by on May 22, 2013 1 Comment

FTC’s Disclosure Guidelines for Online Marketing: How to get it right (Part 1)

FTC Disclosure Guidelines This article was written in collaboration with our stellar summer associate, Jake Perry.

The world we live in today is changing at a rapid pace. Technological developments have revolutionized the way we communicate and live. We can now complete our Christmas shopping lists from the comfort of our recliners. But while these technological advancements bring great convenience, they also create serious problems for marketers. Bottom line: technology is growing faster than the law can keep up. It was easy to regulate marketers back in 2000 when the original guidelines were written. Few people had the ability to publish…anything.  But today, it’s a different ballgame.  We all have the means of production in the palm of our hands with our mobile devices. With communication tools such as YouTube.com, Facebook, Twitter and WordPress, it’s been really difficult for network marketing companies to create clear policies for their salespeople.  Luckily, the Federal Trade Commission clarified much of the confusion. The FTC has recently published the .com Disclosure Guidelines (fully included below). Essentially, the guidelines provide a “how to” guide for giving adequate disclosures in online advertisements. This is a good thing. The FTC has recognized that this area of the law is fuzzy, blurry, and every other synonym for “unclear” you can find in Merriam-Webster.

These guidelines are extremely helpful and a step in the right direction for our industry. But….the document is over 50 pages long. This is why I have decided to boil them down in a way that makes sense for you all. The purpose of this series is to give you specific instructions on how to stay within the boundaries of these guidelines. While the guidelines never referenced any MLMs, I’ll be providing examples using fact patterns that are common to our industry.

Before we get into those fact patterns, it’s important to understand the basics of these guidelines. There are several key themes to keep in mind when providing “adequate disclosure.”

1) Required disclosures must be “clear and conspicuous.”
A clear and conspicuous disclosure is:
i. One that is within close proximity to the relevant claim in question.
ii. One that is not hidden in a bunch of senseless words.
iii. One that is prominent and easy to spot i.e. clearly visible.
iv. One that is in plain language that your target audience will understand.
v. One that is not accompanied by other distractions in the advertisement.

In other words, do not bury the disclosure in the fine print.  It needs to be seen.  Period.  Keep in mind, the manner you communicate the relevant claim should also be the manner you communicate your disclosure. Therefore, a YouTube video should contain a disclaimer in both video and audio formats.

2) Do not partake in “unfair or deceptive acts or practices.”
While this should go without being said, it’s important to remember that “honesty” is always the best policy. Never try to hide the ball or position your product or service in a way that’s inconsistent with reality. Transparency with customers is actually good for business long term.
If the claim is untrue, there is no amount of disclosure or substantiation that can “sanitize” the statement. For example, an advertisement states that an individual lost 100 pounds taking a new weight loss supplement when in reality she only lost 75 pounds. In this scenario, no disclosure or amount of substantiation can qualify or limit the claim being made because the claim is blatantly false. Therefore, in this scenario, the claim itself must be modified, i.e. individual X lost 75 pounds using the dietary supplement.

3) Claims must have “substantiation,” regardless if they originate from the company or the field.
Substantiation refers to evidence that backs up your claim. The FTC states in the guidelines that before distributing an ad, advertisers must have “appropriate support for all express and implied objective claims that the ad conveys to reasonable consumers.” In other words, if a company or its sales people make aggressive marketing claims, those claims need to be backed up with reliable data. Research studies, expert opinions, and other types of data must be used to support any type of claim you make.

With MLM companies, distributors are also required to provide substantiation when promoting a product or service. As made clear in the Endorsements and Testimonials Guidelines published in 2011, the company can be held responsible for any false or misleading claims made by its distributors. Therefore, it’s vitally important to ensure the field is educated on ways to properly market the products and services. It’s crucial that the field understands when and how to provide substantiations and income disclosures. This is where compliance training becomes a key factor. If you care about the longevity of your business, you’ll make the investment to make sure your reps are adequately trained.

4) Would your disclosure give a “reasonable customer” notice of the information?
A reasonable customer is a hypothetical person who contains the necessary intelligence, judgment, attention, knowledge, and experience required to function in our society. For example, where a disclaimer is located at the bottom of a website in 30 lines of small text titled “LEGAL TERMS AND CONDITIONS,” a reasonable person would never expect to find a disclosure about the product they are buying buried there. A reasonable person would expect to find the disclosure somewhere within close proximity of the statement in question.  When you’re creating promotional materials, use common sense when figuring out the location and form of your disclosures.

5) Research and follow-up on the effectiveness of your disclosure.
The FTC states that the ultimate test to determine the adequacy of a disclosure is whether the information intended to be disclosed is actually conveyed to consumers. While this is not a requirement made by the FTC in making an adequate disclosure, be forewarned that you will run the risk of having your disclosure declared inadequate. The FTC recommends conducting controlled side-by-side research experiments to determine where the average consumer does and does not look on a computer screen to test the effectiveness of your disclosures. The FTC also recommends assessing the effectiveness of a disclosure via hyperlink by monitoring the link’s click-through rate and make adjustments accordingly. If you know of an analytics geek that’s good with tech, it’s time to pay him or her.  That data is going to be very important.

6) If you cannot follow the FTC guidelines in your advertisement, do not make the claim in question.
Where it is not possible to follow the FTC’s guidelines in giving adequate disclosure to customers, the claim in question should NOT be disseminated. This further reiterates point #1 and #4. A disclosure is not adequate simply because it is the best you can do under the circumstances. The disclaimer must actually convey the qualifying or limiting information to the ultimate consumer.

A perfect example of when it is not possible to ensure compliance with the FTC’s guidelines is when a distributor makes an income claim via Twitter. The character count allowed per “tweet” is simply not high enough to ensure that adequate disclosure is given to the consumer.  As an example, a proper disclaimer could take up half of the tweet: “the average person can expect to earn between $300 and $500 per month.”  While it’s true that a hyperlink may be included within a tweet, a reasonable consumer will not likely realize that “bit.ly/f56” leads to a disclosure of the statement made. Therefore, it is best to completely avoid making income claims on Twitter altogether.

