MLM Special Deals: The Fraud Ends Now

We’ve been tip-toeing around this issue for years.

The first question: Is it legal to offer distributors special incentives (in addition to the pay plan) to join a company? Yes. Just like it’s legal to hire the services of a doctor to promote a new medical device.

The second question: Is it legal when the company / distributor fail to disclose the existence of these deals? No. Actually, it’s fraud. And as an industry, it’s been going on for years. We’ve known about it, yet we’ve done very little to stop it (or even slow it down). I tried humor when I wrote why more disclosure is bad. I addressed it more assertively in my “Is It Better to Raid In Plain Sight” article when Epic was aggressively cutting deals. I addressed it from an academic standpoint four years ago in my article “Master Distributors: good or bad?

I’ve been dancing around it for years.

Here’s the bottom line: FAILURE TO DISCLOSE IS FRAUD! IT’S DECEPTIVE. In the competitive landscape of MLM, in order to stimulate recruitment, companies with cash are tempted to drink from the fraud-cup and poach from the more seasoned companies. When the “top leaders” make their move and boast of the benefits of the product and company, it creates synthetic success stories. It creates the appearance of momentum, which creates a more favorable recruiting environment.

What Do These Deals Look Like?

  • Distributors are paid in a multitude of ways. I’ve seen countless deals, and no two are the same. These distributors are incentivized by way of the following methods (or a combination):
  • Given a “power-leg” of volume, which makes it much easier for the distributor to derive income via the pay plan (easier path to larger commissions);
  • Given a percentage override on top of their entire organization i.e. 2% on all gross revenues accumulated in their downline;
  • Given monthly pay IN ADDITION to the payout of the compensation plan i.e. $10,000 per month on top of the payout;
  • Given a percentage of the enrollment fees captured by new participants in their organization;
  • Given preferred compensation based on gross volume i.e. the typical pay plan is disregarded, and a new one is used that pays out more based on gross volume for a specified period of time (“50% of all CV paid out as dollars);
  • Given substantial signing bonuses;
  • Given cash advances against future commission cycles.

Why Should Companies Care?

If companies are building their organizations the right way, brick by brick, deal-free…they’re having the fruits of their labor stolen. And because there’s so little discussion about this practice, it creates an environment where companies can raid effectively without consequence. The non-deal receiving distributors (“lemmings”) follow the distributors because, in most cases, these deal-receiving distributors are great communicators and great recruiters. The lemmings TRUST their upline. But if the lemmings actually knew there was a little extra in it for the promoters….it would slow things down dramatically. The magic would vanish and people would be in a better position to make informed decisions.

Another reason why companies should care: the pressure of these deals leads distributors to play the “my company is better than your company game” in an effort to raid their old groups. It’s like throwing red meat to hungry lions…it causes people to go on a recruiting frenzy, making aggressive claims along the way. In some egregious cases, the leaders are given authority by the company to cut individual deals at the leader’s discretion. This gives the leader more ammunition to raid deep.

What Does the Law Say?

Regarding undisclosed deals, it’s fraud. And it’s getting worse, not better. I’ve flirted with the subject in the past, without much luck. Troy Dooly has published some content about it, without much luck.

It’s time to be more direct. It needs to stop.

Back to the law: In their Testimonial and Endorsement Guidelines, the FTC states, “When there exists a connection between the endorser and the seller of the advertised product that might materially affect the weight or credibility of the endorsement (i.e., the connection is not reasonably expected by the audience), such connection must be fully disclosed. . . . “ These special deals are absolutely material and they absolutely affect the “credibility of the endorsement.” The FTC goes on to provide the following example:

Example 4: An ad for an anti-snoring product features a physician who says that he has seen dozens of products come on the market over the years and, in his opinion, this is the best ever. Consumers would expect the physician to be reasonably compensated for his appearance in the ad. Consumers are unlikely, however, to expect that the physician receives a percentage of gross product sales or that he owns part of the company, and either of these facts would likely materially affect the credibility that consumers attach to the endorsement. Accordingly, the advertisement should clearly and conspicuously disclose such a connection between the company and the physician.

In their FAQs on the subject, the FTC adds extra insight by answering related questions:

A famous athlete has thousands of followers on Twitter and is well-known as a spokesperson for a particular product. Does he have to disclose that he’s being paid every time he tweets about the product?

It depends on whether his readers understand he’s being paid to endorse that product. If they know he’s a paid endorser, no disclosure is needed. But if a significant number of his readers don’t know that, a disclosure would be needed. Determining whether followers are aware of a relationship could be tricky in many cases, so a disclosure is recommended.

I have a small network marketing business: advertisers pay me to distribute their products to members of my network who then try the product for free. How do the revised Guides affect me?

It’s a good practice to tell participants in your network that if they get products through your program, they should make it clear they got them for free. It also makes sense to advise your clients – the advertisers – that when they give free samples to your members, they should remind them of the importance of disclosing the relationship when members of your network praise their products. You might consider putting a program in place to check periodically whether your members are making these disclosures.

Based on these examples, it’s clear: if the FTC expects people to disclose that they received free product, they will certainly expect companies and distributors to disclose the existence of non-public financial arrangements.

