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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.
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.
The Federal Trade Commission has announced two proposed settlements that will conclude their sweep against online marketers that allegedly used fake news sites to promote weight-loss products.
The two settlements, one with Beony International and owner Mario Milanovic and one with Beony International employee Cody Adams, each impose a $13 million judgment. However, that will be suspended when the defendants pay more $1.6 million and sell a 2008 Porsche. However, if the financial information the defendants provided is later determined to have been false, the full amount of the judgments will be imposed.
The Federal Trade Commission has upheld an Administrative Law Judge’s May 2012 decision that the marketers of POM Wonderful Pomegranate Juice and POMx supplements deceptively advertised their products as being able to would treat, prevent, or reduce the risk of heart disease, prostate cancer and other conditions.
Spencer Reese will present on key legal elements for network marketers at the February 21-22 Direct Selling Symposium in Salt Lake City. Learn how to run your network marketing business legally and ethically.
PUH, which markets products under the brand names Pharmacists Ultimate Health and Doctor’s Natural Therapy, and its president, Stephen J. Poindexter, have entered into a consent decree of permanent injunction sought by the Food and Drug Administration for allegedly distributing unapproved new drugs and adulterated dietary supplements.
Circa Direct LLC and Andrew Davidson will pay more than $2 million to settle the FTC complaint charging them with deceptive advertising by operating fake news websites to promote acai berry weight loss products. This follows September’s $1 million settlement with the Coleadium, Inc. affiliate network, also known as “Ads4Dough,” and its owner will pay $1 million to settle a similar FTC complaint.