On March 23,2023 the FTC published a notice to amend the Negative Option Rule (16C.F.R. §425). At first blush, the proposed amendments to the Rule seem reasonable and fair. But direct sellers must BEWARE! There’s a seemingly innocuous element to the proposed amendments that negates a defendant’s ability to contest injunctive relief and damages. Thus, the gains from the Supreme Court’s ruling in the AMG Capital case could be lost.
Under Section57b of the FTC Act, if a defendant violates a “rule” the FTC may institute an action against the defendant AND seek damages pursuant to Section 57b(b) of the Act. The Negative Option Rule is a “rule” that if violated, provides the FTC with authority to pursue damages, including restitution. If the proposed amendments to the Rule become operative, a violation occurs if a false or deceptive statement is made that is “related to” the underlying goods or service sold pursuant to a negative option plan. Thus, direct seller’s Section 13(b) gains following the AMG Capital decision, will be lost because the FTC can obtain injunctive relief and damages under Section 57b(b) for the violation of the Rule.
If the amended Rule is enacted, the key to avoiding its reach lies in the fact that the amended Rule will only apply to those who utilize negative option plans. The current iteration of the Negative Option Rule does not present a problem because it applies only to negative option plans that fall into the prenotification format, which is rarely used by direct sellers. However, the proposed amendment to the Rule broadens the reach of negative option plans that if adopted, will apply to formats that are commonly used by direct sellers.
Unlike the existing Negative Option Rule, the proposed amendments to the Rule impact three common facets used by Direct Selling Programs: (1) autoship programs; (2) automatic distributor and customer renewals; and (3) recurring fees that are automatically charged to distributors such as back office & replicated website fees. In addition, there is a problematic aspect to the proposed amendments that have gone largely unrecognized by the direct selling community. The proposed amendments will prohibit any alleged deceptive facet of the transaction even if it does not relate to the negative option plan.
There are four types of negative option plans: prenotification plans, continuity plans, automatic renewal plans, and free trial marketing. The common thread of each negative option plan is that the consumer commits to spending money through his or her silence. The current Negative Option Rule applies only to prenotification plans, which are rarely used by direct sellers. If the proposed amendments are enacted, the amended Negative Option Rule will also apply to Continuity Plans, Automatic Renewal Plans, and Free or Trial Marketing Plans. Here is a brief description of each type of plan.
Prenotification Plans. In a “prenotification plan” a seller provides occasional notices to consumers offering goods, then sends the goods and charges the consumer if he/she takes no action to cancel. Book of the month clubs commonly take this approach.
Continuity Plans. “Continuity plans” have become very common. In a continuity plan, consumers agree to receive periodic shipments of goods that continue until he/she cancels the order. If that format sounds familiar, it’s because most autoship programs follow this model.
Automatic Renewal Plans. In automatic renewal plans, the order automatically renews unless a consumer affirmatively cancels. This again applies directly to direct sellers as it’s a common approach to renewing a membership (a distributorship). Direct sellers also oftentimes charge a monthly technology fee to provide their reps with a back office or replicated website. Those charges are automatic renewal plans that are covered by the proposed Rule.
Free Trial Marketing. Free trial marketing has not been popular in direct selling. As the name implies, under free rial marketing programs, a consumer obtains merchandise for free or at a deep discount but is shipped additional merchandise until he/she takes the step of affirmatively cancelling. This type of plan is popular with software and news subscriptions.
Because the proposed amendments to the Rule prohibit general deception by anyone offering a negative option plan and not merely deception tied to the negative option program itself, direct sellers should avoid offering negative option plans altogether. That of course is entirely unrealistic as it’s a case of the legal tail wagging the marketing dog!
The other option of course is not to engage in deceptive conduct. Given the FTC’s penalty offense notices relating to earnings and product claims, it’s highly likely that a company’s sales force will unwittingly make a product or earnings claim that the FTC will assert is“ deceptive,” and thus trigger a claim for an injunction and damages against the company pursuant to §57b(b). If the products and the direct selling program itself utilize a negative option plan, they are actionable given the breadth of the proposed Rule and the Commission can pursue damages and injunctive relief.