And let’s not forget common sense: If someone is proclaiming the greatness of a company while under the influence of a special arrangement that’s NOT AVAILABLE TO THE PEOPLE THEY’RE RECRUITING, it’s misleading.

What happens now?

Ask! Just ASK. When you see a networker making a move, never feel embarrassed to ask “Were you given extra incentives to switch over? Did the upline kick in extra incentives to get you to switch?” If they actually answer, ask, “If not for the incentives, would you join this company as a new distributor?” I’m sure you’ll be attacked, because you’ll be honing in on a very sensitive subject. Basically, you’ll be questioning their integrity because deep down, they know its shady to withhold that kind of information.

Where should you start? Whenever you see an announcement on Business for Home, ask in the comments. Ted Nuyten over at Business for Home is a friend. I like him personally. But his site frequently gets used by companies looking to create a sense of momentum when, in some cases, the momentum is fabricated. When you see announcements about big moves, ask.

If the company cutting undisclosed deals is a DSA member, file an online Code of Ethics complaint here. Reference Section A of the Code of Ethics (available here). Section A prohibits unethical recruiting practices.

As a corporate leader, if you refuse to cut deals, stand up and make yourselves known. Let people see that you’re willing to forgo quick cash for an honorable organization. The average distributor will trust you more, creating more long-term value in your company. I’ll recognize those companies on this site in a separate page.

Conclusion

If this is the first time you’re learning of this issue, how does it make you feel? How can we work together to stop it?

If you’re reading this via email, the video can be viewed here.

Eric Worre’s Go Pro Recruiting Mastery Event

Network Marketing Go Pro 2014

Wow! It’s all I can say about it. I’m not easily excited, and I’m incredibly excited to share with you what I observed at this event. I was deeply honored when Eric asked me to speak at his 2014 Go Pro event in November. When I say “deeply honored,” I really mean it. With speakers like Todd Falcone, Jordan Adler, Chris Brogan, Les Brown, Richard Brooke, Eric Worre, Harry Dent, Paul Pilzer, Kevin Harrington and the lovely Donna Johnson….I was by far the least qualified of the speakers. It’s like being chosen for the all-star team and I was happy to serve as best I could.

I was blown away. Eric Worre has really cracked the code. I’m not a sales kind of person, and if you’ve been reading my blog over the past several years, I never get excited and I never promote. I’m funny about what I do with your attention (which I value and appreciate very much). At this event, people were talking about ethics, integrity, character, trust…elevating network marketing by committing, as a unified community, to doing things right. There were countless companies represented, several thousand distributors from all across the world….and it was a safe environment for everyone. There was no recruiting! Distributors came together to learn about best practices, as a unified group.

This is one thing I appreciate about Eric: he’s not willfully ignorant. He’s not putting his head in the sand, ignoring the problems in network marketing while proclaiming its virtues. He honestly admits that there’s room for improvement, and he confronts those issues. In order to advance as a community, we’ve got to have an adult conversation about the challenges so we can figure out what we need to solve. At this event, speakers were talking about the importance of avoiding hype, the importance of income disclosures, the importance of transparency, honor, etc. As a professional that’s been beating on this drum for several years, it was very encouraging to witness.

I was not paid as a speaker. I do not get paid via ticket sales. There’s no “catch.” I’m promoting the next event because I think the value exceeds the price. I have no idea if I’ll be speaking at it next year. But I do know that I’ll be there. Companies are starting to SAVE money by NOT having a convention and sending their folks to this one. It’s a safe environment where people learn the basics and walk away with a lot more belief. If a client is unable to draw a decent audience for their own convention, I’m going to recommend that they simply send their folks to this one.

Plus, Tony Robbins is going to be there next year. TONY ROBBINS!

Get a ticket. Click here to put your name on a list for next year’s event.

I’ve also included some pictures from this year’s event. I wish I took more! My wife, Sharon, and I had such a wonderful time. If you’re reading this via email, the photos can be viewed here.

Pershing Square’s lawyer, David Klafter, Sends a Letter to Herbalife’s Chief of Compliance, Pamela Jones Harbour

AdviceDavid Klafter, Senior counsel at Pershing Square, wrote an extensive letter to Herbalife’s new chief of compliance, Pamela Jones Harbour. Before diving into the letter, the basics:

Pam Harbour was a former FTC Commissioner. The FTC is led by 5 commissioners, she was one of them for 7 years. She recently took a position as head of compliance at Herbalife. Based on public comments, she’s been given tremendous authority.

David Klafter is a lawyer. He’s obviously well qualified and talented. With that being said, in this arena, I think it’s safe to assume the following:

He’s never represented a network marketing company;
He’s never represented a distributor in a network marketing company;
He’s never represented a network marketing company against Federal regulators;
He’s never worked with a compliance department in a network marketing company;
He’s never given advice on the appropriateness of penalties for compliance violations;
He’s never sued a network marketing company;
He’s published no articles, neither academic nor online, relative to the network marketing industry.

