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After what seems like an eternity, the FTC has issued guidance to multilevel marketing (MLM) companies. As guidance, the document issued on January 4, 2018 does not carry the force of law, but is instead intended to help MLMs to “apply core consumer protection principles to their business practices.” The guidance itself is a series of questions followed by the FTC’s answers, purportedly designed to help MLM companies adhere to the said core consumer protection principles. To view the actual guidance document, click here.
Those who were hoping that this long-awaited guidance would provide objectively measurable guideposts to MLM companies will be sorely disappointed; and those who are familiar with the legal issues confronting MLMs will find much that there is really nothing new in the guidance. For example, in response to the ultimate question “How does the FTC distinguish between MLMs with lawful and unlawful compensation structures?”, the guidance pretty much tells us what we have always known:
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.
The FTC recently announced that it has finalized the amendments to the Federal Cooling-Off Rule, (aka Door-to-Door Sales Rule). The amended Rule will go into effect on March 13. When the proposed amendment was published, there was some anticipation on the part of the direct selling industry that sellers would be granted some relief from the Rule.
For those not familiar, the Rule requires that customers (including new distributors or consultants) be given two copies of the 3-day Notice of Right to Cancel whenever a purchase transaction for consumer goods or services takes place at a location other than the seller’s place of business. While there are some possible exemptions, for the most part the rule covered many transactions between distributors and their customers and between distributors and their newly recruited distributors.
Fortune Hi-Tech Marketing and additional defendants, settling claims by the Federal Trade Commission and three states that it operated an illegal pyramid scheme, have agreed to be banned from multilevel marketing and surrender at least $7.75 million in assets.
The surrendered assets will be used to compensate consumers enrolled in pyramid scheme. The original complaint, filed by the FTC and the states of Kentucky, Illinois and North Carolina, alleged that in addition to operating an illegal pyramid scheme and making false earnings claims, Fortune Hi-Tech Marketing provided consumers with false and misleading materials for recruiting new participants.
The Direct Selling Association’s recent Code Responsibility teleconference featured a presentation on deceptive representations in earnings claims by FTC attorney Janice Kopec.
An earnings claim is a statement made by a company or its representative about the income an individual can earn from a business opportunity. The FTC requires any earning claims be presented in writing; any claims not supported by written documents are illegal. According to Ms. Kopec, the Earning Claims Statement must include:
- The name of the person making the claim and the date
- The specifics of the claim
- The start and end date those earnings were achieved
- The number and percentage of your buyers who got at least that result
- Any information about the buyers who got those results that might vary from prospective buyers – for example, where they’re located
- A statement that prospective buyers can get written proof for your earnings claims if they ask for it
Kopec talked about how the FTC examines earnings claims to determine whether they comply with the rule. Aside from the basic criteria – whether a claim is material, whether the proper disclosure statements are provided, etc. – the FTC looks at how the typical consumer will perceive the claims.
The federal district court for the District of Arizona, at the Federal Trade Commission’s request, has frozen the assets of the defendants’ against whom the FTC has alleged falsely promised consumers in the U.S. and Canada that they could make money by referring merchants in their area to a non-existent money-lending service.
The court also appointed a receiver for the operation, which allegedly collected more than $6 million from consumers, as the FTC seeks to shut down the operation permanently and return money to consumers.
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 …