Conclusion

Be careful.  With companies that exercise tight control over their marketing efforts, complying with these standards will be easy.  But for network marketing companies that rely on the creativity of a volunteer army, it’s going to be incredibly to walk this tight rope.  Compliance training is going to be incredibly important to ensure sales leaders really understand how to do things right.  Proper behavior in the field is not going to happen by sending out a single newsletter once a quarter or  referencing the “C” word (compliance) at an annual convention.  It’s going to take commitment.  In Part 2 of this series, I’ll provide you with specific instruction on ways to do this right.  I’ll be sure to use fact patterns that are common in the MLM industry.

If you’re reading this via email, please click here to review the full .com Disclosure Guidelines.

Filed Under: mlm attorney, MLM Consulting, mlm legal, MLM News, MLM startup Tagged With: , , ,
by on May 2, 2013 11 Comments

BREAKING NEWS: FTC’s Case Against Fortune Hi Tech Removed to Kentucky

FTC - FHTM case transferred to Kentucky | MLM AttorneyIn February of 2013, the FTC filed a lawsuit against Fortune Hi Tech Marketing. The lawsuit was filed in Federal Court in Chicago. The FTC is alleging that FHTM operates as a pyramid scheme. As mentioned in my last article, the FTC passed on the scalpel and picked up the sledgehammer. Basically, they departed from their traditional, math-based pyramid scheme arguments and went for a more generic approach. This new strategy is even worse than the other one. If it sticks, it represents a significant threat to the industry. Based on the FTC’s argument, rewards triggered via distributor consumption are illegal recruitment bonuses. This is a very important case.

Time for the Update

FHTM filed a motion to get the case transferred to federal court in Kentucky. Kentucky is the home state for the company and most of the principals. The judge in Chicago punted the file to Kentucky. The factors considered when deciding on such a transfer include:

(1) site of material events relative to the case;
(2) relative ease of access to sources of proof;
(3) convenience of the parties litigating;
(4) convenience for the witnesses.

This is big for two reasons. First, the judge in Chicago thought so little of the case that he sent it south. If he wanted it, he could’ve kept it. Second, the law in Kentucky is clearer with respect to pyramid schemes. It states:

Pyramid distribution plan” means any plan, program, device, scheme, or other process by which a participant gives consideration for the opportunity to receive compensation or things of value in return for inducing other persons to become participants in the program;
(5) “Compensation” means payment of any money, thing of value, or financial benefit conferred in return for inducing others to become participants in the pyramid distribution plan. Compensation does not include payment based on sales of goods or services by the person or by other participants in the plan to anyone, including a participant in the plan, who is purchasing the goods or services for actual use or consumption…..

Again, the FTC was initially arguing that commissions triggered via internal consumption are illegal bonuses. But the statute in Kentucky says the exact opposite. This case is FAR from over. There’s likely going to be a hearing next week in Kentucky regarding the injunction over Fortune Hi Tech. If FHTM wins, they’re back in business. The judge’s reasoning for sending the case to Kentucky is included below.

If you’re reading this via email, please click this link to read the judge’s opinion.

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by on April 25, 2013 4 Comments

Are Non-Compete Agreements Binding on Distributors?

Guest post by +Cole Dowsley, Thompson Burton litigator. This is controversial subject in the network marketing profession. When independent distributors join a network marketing program, should they be “stuck” by way of a noncompete? Short Answer: legally, noncompetes are enforceable (in most cases, not all). When two adults sign a contract, it’s hard to get provisions thrown out. But, in my opinion,….the market might soon demand that companies remove these restrictions. Cue, Cedrick Harris. Harris, one of ViSalus’s top leaders, publicly (and respectfully) resigned from the company. His main gripe: the lack of flexibility to work other programs. As distributors get more educated in this area of the law, they’re going to start demanding that companies remove the restrictions. And when that happens, the restrictions will disappear. — Kevin Thompson

Guest Post

independent contrator non-competeMost people think of non-compete agreements as a contract between an employer and an employee. However, this is not the only relationship where covenants not to compete may be valid. There are a number of other relationships in which courts have enforced non-compete agreements, including non-compete agreements between a business and an independent contractor and non-compete agreements between a buyer and seller of a business. Covenants not to compete may be included in or ancillary to a variety of business contracts, such as MLM distributor agreements and joint marketing agreements.

One of the most common questions is whether a business can require a “1099” independent contractor to execute a non-compete, and if so, whether the agreement is enforceable as to the independent contractor.

As noted in my recent blog post regarding the general enforceability of non-compete agreements, the law governing non-compete agreements is state specific. In Tennessee, the Court of Appeals has determined that covenants not to compete may be applicable to the independent contractor relationship.Baker v. Hooper, 1998 WL 608285 (Tenn. Ct. App. 1998). Courts in other states have reached the same conclusion. In the independent contractor context, non-compete agreements will generally be treated in the same fashion as employer/employee agreements. The U.S. District Court for the Middle District of Tennessee explained the law, as follows:

Although these provisions [with independent contractors] arise outside the employment context, and are entered into between companies with relatively more bargaining power than the average employee, they are still restraints on trade, and the Court concludes that Tennessee courts, if called upon to consider these provisions, would view them in essentially the same light it views non-competes in the employment context.

As such, the provisions are enforceable under Tennessee law only if they are reasonable under the circumstances. Tennessee courts have instructed that the factors to be considered in assessing reasonableness include whether the covenant not to compete seeks to protect a legitimate business interest, the economic hardship imposed on the restricted party, and whether such a covenant would be inimical to the public interest.