I’m not saying he’s a bad lawyer. He’s actually a good one. But it’s important to step back and look at the full picture.

As for his employer, Bill Ackman: Ackman warns PwC

He’s vowed to “go to the end of the earth” with his assault on Herbalife;
He’s bet $1,000,000,000 on Herbalife’s demise, accusing them of being a sophisticated pyramid scheme;
He’s spent $50,000,000 researching / attacking Herbalife;
He’s being investigated by the SEC for Insider Trading;
He’s counting on the Federal government to bail him out of his bet with Herbalife, hoping for regulatory action;
He’s suing the Federal government over Fannie Mae and Freddie Mac;
He’s been busy bribing / lobbying Congress to stimulate regulatory pressure. There’s nothing illegal about bribing people in Congress…money in politics is a disgusting reality these days;
He secretly promised a disgruntled former Herbalife executive as much as $3.6 million over 10 years if he blew the whistle.

With all of that being said, it was very magnanimous of Pershing Square to offer assistance to Pamala Harbour.

Since you now have a little more context into the history, it’s time to dive into the letter (available here if you’re reading this via email).

I’ve always believed it to be important to understand from the critic’s point of view. When I process all of the information, both good and bad, I feel I’m in a better position to give advice and make decisions. The “we’re completely right and they’re completely wrong” attitude is held by many in the MLM industry, and it’s juvenile and stupid. This eyes-wide-shut mentality has led to the proliferation of countless scams, all operating under the guise of legitimate network marketing. The largest trade association of network marketing companies, the DSA, has failed to appreciate the enormity of this problem. It’s this failure to spot these issues both inside and outside of its walls has led some member companies to question their continued involvement.

To steal a word from Herb Greenberg, the industry is due for a reset. Based on methodologies, this reset will impact some companies more than others. But make no mistake about it, the screws are about to be tightened and companies will no longer be able to turn a blind eye to questionable activities in the field. The days of “faux compliance” are over.

The question that has analysts on Wall Street scratching their heads: How will this reset affect Herbalife’s revenue? Is the more responsible Herbalife capable of producing similar results as the pre-Ackman Herbalife?

The reality is that the industry absolutely needs to improve. It’s true that many of the sins being referenced by Pershing Square are indeed problematic. Do those transgressions warrant an injunction? No. Is Herbalife a pyramid scheme? No. Have they been caught in the middle of some embarrassing mistakes? Yes. Will they continue to grow? Yes.

In my opinion, unless he exits from his position, Ackman is not going to profit from his gamble with Herbalife. Instead, he’s made an investment that will ultimately benefit the entire network marketing industry, revealing the vulnerabilities and leading to eventual reforms.

Back to the letter…

It’s hard to take this letter seriously when it starts off by saying “[W]e believe Herbalife operates the largest and best managed pyramid scheme in the world.” And with that being said, Klafter proceeds to offer Harbour some free advice.

He does have some good ideas. His compliance recommendations, of which he makes 17, can be boiled down to 2 categories:

(1) Transparency
(2) Authority

Transparency

DisclosuresThe majority of the letter is dedicated to Herbalife’s purported lack of adequate income disclosures. According to Klafter, Herbalife’s current income disclosure document needs to be more robust. Klafter appears to think that more substantial disclosures will result in fewer enrollments and less revenue. He writes, “It is the image (true or not) of their financial success that motivates existing distributors to continue investing time and money, and arms these top distributors with an essential deception that they use to lure new recruits into the scheme.”

He accuses Herbalife of condoning a “fake it till you make it” culture. Earlier in the letter, he writes, “Consider what would happen if, in all meetings with potential recruits, the recruiters were required to remind the audience clearly of certain key facts, for example: 88% earn nothing from the Company; Most money goes to the top 1%; Members churn rapidly; Most distributors suffer net losses. . . ”

Cultures of hype and hyperbole are problematic and do exist. Is it inherent in Herbalife’s culture? Does Herbalife sanitize this sort of behavior with its income disclosure measures? It’s not for me to decide.

Will an increase in disclosures slow down enrollments? No.

I have had numerous clients become more aggressive with its disclosures of average earnings. I’ve seen a client go so far as to say, on camera, “there’s a good chance you’re not going to make any money in this business.” As it turns out, the majority of people aren’t stupid. People intuitively know that there are no guarantees in anything, especially with an income opportunity. When they hear clear messages regarding average earnings, their level of Trust for a company increases, which is actually good for business.

As pointed out by Plaintiff’s counsel in the proposed settlement order in the class action case, “Herbalife claims, and has produced some documents and information indicating, that, since it began publishing the information regarding the winners and losers in its 2012 Statement of Average Gross Compensation [which contained more information regarding the average results], the number of people becoming new Herbalife members has not declined at all. In fact, new memberships have increased. In other words, Herbalife argues that after it began disclosing more information about those who received no payment from Herbalife in its SAGCs, there was no ‘impact’ on the number of people who wanted to become Herbalife members.”

While Klafter is looking to give Herbalife a poison pill, one that he thinks will lead to their end, pressuring them to up their game with income disclosures is not it.

