it had fired four executives accused of paying bribes to Chinese government employees and was continuing to investigate possible corruptions in other countries.
The fired executives were the former general manager for China; the former head of corporate affairs for China; the former head of finance for China; and the former head of global internal audit and security, who was previously head of finance for the Asia Pacific region.
According to Avon’s May 3, 2011, 10-Q filing, the internal investigation reviewed various expenses and books and records processes, including, “travel, entertainment, gifts, use of third party vendors and consultants and related due diligence, joint ventures and acquisitions, and payments to third-party agents and others, in connection with our business dealings, directly or indirectly, with foreign governments and their employees.”
The filing said the internal investigation is continuing and could result in additional “personnel actions.” In addition, Avon said that continues to develop and enhance its U.S. Foreign Corrupt Practices Act compliance-related training, FCPA third party due diligence program and other compliance-related resources.