Affinion Benefits Grp., LLC v. Econ-O-Check Corp., 784 F.Supp.2d 855, 866 (M.D. Tenn. 2011)

For a general discussion of the factors courts in Tennessee consider when determining the reasonableness of non-compete agreements, see my recent article on the subject. In the independent contractor setting, courts will likely place an emphasis on whether there is a legitimate protectable business interest under the circumstances of the case. The cases in Tennessee emphasize that there is no legitimate interest in protection from competition, only from unfair competition. In making this determination, a business must show the presence of special facts above and beyond ordinary competition that would give the independent contractor an unfair advantage when competing with the business.  Such facts might include whether the independent contractor had access to confidential or proprietary information, such as business secrets, confidential pricing information and confidential customer lists. Unfortunately, there is no simple rule to easily determine whether or not an independent contractor non-compete agreement is reasonable and enforceable; it is a highly fact-driven analysis and the determination will depend on the unique circumstances of each case.

Do you have questions or concerns regarding a non-compete agreement? Contact the Business Litigation & Dispute Resolution Attorneys at Thompson Burton PLLC, who are regularly called upon to prepare, review, negotiate, and litigate non-compete agreements on behalf of businesses and individuals.

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by on April 1, 2013 3 Comments

The FTC Is Now Regulating Boxing

FTC Regulating Boxing

See below for the FTC’s latest effort to protect people across the country.

Begin Press Release

The FTC has been commissioned to address the growing belief that shorter men can actually compete at a high level in professional boxing. In fact, after conducting surveys over a period of four years, speaking with numerous experts (none of whom have actually boxed), the FTC has ultimately concluded that the empowering message of the Rocky franchise to be misleading for prospective boxers throughout the country. This report is intended to provide guidance for coaches and trainers going forward when they’re soliciting involvement from young fighters.

As per our newly published guidelines, trainers and coaches are required to obtain separate signatures on a disclosure document from prospective fighters before they begin training. The disclosure document addresses numerous myths associated with the Rocky character as well any false expectations held by prospective fighters. The disclosure document must contain a “purpose statement,” which is included below. The purpose statement must be included in red, 16 pt san serif font, center justified, all caps bold. The purpose statement must also be read aloud in English, Spanish, Mandarin and Russian.

THERE ARE BETTER WAYS OF EARNING A LIVING. WE, THE COACHES AND TRAINERS, STRONGLY ENCOURAGE YOU TO GET REAL JOBS. BUT IF YOU DECIDE TO PROCEED WITH A DREAM OF MAKING IT AS A BOXER, THIS IS A REQUIRED DISCLOSURE BY THE FEDERAL GOVERNMENT

The disclosure must state:

The average annualized income for all active Boxers during this period (before expenses) was $8.37. The average boxer can expect to suffer much and earn little.

Regarding the Rocky franchise: Rocky Balboa is a fictional character. Statistically, a 5’8″ Italian man over the age of 30 has zero shot of winning a heavyweight boxing title. Chasing chickens has not been scientifically proven to make you faster. There has never been a man that could really piss lightning or crap thunder. Pounding frozen meat has not been validated as an effective way to improve hand strength. After our medical advisory board reviewed the original Rocky film, they concluded that Rocky Balboa would have suffered 27 concussions at the hands of Apollo Creed before the final bell.

There are no guarantees of income as a fighter. Boxers that fail are condemned socially, labeled “wishful thinkers.”

End

Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM startup Tagged With: , , , , ,
by on March 21, 2013 8 Comments

The First One is On Us, Second One is On You: Be warned of Leveraged Profit Sharing Programs

Leveraged Profit SharingWhen Zeek Rewards got shut down, the consumers really lacked an understanding of the problems. As I wrote about in the past, this ignorance in the market was largely our fault. Our “self-regulated” industry failed them. The first one is on us. But with this new breed of Leveraged Profit Sharing Programs (“LPSP”), it’s now on you.

Remember Zeek? It’s been close to eight months since they were shut down. If you will recall, Zeek Rewards was nailed by the SEC mainly for operating as a pyramid scheme and for selling unregistered securities i.e. encouraging passive investments, hinting at lucrative returns on the money, etc. Zeek Rewards taught its participants and the entire network marketing industry a very painful lesson: promises of passive return on investment + a network marketing compensation plan = hurricane of pain.

But it’s not an investment…

Sure, I know the counter-argument. People argue that Zeek never “asked for investments.” Instead, they were selling “sample bids” (wink, wink), which led to activity on the website, which led to profit, which led to profit distributions to the investors / distributors. Curiously though, the vast, overwhelming, ridiculous majority of those sample bids (99%+) were never used, which means the program was just cycling money from older investors to newer ones. While I know the counter-argument, it’s flat out silly. And those of us in the industry, we knew it and we said nothing. We let Zeek take advantage of the credibility we all work hard to create.

I’m getting to the point…

Zeek Rewards was like cocaine for a number of the net winners. They’re now hooked on the high. They want more. As the air in Zeek is deflated, reality is starting to sink in for people: Zeek Rewards is never coming back. With that in mind, it has led to the next generation of high yield investment MLM. I’m referring to these sorts of programs in the industry as “Leveraged Profit Sharing” programs. High Yield Investment Programs, or HYIPs, is a phrase commonly used; however, it’s easy for LPSPs to distinguish themselves from HYIPs because there’s “no investment.” I think LPSP is a better fit because it embraces the very terms they promote in their plans: profit sharing. And it’s precisely how they work in practice. The companies leverage the investments made by participants to grow the company. With growth, comes profit. And with profit, comes distributions to the investors i.e. leveraged profit sharing.

The point…

At some point, consumers have to accept responsibility for their financial decisions. Zeek brought painful clarity on the subject. And it was widely publicized. Perhaps I live in a fantasy world, but I think consumers should now know better. When participants are asked to fund the growth of a company by way of buying “samples” for anonymous, no-name customers, and when they’re promised a return based on company profits, they should simply know better! In this Information Age, where information is readily available on computers and cell phones, the excuses are starting to shrink. LPSPs would cease to exist if they lacked support from participants.