Regarding the sale of “recruiting materials,” Klafter might have traction here. In some companies, particularly the older ones like Amway and Herbalife, some sales leaders have historically made additional income selling “tools.” In some cases, this “additional income” dramatically exceeds the money provided by the MLM. With Herbalife, it has come out that some of their leaders have earned significant incomes from the sales of leads (an old practice, recently shut down) and tools. The issue: It can be construed as misleading when leaders are showing images of wealth at an opportunity meeting when the source of that wealth was not from the sale of products. Amway has bled because of this very issue, being the main driver for its $50M+ settlement to a class action case. If leaders are talking about yachts and mansions while they’ve only made $200,000 from an MLM and $2,000,000 from tool sales, it’s a problem.

Companies in the industry need to be better when it comes to MLM income disclosures. The rules are simple. Whenever money is discussed, the prospect needs to see the average earnings. Instead of simply checking a box where the new person asserts that he or she has seen the disclosure document, I recommend that companies be more clear and have the prospects assert “I understand that the average participant earns a net income of $20 in this business.”

Authority

BOSTON_BOMB3_2541703bThis other category of his compliance suggestions is far more interesting. And candidly, I had never considered these sorts of concepts. Basically, Klafter expresses his hope that Pamela Harbour will have enough authority to protect consumers, regardless of the impact it may have on her employer. This is made clear in the letter when he writes:

“You may find yourself at the fulcrum of choosing between protecting consumers or protecting the Company. Based upon our research, we do not believe you can do both.”

He wants Harbour to have the authority to act independent, free from company pressure, to protect consumers. I’ve seen this sort of conflict inside companies between compliance administrators and company executives. Field leaders will align themselves with company executives, insulating themselves from the big, bad compliance department. When it comes time for the compliance department to root out bad behaviors, the distributors run to mom and dad and ask for protection. And more often than not, they get protection.

He also pushes for the compliance department to have the authority to retain separate legal counsel and/or report wrongdoings to the proper authorities without fear of termination.

His compliance suggestions are summarized below:

Modifications to rules to allow online selling

This is a poison pill. Herbalife, along with every other network marketing company, has every incentive to protect its channel of distribution. Online selling (via eBay and other third-party sites) should never be allowed because it completely undermines the field’s ability to sell. And candidly, online selling amounts to less than 1% of all sales activity.

Public announcements of the imposition of sanctions.

I call this the “head on a stake” policy. I’ve seen companies do it and it’s effective.

Protections for compliance admin to allow them to work without fear of termination.

This is interesting. It’s important; however, I’m drawing a blank as to how to execute this at the employment level. People can be fired for anything (in most states); thus, it would be hard for a compliance officer to argue that he or she was terminated because of their actions against distributors.

Independence of compliance from senior executives and senior distributors, such that top distributors are prohibited from inserting themselves into investigations.

This is very important. I’ve never seen a compliance admin be given the ultimate freedom to sanction distributors without an executive’s authority. And executives are under tremendous pressure to protect the relationship with top-leaders; thus, there’s usually a bit of a conflict between protecting consumers and protecting the leaders.

An anonymous procedure for receiving and investigating wrong-doing.

I call this a “911 Mechanism” where people can report bad activity. Most companies already have this in place.

An extensive monitoring system to capture distributor promotional material.

These tools exist. It’s my understanding Herbalife has some cutting edge tools to search content on YouTube and other areas of the web.

Making top distributors responsible for conduct in their downline.

I like it. If the distributors are going to profit from the bad behavior, they need to also share in the consequences.

Imposition of material financial sanctions to those who profit from wrongdoing.

I like it. I would surmise that regulators want to see more than slaps on the wrist when fraud in the field is detected.

Authority for the compliance department to engage separate legal counsel.

This is interesting. I’m not sure how it would work logistically, though.

Authority for the compliance department to refer matters to Federal, State and local regulators.

This is also interesting. I actually agree with it, provided that this authority is used sparingly. I’ve seen clients of mine snitch on field leaders AFTER the leaders were terminated, to give the authorities a heads up. It’s a pro-active way of saying “If you see this knukcle-head, he’s not with us!”

Conclusion

Regarding Herbalife, these changes, if adopted, would not sink the organization as many critics hope. I have found that investments in tighter compliance processes leads to MORE growth, not less. Compliance kills pyramid schemes, not legitimate companies that offer real products. While Herbalife’s domestic revenue has slowed as the field is absorbing these changes, it’s not going to collapse.

Regarding the network marketing community in general, some of these suggestions are worth considering. If done properly, a robust compliance department can actually be really good for business.

It’s true that some companies operate with a “veneer” of compliance, without taking it seriously with the hopes of fooling regulators. Those days are long-gone. The sooner companies come to terms with this reality, the safer they’ll be. Build the ark before it rains.

What do you think? Do you think some of these ideas could fly?