Yet a third option exists. Any U.S. citizen (including a U.S. entity) may file a comment with the FTC objecting to the application of the proposed Rule to deceptive conduct that is not related to the negative option program itself. Comments must be filed by June 23, 2023. This is a procedural remedy that can have a significant impact. It’s likelihood of success however must be weighed against the fact that the FTC is still smarting from their 2021 loss before the Supreme Court in the AMG Capital case and its desire to regain its ability to obtain injunctive relief and disgorgement. If you want to be proactive and file your comment, you can do so at https://www.regulations.gov/commenton/FTC-2023-0033-0001.
In addition to the problems associated with violating the Rule, direct sellers must also comply with the mechanics of the Rule itself. There’s good news in that compliance with the Rule is relatively easy (I say “relatively” because it involves programming and rep training. Dealing with programmers is never “easy” and getting reps to follow the law is akin to herding cats!). The Proposed Rule applies to all forms of media, such as the internet, traditional print and live in-person verbal communication, and requires:
Honesty! Be 1000% honest! Don’t say anything deceptive. EVER. That statement is painful to write because it’s such a “duh” remark but given the FTC’s ever-changing posture on what is deceptive, constant reminding is appropriate.
Disclosure. Before a consumer inputs their credit card information, tell the consumer everything they need to know. Necessary disclosures are:
Clear and Conspicuous. Make the disclosure “Clear and Conspicuous.” The type of media used to present the negative option plan dictates what is “clear and conspicuous” as the disclosure should be made through the same media format that was used to present the negative option plan (i.e., if the negative option plan was presented on the internet, the disclosure should also be on the internet).
Placement. The disclosure must appear immediately adjacent to the means of recording the consumer’s consent to purchase.
Consent. Obtain consent for a monthly charge separately from other transactions. This is an important nuance for direct selling because software commonly takes a rep enrollment as part of the same transaction as the autoship enrollment. Under the proposed Rule, the rep enrollment should be separate from the autoship enrollment. Similarly, when a rep signs up for aback office and replicated website, it should not be part of the enrollment. The rep auto renewal should likewise not be part of the initial enrollment process.
Records. Maintain records of consumer consent verification for at least three years.
If the enrollment as a distributor or in an autoship program are accepted over the telephone, telephone cancellation is necessary, and the telephone cancellation must not impose an expense on the consumer that was more expensive than the initial enrollment. That means the company must provide a toll-free telephone number and maintain sufficient staff to promptly answer cancellation calls.
Direct selling is unique in that in-person sales and enrollments are commonly done verbally by independent distributors. In that case, an internet or telephone cancellation method is acceptable. If telephone cancellation is permitted, all calls made during normal business hours must be promptly answered, and if it is practical, an in-person method of cancellation is needed.
Annual Reminders. If no physical goods are delivered (as is the case with distributor renewals and non-tangible product subscriptions), the seller must provide consumers with an ANNUAL renewal notice that specifies:
Prompt Cancellation. Promptly cancel a consumer’s renewal or autoship when it’s received during normal business hours.
State Laws. State laws still apply even if a company meets the above requirements.
Although compliance with the proposed Rule is mechanical, the danger lies in that it applies to deceptive conduct in general. Given the FTC’s disdain for direct selling, it is highly likely that we will see the Commission apply § 57b(b) of the Act (if the proposed Rule is adopted in its current form) to pursue injunctive relief and damages. That will effectively negate the wins garnered in the AMG Capital decision.
If you have questions about the potential impact of this proposed Rule revision, feel free to reach out to us. We would be happy to have a discussion with you.
AMG Capital Management, LLC v. Federal Trade Commission, 141 S.Ct. 1341,209 L.Ed.2d 361 (2021).
The proposed Rule provides: "In connection with promoting or offering for sale any good or service with a Negative Option Feature, it is a violation of this Rule and an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade Commission Act (“FTC Act”) for any Negative Option Seller to misrepresent, expressly or by implication, any material fact related to the transaction, such as the Negative Option Feature, or any material fact related to the underlying good or service." Proposed 16 C.F.R. § 425.3.
There will certainly be a battle whether the FTC’s penalty offense notices were proper.