Today…

Where there was 1, now there are many. This is just an example. Recently, I’ve heard of “investor co-ops” where people pool money together and invest in multiple LPSPs. It functions sort of like of a mutual fund, but for…other kinds of programs. The companies they were allocating investor dollars: Banners Brokers, Profit Sunrise and GoFun Places. Why would people pool resources and passively invest in these programs? Because…well, you can decide for yourself. And these are just a few. If you get burned in a LPSP, do not blame the consultants or any vendors. Blame yourself. The information is out there. And by the way, the idea of “invest now, get out fast” might come back to bite you. There are a number of net-winners in Zeek that are currently negotiating deals with the receivership to pay back their gains. The other net-winners, the ones that are hoping for the clouds to clear, they’re about to be jack hammered in a whirlwind of litigation.

Think about it.

+Kevin Thompson

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by on March 13, 2013 11 Comments

Update on the Fortune Hi Tech Case – FTC Passes on Scalpel, Goes for Sledgehammer

As a refresher, in early February of 2013, the FTC got an injunction issued against Fortune Hi Tech Marketing. The summary of the lawsuit can be found here: FTC vs. Fortune Hi Tech.

FTC’s Strategy

FTC passes on the scalpel and picks up the sledgehammer.

FTC passes on the scalpel and picks up the sledgehammer.

Since the lawsuit was filed, I’ve had a lot of time to study the FTC’s arguments against FHTM. In particular, I closely studied the FTC’s expert report prepared by Dr. Peter Vander Nat. The FTC’s entire case hinges on the validity of Peter Vander Nat’s report.

In the lawsuit, the FTC passed for the scalpel and picked up the sledgehammer. In summary, they’re no longer relying on Vander Nat’s convoluted math formula, which I discussed in my last article regarding the FTC’s economist. If you’re following the news with Herbalife, I think you’ll find this next point interesting. Currently, there’s a lot of bickering back and forth between MLM proponents and critics alike over the interpretation of Vander Nat’s formula. People are discussing how Herbalife stacks up to the standard. With one word, I can put the entire debate to rest for both sides.

Are you ready for it?

The word is:

IRRELEVANT

The formula is irrelevant. In Vander Nat’s lengthy declaration used against Fortune Hi Tech, the formula is never mentioned. Not once. Why? The answer is obvious. The FTC is distancing itself from it because the formula is too broad and too confusing. The FTC’s case against BurnLounge (sued in 2006) is jeopardized due to the ambiguity of this standard. The case is currently under appeal. The main source of contention: Vander Nat’s qualification as an expert. Vander Nat had never studied an MLM that he concluded was legal. Where’s the fairness in using an objective standard to measure right from wrong when you never find anything right? There’s no wisdom in designing a water-filter if there’s no opportunity for water to pass through.

Sledgehammer

In his declaration, Vander Nat opines and argues that FHTM was operating as an illegal pyramid scheme. Instead of relying on his formula, he bases his finding on a few assumptions. Those assumptions are all addressed in Charles King’s declaration (available below). Dr. King was retained by FHTM as its expert in their effort to dissolve the injunction. Out of Vander Nat’s assumptions, there’s one that should be concerning for all people in the network marketing industry: commissions triggered via internal consumption are “recruitment bonuses.” In other words, rewards triggered via distributor consumption are illegal. This argument represents a dangerous and irresponsible strategy employed by the FTC. In one of the footnotes in his declaration, Vander Nat writes, “…I also understand that the ultimate users of the products – for purposes of the Koscot test – are people who are not participants in the business venture.” With this framework, he pulls out all revenue garnered from distributor consumption. He then compares the money left over (not much) with the money paid out in bonuses. He then concludes that the pay plan is underfunded and relies on “recruitment bonuses” to survive. Charles King sums it nicely when he writes:

Since Vander Nat is not counting commissions generated via internal consumption, it creates the impression that the plan lacks sufficient revenue from product sales to support the commissions. He treats the difference between revenue available for commissions and the amounts paid as recruitment bonuses. Using his own definition of “end user,” he’s able to dramatically shrink the commission pot; thus, creating the false impression that the Commission Plan is insufficient and underfunded.

Optimal Scenario

Vander Nat also relies on an economic theory known as “Optimal Scenario.” Using the Optimal Scenario framework, Vander Nat assumes that if EVERYONE were to hit the high levels in the FHTM business, the plan would be underfunded. The reality: not everyone hits the levels nor does everyone try. While Vander Nat acknowledges that breakage exists (money in the plan from un-earned commissions), he ignores it completely. In network marketing, the participants operate with various goals. There are some that want to earn a few hundred dollars a month, some do it for social reasons, some want to save money on product, some are supporting a friend or relative, etc. They’re not all trying to “max out” the pay plan. This assumption was faulty and led to a faulty conclusion.

What does all of this mean?

Change is coming. Stay tuned. In 2004, the FTC said that the amount of internal consumption is inconsequential for pyramid scheme analysis. Based on their recent case against FHTM and various posts on their website, the FTC appears to be back-tracking. It’s going to take strong leadership to steer this conversation in a favorable direction for the industry. And strong leadership requires that we at least acknowledge the areas where we’re weak. Cultures of hype need to stop. Product value matters. Without question, the industry is going to look different within 18 months. How different? We’ll see.

If you’re reading this via email, click this link to review the declaration prepared by Charles King.

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by on February 6, 2013 23 Comments

FTC Shuts Down Fortune Hi-Tech Marketing, Summons the Krakan

Peter Vander Nat

As most of you know, the FTC has filed a lawsuit against Fortune Hi-Tech Marketing, alleging them to be a pyramid scheme. This is the first action taken by the FTC against an MLM since December of 2006. The most informative pleading that shows the FTC’s position is the memorandum supporting the FTC’s motion for an injunction. WARNING: It’s 54 pages…and boring. When describing these cases, I’ve found that it’s always best to give a brief summary of the business model.