Pershing Square Letter to Pamela Jones Harbour by kevin_thompson

Herbalife Settles Bostick Class Action Case

Herbalife announced its settlement to a class action lawsuit. The case was filed within months of Bill Ackman’s initial presentation where he announced his short position, so it could be an example of a law firm seizing on “blood in the water.” But I digress…

The settlement basically amounts to two things: (1) $15,000,000 in cash for product refunds and remuneration for excessive business expenses (with $5M of that fund going to the lawyers); and (2) Several reforms to Herbalife’s marketing practices. Candidly, Herbalife is already doing most (if not all) of the reforms required as part of this settlement. The cash portion of the settlement was quite smaller than I anticipated, given the size of Amway’s settlement to a similar lawsuit a few years ago ($60,000,000).

Already, there’s a group that’s announced they’re going to oppose the settlement. Brent Wilkes, the director of the League of the United Latin American Citizens (“LULAC”) said via a NY Post Article, “We plan to object to the settlement because it won’t begin to pay for the true damages that Herbalife has caused this class.” On a related topic, I have for a few months suspected that Bill Ackman promised to contribute some of his gains (if the bet goes his way) to various civic organizations. I suspect that LULAC is on that list. I sent both Brent Wilkes and LULAC a message via Twitter on Monday morning asking if any funds were promised. I have yet to receive a response. The question is relevant, in my opinion, because it’s important for all material facts to be fully disclosed. If there’s financial motivation in the background, the public deserves to know so the attacks can be judged accordingly. Again, it’s an unconfirmed suspicion. When I get a response, I’ll update the article.

UPDATE: See below. Brent Wilkes denies having any financial motivation in his attacks against Herbalife.

The required corporate reforms are included below. h/t to Seeking Alpha contributor, Ben_Nimaj for typing it up.

1) Simplified Pricing Structure: combine “Package & Handling” and “Order Shipping Charge” into a single “Shipping & Handling” charge

2) Differentiate “Members” and “Distributors”

3) Discourage members from incurring debt to buy product

4) Pay return shipping charges for legitimately returned product

5) Prohibit members from selling “leads” to or purchasing “leads” from other members

6) Prohibit the purchase of product as a condition of being a member

7) maintain procedures for enforcement of these and other rules, ie. implement a member compliance department

8) Include the Statement of Average Gross Compensation (SAGC) of member with any membership application

9) Require any applicant to actually acknowledge having reviewed the SAGC

10) The SAGC must contain the total number and percentage of all members who do not receive any compensation payment directly from Herbalife, [not just numbers from members that actually made money].

Bostick v Herbalife_Preliminary Settlement by kevin_thompson

Time to Revisit DSA’s Code of Ethics: Suggestions

It’s old news now. Avon left the DSA. In their announcement, they stated the DSA’s Code of Ethics needed revision. Specifically, Cheryl Heinonen at Avon said, “We believe the association’s agenda in the U.S. is overly focused on the issues of a few specific brands rather than industry-wide challenges. . . We believe that the U.S. DSA Code of Ethics requires updating to better reflect the current state of the industry in the U.S.”

In a separate article in the Washington Post, Heinonen gave a quote that shed a little light on what she meant. She said,

I think it’s problematic when you sell inventory — bulk product — that the person who is acquiring it can’t use themselves and sometimes may not know how to sell,” Heinonen said. She added that the language in the trade association’s code of ethics on this point and other aspects of consumer protection need to be firmer.

The problem: inventory loading. And I’ll drill down a little deeper because inventory loading, when it exists, is a symptom of a larger problem: lack of product value. In other words, when there’s a lack of legitimate demand for product, companies incentivize participants to “load up” on items they might not want or need in an effort to qualify for bonuses.

The cure for this problem has historically been the 12-month refund policy. If you boil down the DSA’s Code of Ethics, the most valuable requirement is the 12-month refund policy. According to Avon, this is not enough. And I agree.

The DSA has invited people to propose changes to the Code. Here’s a start. Call it “The KT Optimus-Prime Plan” (everything is better when you use Transformer names).

(1) Proper Customer Coding

I suggest that companies be required to offer an option for Customers to receive product discounts without joining. The technology exists. The most basic of startup companies in the industry can pull this off. The Preferred Customer concept has been around for at least 5 years, possibly longer. Today, it’s a great source of confusion when we, as an industry, say “We’re not able to deduce the amount of customer activity because many people join to save money on product.” While it’s a true statement, we’re in a position to clear this ambiguity and offer clean data. The alternative is nebulous and unprovable (short of paying for surveys, which has been done by Herbalife). Understand, it’s not illegal to operate without a preferred customer option. The absence of a customer option is not conclusive proof of fraud; thus, it’s not legally required. But, in my opinion, the DSA should not want to swim with average, they should strive to be above-average. Currently, the 12-month refund requirement is good, but by itself, it’s not good enough. There’s a cancer that has developed where companies, using the DSA’s Code, are “looking good” without actually being good.

Requiring that companies clearly track their buyer motivations / offering a clear path for customers will help eliminate all doubt regarding the motivations driving volume consumption. There’s no need to mandate the AMOUNT that needs to come via customers, just to have the ability to clearly track the data.

Also, along these same lines, when it comes to direct sales i.e. belly to belly sales, there needs to be a requirement that companies accumulate receipts from their sales leaders. The excuse that “we’re not able to track the retail activity in the field” needs to end. In the past, the excuse was reasonable. Going forward, it makes little sense.

