Law Library

Seeing the Forest for the Trees

Spencer M. Reese

"Is my plan legal?" Not a week goes by that I'm not asked this question. Sometimes the question is couched in a slightly different fashion ("Is my plan a pyramid?"), but regardless of the terminology used, those posing the question universally expect an answer based on my review of their compensation plan as it is presented on paper. This highlights the overwhelming misperception among network marketing executives that they have nothing to worry about from the Federal Trade Commission or State Attorneys General so long as their compensation plan is not a pyramid. Nothing could be further from the truth.

In reality, the FTC and the AGs rarely initiate attacks on network marketers based on the structure of their compensation plans. Only gifting clubs, airplane schemes, and other easily recognizable Ponzi schemes are attacked up-front with pyramid allegations. In the case of network marketing programs, regulators focus first and foremost on the conduct of the company and its sales force to determine if they are engaging in unfair or deceptive consumer practices in their sales and marketing techniques. Since this is what regulators look at first, network marketing companies are well advised to follow the regulators' lead.

In the last decade all of the major FTC lawsuits against network marketing companies were initially instituted under the broad umbrella of deceptive trade practices. This is because unfair and deceptive consumer practices are much easier to identify and prosecute than are pyramid schemes. There is little technical expertise required to identify abusive consumer practices, so the courts readily issue restraining orders and asset freezes when requested to do so by the FTC. In contrast, pyramid cases quickly become murky because distinguishing a pyramid scheme from a legitimate network marketing business is not always clear-cut.

Once regulators have the necessary evidence to make out the easy case of unfair or deceptive conduct, they will then proceed with the more difficult task of assembling a pyramid case against the defendant company and its principals. They know that even if they lose the pyramid battle, they will most likely win on the deceptive conduct theories. Therefore, companies must focus should on their internal and field sales and recruiting practices.

This is actually good news! We have substantial historical guidance identifying conduct commonly practiced by network marketers that regulators attack as deceptive or unfair. Therefore, when analyzing a program for legal compliance, companies must take stock of their in-house and field practices to ensure it's not treading in the same minefields as those that have fallen before them. So where do the mines lay? Here are the most common:

  1. Income claims! It comes as no surprise that deceptive income claims top the list. The FTC has attacked such claims for years as they are one of the primary means used to recruit new prospects. Note that the term "deceptive" precedes the term "income claims." Not all income claims are improper; the key is presenting proper disclosures to support the claim so that it is not deceptive.
  2. Product claims. Again, no surprise here; we've seen unsubstantiated product claims attacked since the days of the wagon-drawn snake-oil salesman! Unfortunately, people don't seem to learn. No product will not cure everything from AIDS to zits, nor will it increase a car's mileage by 300%, and everyone will not become a millionaire by following an infomercial real estate course. Anyone who claims their products will do these or any other unsupportable things should not be surprised when they receive an FTC Access Letter or a Civil Investigative Demand.
  3. Testimonials. Testimonials are a unique category of product claims. Although they have been around forever, in the last few years they have become more aggressive than ever. The FTC has been cracking down, but it seems as though they are trying to plug a floodgate with a cork. Nevertheless, those who are indiscriminate and cannot substantiate the claims made in testimonials run an increased risk of regulatory action.
  4. Faulty refunds. If you offer an industry standard 90% inventory refund upon a distributor's cancellation, do it without delay when a distributor quits the business - don't play games! With that in mind, it is important to understand the rules. You may recapture commissions paid to a distributor which is subsequently rendered unearned based on the product return (so long as you reserve the right to do so in your policies), but don't try the artifice of claiming that since a distributor was to resell 70% of their inventory, you will only issue a refund based on the 30% of the inventory they should have remaining.
  5. Late commissions. It's deceptive to say you will pay someone on a given date, and then fail to do so. You may have a bit of leeway if a problem results from a computer glitch or something out of your control, but not much.
  6. Job offers. When recruiting for prospects, a network marketer is not offering a job. They are seeking independent contractors who will go into business for themselves. Recruiting by leading people to believe that you are offering a job is unquestionably deceptive. Don't let it happen in your company.
We could go on as the huckster's imagination for deception is seemingly limitless. But the above are common practices every network marketing company should look out for in its own internal practices and the conduct of its distributors. Sure you need to pay attention to the structural elements of your compensation plan to ensure its legality, just don't lose sight of the fact that it is everyday deceptive conduct that really catches regulators' attention and presents a much easier target!