Fortune Hi-Tech Marketing (“FHTM”) Business Model

FHTM_logoFHTM is a network marketing company that specializes in selling nutritional supplements and beauty products. It also dabbles in selling cable and telecom services. Participants join FHTM by paying a $250 administrative fee. In order to qualify their positions, these “Managers” are required to move (buy or sell) 1,000 volume points. This usually costs between $100 and $400 per month, totaling at least $1,200 annually in product sales / purchases.

Managers can advance to “Regional Sales Managers” by recruiting six additional Managers. RSMs can advance higher by recruiting additional Managers. RSMs are eligible to earn $100 for each new Manager in their downline. While the new Manager doesn’t generate $100 worth of margin based on his or her product purchase, I doubt FHTM is using money from the $250 enrollment for the $100 bonus (which would obviously be a recruitment bonus). Instead, they’re probably allocating some of the breakage in the plan from unpaid commissions from product sales i.e. the majority of reps do not hit the RSM rank; therefore, there’s plenty of money in the pot for the bonus. Using Vander Nat’s “perfect scenario” theory, assuming everyone were to hit the RSM rank, the plan breaks. The FTC is exploiting this as a weakness in the plan.

FTC’s Thesis

The FTC’s thesis is simple: the FHTM products are merely incidental to the money making opportunity. The FTC makes itself clear: while FHTM talks about “selling product,” the references to sales are cosmetic designed to conceal a money transfer scheme. Additionally, the FTC is arguing that the structure of the pay plan itself is turbo-charged to reward recruitment over legitimate product sales.

FTC’s Purported Expert a/k/a the Kraken

Peter Vander Nat

The FTC’s attack dog throughout the years has consistently been its economist, Dr. Peter Vander Nat. Vander Nat co-wrote an article titled “Marketing Fraud: An Approach for Differentiating Multilevel Marketing from Pyramid Schemes.” In the article, Vander Nat publishes his math formula that he uses when reviewing a multilevel marketing program. Vander Nat is an interesting anomaly in the MLM industry. In my opinion, he’s similar to the the Kraken in Pirates of the Caribbean. In the movie, the Kraken is a large beast residing in the depths of the ocean, only to surface when called upon by its master to destroy a vessel. And when the job is done, it vanishes…

Vander Nat operates in simliar fashion. While the FTC recognizes the legitimacy of the MLM industry, their chosen expert does not share the same sentiment. I suspect they keep him locked behind closed doors for years, only to use his services when they need to sink a ship fast. Can you blame them? Vander Nat has never once found an MLM legal using his math formula. I’m not kidding. In the FTC’s case against BurnLounge, Vander Nat’s credibility as a witness is being contested at the appellate level. In its brief, BurnLounge references Vander Nat’s deposition transcript and writes:

Vander Nat had never studied any MLMs that he concluded were legal. He could not testify that using his analysis, one would ever find an MLM to be legal. . . Nothing was presented to show that his test had gained widespread acceptance. He likewise admitted that he did not know if his test complied with the Koscot/Omnitrition test.”

If you want the full text, check out page 43 of BurnLounge’s Appellate Brief.

I’m not making this up. The FTC’s expert, the man charged with distinguishing good companies from bad companies, has created an impossible standard. And furthermore, if you review his math formula published in his article, it requires a doctorate in quantum physics to truly understand. As if that’s not enough, central to his formula is this definition of “retail sales.” He writes, “We rely on Omnitrition’s findings that for purposes of pyramid analysis, the sale of product to ultimate users means the sale of product to those who are outside the organization.” In other words, for purposes of his formula, commissions triggered via internal consumption are considered “recruitment bonuses.” When you control the terminology, you control the outcome.

On a side note, his reliance on Omnitrition is misplaced. Omnitrition was never held to be a pyramid scheme. But I digress…

What does the FTC say on the issue of MLM internal consumption? Unlike Vander Nat, the FTC takes a softer stance on the subject when it writes, “In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme.” Clearly, there’s some incompatibility between the FTC’s public statements and their arguments made in litigation. Do they reserve the Kraken for what they perceive to be the most egregious of companies? It appears to be the case.

Why Fortune Hi Tech Marketing

Just to be clear, I’m not defending the Fortune Hi Tech model. I lack adequate information to form an opinion one way or the other. I’ve learned that it’s ill-advised to form an opinion based on the initial complaint. But I do know this: FHTM is isolated. The DSA rolled them under the bus and it only took them 24 hours after the FTC filed its lawsuit. FHTM is not part of the tribe, which means they’re not going to score many sympathy points from industry participants. Will this hurt them? I think so. If they survive the injunction (very high bar there), there’s not going to be enough positive press to keep their sales force engaged. The industry, traveling in a pack, will keep moving in a herd knowing full well that occasionally, some get eaten.

The FTC’s allegations can be summarized in two small sections.

(1) Recruitment Culture.

FHTM heavily emphasizes recruitment over sales. In fact, the FTC commonly places sales in quotes i.e. “sales.” They know that there’s a theoretical opportunity for sales, they just dismiss it as fake. They allege that as a requirement for participation in the plan, Managers must buy (or “sell”) a certain amount of inventory each month. This amount averages over $1,200 per year. Are the prices inflated? The FTC never says one way or the other. The FTC also accuses FHTM of overstating the benefits of their partnerships with nationally known brands i.e. DISH Network, Xoom Energy, etc. The FTC alleges that Managers in FHTM tout these partnerships as validation of the model; however, there’s very little commission to be gained from those sales because those partnerships are just “run-of-the-mill affiliate agreements.”

(2) Income Claims.

FHTM allows its sales force to make inappropriate income claims. The FTC provides a number of crazy claims made by leaders and executives. These statements were taken from all over the place, including company meetings, YouTube videos and, most surprisingly, Twitter. If you’re an executive for an existing MLM, pay attention. Compliance matters. While FHTM has an income disclosure document, the FTC is alleging that FHTM never made it a priority to get it in the hands of prospects. Also, the FTC alleges that the income disclosure document uses fuzzy math to reach its numbers because it excluded a large population of the sales force.