The downside (or upside, depending on how you view it): regulators, via a subpoena, will be able to clearly see the amount of customer activity.

An argument against this concept: “When people join to save money on product, they might turn out to be productive distributors later.” In my opinion, the likelihood of these participants producing significant volume is slim; thus, the upside is not worth the alternative.

(2) Zero Personal Volume Requirements

This should be easier than the #1 idea above. It’s common for companies to require personal volume each month for participants to earn commissions i.e. move $100 worth of product to remain qualified for bonuses. While companies are smart enough to construct this in a way where it’s technically not required for people to buy the product (because they can qualify by SELLING too), in most cases, participants get on autoship and self-qualify. This is not illegal; however, the concept has been abused. It leads people to buy things they might not otherwise want or need in order to remain qualified for bonuses.

This sort of rule would be consistent with the current state of the law. In BurnLounge, the court cited the fact that participants were required to purchase products in order to qualify for commissions. This fact was used to prove that the participants were buying products primarily to qualify for money instead of the value. While companies today can argue that participants are technically not required to buy, BurnLounge also teaches us that courts and regulators will look at how companies “operate in practice.” If the vast majority of participants qualify via an autoship, it matters not what’s on paper. It’ll be used as proof to show that the opportunity is driving consumption, not the products. Yes, it might be more difficult for companies to get participants to buy products. But if participants do not WANT to buy product, why force them? The DSA, in my opinion, should create space here.

(3) Income Disclosure Statements

The DSA should require its member companies to publish average earnings. We know that EVERYONE makes income claims in the industry. When recruiting, the question always comes up: “What’s in for me?” The pay plan has to be explained, which means that income will be referenced. It’s not illegal to make income claims. It is, however, misleading to make income claims WITHOUT ADEQUATE DISCLOSURE. With this in mind, why allow companies admittance without a solid income disclosure document?

(4) Undisclosed Financial Arrangements

It’s common in the industry for a company to offer additional compensation to leaders in exchange for them leaving another company. While the agreements never explicitly say “We’re paying you to leave Organization X and raid your old downline,” they might as well. This sort of behavior has spun out of control, causing companies to rip into each other and there needs to be a clear signal at the highest levels that this will not be tolerated.

First, the FTC’s Testimonial and Endorsement Guidelines strongly suggests that these sorts of undisclosed deals are fraudulent. I wrote an article on the subject in June of 2010 here.

Second, these sorts of deals are not illegal. It’s only a problem when there’s no disclosure. If the DSA were to require that these deals be disclosed, it might actually curb the activity.

Third, these sorts of deals are bad for the industry because, candidly, they rarely make economic sense. The leader leaves, boasts about the greatness of the new company, takes very few people with him or her and subsequently crashes. This leaves hyperbolic activity in the industry where companies are trying to out-hype each other.

Fourth, the DSA’s Code Administrator, when put onto the case, can easily deduce if a deal has been struck and whether the deal was publicly disclosed.

(5) Compliance Training

Rule 11 in the Code of Ethics states: “Member companies shall provide adequate training to enable independent salespeople to operate ethically.” But what does this mean? If companies are going to be allowed to sell starter packs ranging in price between $500 and $2,000, there needs to be solid training to ensure that the inventory moves properly. Compliance training can be delivered a number of ways: videos, email blasts, etc. If a new distributor was promised easy money, the time to cure this false expectation is at the beginning of their tenure. This is where the company can explain its refund policy, explain that success takes work and also reference its income disclosure statement. And, if the company were confident, it would be a great opportunity to suggest that if the distributor wants easy money, they should quit now and get a refund.

(6) Sales Aides

The Code needs to improve in this category by clearly prohibiting the practice of paying commissions on sales aides. First, it’s clearly pyramiding. Sales aides are not commissionable because there’s no market for the products beyond the network itself i.e. there’s no opportunity for customer sales, i.e x 2 the resulting rewards are “unrelated to product sales to ‘ultimate users,’ i.e. x 3 it’s pyramiding. The Code tries to create space from this practice by saying, “This Code provision is not intended to endorse marketing plans that provide financial benefits to independent salespeople for the sale of company-produced promotional materials, sales aids or kits (“tools”).” The Code needs to revisit this issue and address it head-on.

If the company, or its leaders in the field, sell tools and pay commissions on those tools, they need to adjust or get out. Tool sales are highly profitable, leading sellers to focus primarily on recruiting new participants to expand the market for those tools (because there’s no market outside the network itself; thus, recruiting is the only way to maximize profitability). It leads to a twisted culture in the field, one that depends on hype and hyperbole. The DSA needs to create space here.

Conclusion

It’s time to have an honest discussion about the future of the industry. Candidly, it’s BEEN time for several years. But, it sometimes takes a good crisis to mobilize support for change. Avon’s departure is a good catalyst for this sort of discussion. I’m not a fan of closed door meetings. Transparency is key. And transparency, at times, makes people uncomfortable. If you know me by now, you know that I’m not one to “kiss the hand” and play political games. In other words, I’m not trying to be liked by everyone.

Leadership at the DSA needs to understand that building a consensus on any of these issues is going to be impossible. In order to “tighten the screws,” it’s going to frustrate some member companies. It needs to prepare itself for a little internal-controversy. Candidly, the DSA avoiding some of these issues has also frustrated members, leading to Avon’s departure. Avon was not a fluke. While this subject matter is unpopular, it’s very important for the health of the industry. I think the best ideas come by way of open discussion. And I’m not afraid to lead it.

Do you agree with any of the “KT Optimus-Prime Plan” items referenced above? Disagree?

Don’t be bashful. Share your thoughts and share this article.


Avon Writes Open Letter to DSA Members Regarding Its Decision to Leave

Avon has recently announced its exit from the Direct Selling Association.  The video includes my thoughts. This is a very significant development and represents extreme discomfort experienced by companies in the industry. The reasons for Avon’s exit. I’ll sum it up: (1) They’re not feeling the love. They feel as though other companies, the companies that do not quite match Avon’s values, are setting the DSA’s agenda; (2) They’re not happy with the current Code of Ethics. They feel it should be updated and that the current Code has too many holes; thus, minimizing the effectiveness of “self regulation.” Watch the video. Read Avon’s letter. This is an important subject to process.

Beginning of letter (h/t to Matt Stewart for transcribing the letter)

To our U.S. direct selling colleagues,

At Avon, we strongly believe in the power of direct selling to enhance people’s lives. Our entire business model is based on our commitment to helping women build better lives for themselves and their families. And we know that multi-level marketing, in some markets and with the appropriate guardrails, is a robust and effective channel for distributing products to consumers.

As you may be aware, this week Avon made the decision to exit the U.S. DSA. This decision came after careful consideration and more than a year of thoughtful discussion. This decision was driven by two key issues:

• We believe the association’s agenda in the U.S. is overly focused on the issues of a few specific brands rather than industry-wide challenges.

• We believe that the U.S. DSA Code of Ethics requires updating to better reflect the current state of the industry in the U.S.

As the U.S. DSA is currently operating, we do not believe that either of these issues will be addressed.

Like any industry, direct selling and multi-level marketing evolve and the associations that support the direct selling industry need to evolve as well. As one of the largest direct selling companies in the world, we at Avon feel that it is our duty and responsibility to protect those just starting out in the industry, as well as those who have made careers as independent direct sellers.

In the U.S., we believe there is a need to enhance the DSA Code of Ethics to better ensure that individuals entering direct selling have the benefit of adequate safeguards. If and when these issues are better addressed by the U.S. DSA in a way that is supportive of the industry as a whole, we would re-consider our membership.

Avon is not exiting the World Federation of Direct Selling Associations (WFDSA}, local market DSAs, or other direct selling trade organizations outside of the United States. We continue to believe that industry associations play an important role for Avon and you, our direct selling peers.

As it relates to Direct Selling Associations (DSAs} around the world, Avon has a long history of involvement. In fact, we were a founding member of many of these organizations. The Direct Selling Code of Ethics, as administered by the DSAs, is a key component of the industry’s self-regulation.

Accordingly, Avon abides by the World Federation of Direct Sellers “Code of Ethics.” There are three major aspects of our business model that we believe further safeguard our Representatives and consumers.

1. The Avon business model does not rely on nor does it encourage sales of inventory, training or business support materials between Representatives. The     core of our business model is Representatives selling our products to an end consumer.

2. Avon has reasonable return policies.  Representatives are not left holding excess inventory.

3. Avon limits earnings to three generations. We do not promise commissions on infinite sales. Rather, we primarily promote and incentivize            Representatives based on their sales to Customers.

By adhering to these principles in every market where we operate, we protect our Representatives and help ensure new recruits have a positive experience with direct selling.

It is also important to consider how consumers view direct selling. Avon’s message to consumers is:

At its best, direct selling is “I tried the product. I liked the product. I recommended it to a friend.” If you are considering entering direct sales (or ‘social selling’) here are three tips to remember:

1. Like the product! Make sure it’s a product you use and enjoy yourself. You will be selling to your friends, family, neighbors and co-workers.

2. Understand the product. All good direct selling/social selling companies will provide training and mentoring support. But you should not need to invest heavily in start-up training and marketing materials.

3. Know who you are buying from and who is paying you. When ordering product for your customers, make sure you will be purchasing from the Company, not the individual who recruited you into selling, and that your earnings will be paid by the Company.

With over $32 billion in sales in 2013, direct sales continues to be a vibrant and growing industry in the United States. Every day, people across the country looking to earn extra money are signing up to become direct sellers. These women and men are hoping to build a business, unlock additional earnings, start a college fund for their children, buy a new car or simply supplement their current income

For well over a century, Avon has been committed to assuring that direct selling remains a viable option for individuals looking for financial empowerment. Our commitment to our Representatives today and in the future will not waiver.

Cheryl Heinonen

Senior Vice President, Corporate Relations & Chief Communications Officer  Avon Products.