Due Process?

dueprocessDoes it make you nervous knowing that the Federal government can shut down a long-standing business without a judicial hearing? Critic or not, it’s disturbing. If FHTM is a flaming pyramid, it would never have survived a hearing. After being in business for over a decade, where is the imminent threat referenced by the FTC in its motion for an immediate injunction? The Critics, who commonly take a “win at all cost” approach, even if it means heralding a felon as their champion, will say “serves them right!” But be careful…

“And when the last law was down, and the Devil turned ’round on you, where would you hide, sir, the laws all being flat? . . . And if you cut them down, and you’re just the man to do it, do you really think you could stand upright in the winds that would blow then? Yes, I’d give the Devil benefit of law, for my own safety’s sake!” Sir Thomas More, A Man For All Seasons.

If you’re reading this via email, please click this link to view the FTC’s memorandum in support of its motion.

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by on January 28, 2013 10 Comments

After Six Year Slumber, FTC Wakes Up Big And Goes After Fortune Hi Tech

BREAKING NEWS:

The FTC has sued Fortune Hi Tech marketing, alleging them to be a pyramid scheme.  As of today, an injunction has been issued.  Read below for the FTC’s press release.  Also, a copy of the complaint is provided below.

FHTM Promoted Itself as a Path to Financial Independence, But Most People Made Little or No Money

At the request of the Federal Trade Commission and the states of Illinois, Kentucky, and North Carolina, a federal court has halted an allegedly illegal pyramid scheme pending trial.  The FTC and the state attorneys general seek to stop the allegedly illegal practices of the Fortune Hi-Tech Marketing (FHTM) operation, which claimed consumers would make substantial income by joining the scheme.  The operation affected more than 100,000 consumers throughout the United States, including Puerto Rico, and Canada.  In some areas, including Chicago, the scheme targeted Spanish-speaking consumers.

“Pyramid schemes are more like icebergs,” said C. Steven Baker, Director of the FTC’s Midwest Region.  “At any point most people must and will be underwater financially.  These defendants were promising people that if they worked hard they could make lots of money.  But it was a rigged game, and the vast majority of people lost money.”

According to the complaint filed by the FTC and the state attorneys general, the defendants falsely claimed consumers would earn significant income for selling the products and services of companies such as Dish Network, Frontpoint Home Security, and various cell phone providers, and for selling FHTM’s line of health and beauty products.  Despite FHTM’s claims, nearly all consumers who signed up with the scheme lost more money than they ever made.  To the extent that consumers could make any income, however, it was mainly for recruiting other consumers, and FHTM’s compensation plan ensured that most consumers made little or no money, the complaint alleged.

“This is the beginning of the end for one of the most prolific pyramid schemes operating in North America,” Kentucky Attorney General Jack Conway said.  “This is a classic pyramid scheme in every sense of the word.  The vast majority of people, more than 90 percent, who bought in to FHTM lost their money.”

As alleged in the complaint, FHTM promoted itself as a way for average people to achieve financial independence.  Some FHTM representatives claimed they earned more than 10 times as much as their previous earnings in their second and subsequent years with FHTM.  One person claimed that another representative earned more than $50,000 in his sixth month and millions of dollars in subsequent years.  Another person promoted a recruitment meeting on her Twitter account, stating, “Bring ur friends & learn how 2 make $120K aYR.”  At its 2012 national convention in Dallas, FHTM called its top 30 earners to the stage to present them with a mock-up of a $64 million check, which several of them shared as a photo on social networking websites.

To participate in the scheme, consumers paid annual fees ranging from $100 to $300.  To qualify for sales commissions and recruiting bonuses, they had to pay an extra $130 to $400 per month and agree to a continuity plan that billed them monthly for products unless they canceled the plan.  Those who signed up more consumers and maintained certain sales levels could earn promotions and greater compensation, but contrary to FHTM’s claims, the complaint alleged, its compensation plan ensured that, at any given time, most participants would spend more money than they would earn.

According to the complaint, recruits were told they could earn high commissions by selling products to people outside the operation, but instead only minimal compensation was paid for sales to non-participants, and few products were ever sold to anyone other than participants.  The scheme provided much larger rewards for recruiting people than for selling products, and more than 85 percent of the money consumers made was for recruitment.

In addition to charging the defendants with operating an illegal pyramid scheme and making false earnings claims, the FTC charged them with furnishing consumers with false and misleading materials for recruiting more participants.  The attorneys general offices of Illinois, Kentucky and North Carolina joined the FTC complaint, as well as alleging violations of their respective state laws.

The defendants are Paul C. Orberson, Thomas A. Mills, Fortune Hi-Tech Marketing Inc., FHTM Inc., Alan Clark Holdings LLC, FHTM Canada Inc., and Fortune Network Marketing (UK) Limited.  On January 24, 2013, the court halted the deceptive practices, froze the defendants’ assets, and appointed a temporary receiver over the corporations pending a trial.

The Commission vote, including Commissioner J. Thomas Rosch, authorizing the staff to file the complaint was 5-0.  The complaint was filed in the U.S. District Court for the Northern District of Illinois, Eastern Division.

If you’re reading this via email, please click this review the FTC vs. Fortune Hi Tech lawsuit.

Filed Under: Distributor Resources, mlm attorney, mlm legal, MLM News Tagged With: , , , , ,
by on January 16, 2013 Leave a Comment

CNBC Interview With Herb Greenberg

Kevin Thompson, MLM Attorney, and Herb Greenberg

As most of you know, Herb Greenberg prepared a story about Herbalife for CNBC. The 20 minute documentary was titled Selling the American Dream. Herb worked for a very long time on the story, interviewing several people all throughout the country. I was interviewed by Herb in the CNBC studio in July of 2012. If you blink in the video, you miss me. I was only on for about 10 seconds, right around the 16 minute mark.

While Herb was working on the story for over a year, the catalyst for CNBC airing the story was the saga between Bill Ackman and Herbalife. There’s a great guest post on my site about the impact (or lack thereof) of Ackman’s Bear Raid on Herbalife.

Personal Views on Greenberg

He’s a very pleasant person. And he’s very intelligent, surrounded with a great staff of people. And unlike a lot of MLM critics, he actually gives a little airtime to BOTH sides of the agrement. While he certainly favors the negative side by providing links to MLM critics, he at least tries to inject some pro-industry commentary. I believe he’s spoken with the DSA, he interviewed Herbalife’s CEO and he also interviewed me. He dove deep and did his homework. In his own words, “After 10 months of independently digging into Herbalife and the industry, culminating with the CNBC documentary, “Selling the American Dream,” I can say with a fair degree of certainty: Multi-level marketing, which has been dogged by the same legal questions and controversies for 65 years, needs to be cleaned up.”

While not everyone shares this view with me, particularly leaders in the DSA, I actually agree with Herb on the need for change. I’ve written in the past about the MLM industry’s problem with self deception. Burying our faces in piles of money, pretending there’s not a problem is a sure path to irrelevancy. Paying commissions on internal consumption is fine. But we need to create better standards to alleviate the growing problem of “opportunity driven demand.” Opportunity driven demand exists when people purchase products they never would buy at prices they never would pay with the expectation of recovering their “investment” by recruiting additional participants (to repeat the cycle).

There needs to be legitimate value in the products and services changing hands. The popular sentiment that “all pay plans driven by product volume are legal” falls short of common sense and fails to account for opportunity driven demand. Under the influence of a pay plan, people will literally pay $1,000 for an ounce of lemonade. If you drive a pay plan from such sales, is it legal? Of course not. It’s this distinction that’s leading to so much confusion on Wall Street. We can attack the short sellers for manipulating the market. But really, they’re just exploiting the ambiguity in the law. And until the law is cleaner, it’ll keep happening whether at the hands of short sellers, class action attorneys, regulators, FTC, whoever.

My role in Herb’s story was simple: I was to discuss the laws in place distinguishing legitimate MLMs from illegitimate pyramids. While we discussed a lot of the positives in the industry, there’s none of that content that made the final cut. I’m not complaining. I’ll take the exposure when I can get it. But I’m just letting you know, I tried. The interview was an intense thirty minutes. The questions came at me rapid-fire the moment I hit the seat. It was fun.

Greenberg’s View on MLM

If you’re not able to tell by reading Herb’s stories about Herbalife and the MLM industry in general, he has a bad taste in his mouth. Intellectually, he’s not able to really “feel” and understand the benefits of the distribution channel. In an article Herb Greenberg posted on LinkedIn, he extends his focus away from Herbalife and discusses the potential challenges facing the entire industry. In his view, he predicts some regulatory activity against some of the larger companies. This would, in turn, trickle down and affect the smaller companies. While Herb senses a disturbance in the industry, he’s not able to put his finger on it. In his mind, it makes no sense for people to buy an arguably inferior product via MLM. This rationale assumes that the product is inferior and discounts the benefit of joining a community of people that share a common goal. In Herbalife, that common goal is weight loss and nutrition. Notorious short seller, John Hempton, summarized it well when he said,” Herbalife works in the same way as alcoholics anonymous – by supplying (and in this case selling) a support group to help you kick the ‘fat addiction’.” There’s power (and value) in community.

One thing is certain, as Herbalife’s stock continues to climb, Ackman will get desperate and start lobbying Congress (if he has not done so already). Will he be able to get the regulation he needs to save him from a stupid bet? It’s unlikely. And even if regulation does come, it’ll likely affect the smaller MLMs significantly more than companies like Herbalife. In my opinion, Ackman’s prayer for a government savior will go unanswered.

Conclusion, Lessons Learned and Special Thanks

I learned a lot from this experience. First, if someone with a platform invites you to participate in a conversation, show up. There seems to be this fear of the media by professionals in the industry. While there’s certainly the potential for bad, the upside outweighs the risk. We need more professionals willing to put their necks out there, communicating the benefits of the model. Second, the critics are becoming more organized. The internet is sticky and their content is spreading. The critics are getting in the ear of hedge fund managers, investment bankers, journalists and politicians. They’re like like Agent Smith in the movie The Matrix. If you’re not a tech nerd like myself, Agent Smith was like a computer virus, hell bent on destroying the very program that gave him life.

I want to extend a special thanks to Len Clements of MarketWave. Len is a great friend, and someone I trust very much. He took the time to help me prepare for the kinds of questions that are common from people skeptical of the model. His insight was key. I also want to thank my partner’s wife and Thompson Burton litigator, Melissa Burton. She literally reviewed my notes beat me up for over an hour on the issues. She has a good mind for poking holes in arguments and was invaluable for my preparation.

I’ve included some pictures below from my trip to New York. It’s such a fun place. My wife and I got a babysitter and left the three kids at home for a few days. I hope you enjoy the pictures.

Filed Under: mlm attorney, MLM Consulting, mlm legal, MLM News, MLM startup Tagged With: , , , , , , ,
by on January 10, 2013 Leave a Comment

Battle of Billionaires Commences: Dan Loeb Bets Against Ackman, Puts Over $300M In the Game

Dan Loeb, Herbalife MLM lawyerHerb Greenberg of CNBC said it best on his twitter feed:

“ackman/loeb is classic: two smart guys, same set of books/info, totally different analyst. that’s what makes markets!”

Billionaire Dan Loeb places a $300,000,000+ bet AGAINST Ackman in favor of Herbalife, arguing that Ackman’s short-thesis is “preposterous.” In Third Point’s Q4 letter to investors, Loeb explains his optimism for the potential of Herbalife ($HLF). The full letter to investors is included below. The key sections dealing with Herbalife have been cut and pasted below for your convenience. Take care and stay tuned. There’s bound be some collateral damage when Wall Street giants collide. Note, Herbalife is scheduled to issue a rebuttal on January 10th regarding Ackman’s pyramid allegations. .

Excerpts from Loeb’s Letter to Investors

Herbalife is a leading provider of weight management and nutritional supplements
operating in more than 80 countries through a network of independent distributors. The stock declined by nearly half last month following controversial assertions made by a short seller about Herbalife’s business model and practices. Third Point has a different view and holds about 8% of Herbalife outstanding common stock, which we acquired mostly during the panicked selling that followed the short seller’s dramatic claims.

Based on its strong financial performance, Herbalife is a classic “compounder” – a well-managed company that sustains consistent top-line growth, has a leading market position, and steadily increases margins, earnings per share and free cash flow while demonstrating shareholder-friendly behavior. Since going public in 2004, Herbalife has increased revenue at a double digit rate for seven of the past eight years, expanded gross and operating margins, leveraged operating expenses, and introduced more premium products. Earnings per share have increased by approximately 20-50% each year since 2004, with the exception of 2009. Led by CEO Michael Johnson, management has also used the company’s ample free cash flow to de-lever its balance sheet and shrink the share count by nearly 25%. This type of steady non-cyclical growth is hard to find and puts Herbalife at the head of the compounders’ class.

With results like these, the case against Herbalife rests on a bold claim that the company is a fraud. The short seller’s lengthy argument against the Company can be boiled down to three principal smoking guns: the first, a claim that Herbalife has been operating an “illegal pyramid scheme” under the nose of the Federal Trade Commission for the past 32 years; the second, that Herbalife’s loyal customer and distributor base has been exploited and harmed despite the low number of consumer complaints and generous company return policies; and the third, a claim that Herbalife’s products are commodities sold at inflated prices not supported by sufficient levels of advertising or R&D.

Taken in reverse order, the third claim misses an essential truth that invalidates the indictment. No one believes Starbucks is a scam because you can buy a cheaper cup of coffee at your local bodega. A key contributor to Herbalife’s growth has been its distributor-led “Nutrition Clubs”, where consumers can purchase single servings of the Company’s signature beverages. The short seller’s assertion ignores the significant value customers place on every consumer brand and its community “experience” – whether at a Herbalife Nutrition Club, a Starbucks, or a corner bar. The markup is merited by community and brand identity, not by the commodity itself.

The second claim seems similarly dubious. The FTC, by all accounts, receives a very low volume of complaints annually about Herbalife – fewer than forty per year – and we find it hard to believe the short seller’s theory that hundreds of thousands of people who have been scammed supposedly are too ashamed to speak up. Herbalife is well-known for its generous return policies, buying back product from exiting distributors for up to twelve months. The Company repurchases an average of only 1% of sales volume pursuant to this policy. It is difficult for us to understand why the buyback volume would be so low if there are in fact so many unsatisfied consumers and distributors who presumably would not hesitate to be reunited with their cash.

The pyramid scheme is a serious accusation that we have studied closely with our advisors. We do not believe it has merit. The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for over three decades, and will shortly awaken (at the behest of hedge fund short seller) to shut down the Company. We find this thesis to be preposterous, particularly since the FTC has been sensitive to frauds of this kind. Since 1997, the FTC has brought 13 separate cases against alleged pyramid schemes. None of the companies that the FTC pursued had been in business for more than ten years and 11 of the 13 companies involved were less than five years old, suggesting the FTC actively protects consumers subjected to this type of behavior. The FTC has also aggressively pursued enforcement actions against similarly odious “deceptive business opportunity schemes” [see www.ftc.gov/opa/2012/ll/lostopp.shtm] under the “Business Opportunity Rule” (although this rule does not apply to multi-level marketers such as Herbalife).

. . . We also understand that Herbalife has a series of internal policies in place (based on a 1979 case involving Amway) designed to reduce the possibility of abuses that have been identified in other MLM structures.

Do such policies eliminate all possibilities of bad behavior? Most likely they do not, especially at a company with so many distributors. By the Company’s own admission, past irregularities and misbehavior have been detected and corrected. While the short seller’s presentation was lengthy, it presented no evidence to show that Herbalife has crossed a line that would compel regulators to shut it down. Indeed, there was very little “new” news in the presentation and when pressed in later interviews, even the short seller conceded that the FTC was not looking at Herbalife’s practices. In our experience, expert regulators like those at the FTC do not respond to sudden pressure from hedge fund whistleblowers by acceding blindly to their demands. Finally, even if there were some regulatory intervention that changed how the company does business, we are comforted by the fact that 80% of Herbalife’s revenues come from overseas.

So we return to our compounder thesis, available at an attractive discount, probably for a limited time only. We believe that continued strong operating performance combined with disciplined capital return could easily send the stock back towards its April highs. Let’s not forget: the business itself is performing well. Volume, revenue and earnings are all growing double digits and the balance sheet is largely unlevered. Management has a history of returning 100% of net income to shareholders in the form of dividends and buybacks. If management were to deploy its existing $950 million buyback authorization in the $40-45 range (only taking leverage to approximately 1.5x), we estimate that run-rate EPS for 2013 could be $5.50-5.70 using the reduced share count. Applying a modest 10-12x earnings multiple suggests Herbalife’s shares are worth $55-$68, offering 40-70% upside from here and making the company a compelling long investment for Third Point. Given that the Company has historically traded more in the 12-14x range (and traded at 16-20x earnings through much of 2011 and early 2012), the opportunity for the Company to tell its side of the story tomorrow at its Analyst Day in New York, and the significant short interest, we believe shares could even trade well above our current price target.

If you’re receiving this message via email, please click this link to review Loeb’s full letter to his investors.

Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM News Tagged With: , , , , ,
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