Avon Exits the DSA

FTC Settles with TriVita. Is the word “Inflammation” off limits when you’re selling a health product?

InflammationThe FTC has spoken and we better pay attention. Recently, the FTC announced a $3.5M settlement with TriVita, a network marketing company. TriVita is an Arizona corporation that advertises, markets, distributes, and sells Nopalea. Nopelea is a nutrient rich drink derived from the superfruit of the Nopal cactus. TriVita peppered the marketplace with an aggressive marketing campaign that touted the curative properties of Nopelea. The theme of the advertisements: Nopalea is a drink that will reduce bodily inflammation, which will lead to a reduction in pain associated with inflammation-related diseases.

In May, the FTC obtained an Injunction against TriVita because of the aggressive claims. In the lawsuit, the FTC found the following claims about Nopalea offensive:

• Significantly reduces or eliminates the effects of inflammation on the body
• Provides significant relief from pain, including but not limited to, chronic pain, joint pain, back pain, nerve pain, phantom pain, and pain from inflammation, arthritis, fibromyalgia, surgical procedures, or other conditions;
• Significantly reduces or relieves swelling of joints and muscles;
• Significantly improves breathing or provides significant relief from respiratory conditions, including but not limited to, sinus infections; or
• Provides significant relief from skin conditions, including but not limited to psoriasis.

The FTC found these claims to be disease claims. The FDA defines disease as “damage to an organ, part, structure, or system of the body such that it does not function properly (e.g., cardiovascular disease), or a state of health leading to such dysfunctioning (e.g., hypertension).” Under this definition, a common cold is considered a “disease.” Basically, if an ingredient is marketed expressly or implicitly as having any kind of positive effect on a disease (as defined above), it’ll be treated as a disease claim and subject to further regulations/penalties.

As a result of the settlement, TriVita has agreed to pay a $3.5M fine a refrain implying that its product can be used in the treatment of any diseases.

Regarding the product claims above, they’re obviously over the line. References to diseases like arthritis, fibromyalgia, sinus infections and psoriasis are obvious examples of what not to do.

But what about inflammation?

If a company states that a product can limit the effects of inflammation, is that considered a “disease claim.” In this article by MonaVie, the word “inflammation” is referenced 16 times. Vemma went so far as to commissioning a report on Vemma’s affect on inflammation. I’m not picking on MonaVie and Vemma, I’m just referencing the links to show that it’s quite common for juice companies to talk about their products’ affect on inflammation in the body.

The big question is whether “inflammation” is now in the government’s little black book of unusable words. Based on their position in this case, it would certainly seem to be the case. While one could argue that TriVita was not sued SOLELY because of their use of the word inflammation, it was certainly a strong factor.

If a company promotes a product as an anti-inflammatory, the logical conclusion is that the field will take it one step further. While “inflammation” by itself is not a disease, the easy association of the word to several ailments will result in the inevitable (and predictable) disease claims. The field will naturally explain that inflammation is a leading cause of various diseases, with arthritis and fibromyalgia being on top of the list.

TriVita was too aggressive. Nopalea was advertised as a product that could do more than alleviate ailments, it was advertised as a product that could treat and cure. TriVita, and its field leaders, marketed the product explicitly as one that can mitigate horrible disease symptoms. They portrayed their product as the Ferrari of all anti-inflammatories.

Takeaway

The FTC is taking its job seriously. If a company is going to play in the gray with the word “inflammation,” it’s playing with fire. Again, “inflammation” might not be a disease by itself; however, it’s going to be nearly impossible to prevent field leaders from taking it to the next level. If a company insists on keeping the word “inflammation” in its marketing literature, it needs to take EXTRA precautions to ensure that the field is not extrapolating the message and stating that the product can cure or mitigate diseases associated with inflammation. This is where compliance enforcement is critical i.e. disciplining people when infractions are observed.

Bottom line: While it’s treacherous water to promote a product as one that can reduce inflammation, it’s not illegal to swim there. If the FTC or FDA releases a clear statement regarding their thoughts on whether “inflammation” is an actual disease, I’ll update this article. In the meantime, companies need to tread cautiously. Candidly, I would advise my clients to stop using the word “inflammation” because the message in the field is nearly impossible to control and the downside is too great.

What do you think? Do you think this is a fair outcome for TriVita? Should the word “inflammation” be a privilege only allowed by FDA approved drugs?

(ARTICLE FEATURED IN SEEKING ALPHA) Battle Over BurnLounge: Both sides claim victory

Below is an excerpt from my article about the Ninth Circuit opinion on BurnLounge.  The article can be read in full over at Seeking Alpha.  It’s an important subject.  Click here to read it.

Summary

  • The Court successfully threaded the needle on the issue of “ultimate users,” essentially creating two classes of participants.
  • The Court provided several factors throughout the opinion to help outsiders deduce the motivation driving consumption. This is especially helpful in assessing $HLF.
  • The Opinion will require the FTC’s pyramid scheme expert to create another analytical framework to distinguish pyramid schemes from legitimate direct selling companies (assuming they need one).
  • The Court adopted the logic provided by the FTC in its 2004 Staff Advisory Opinion.
  • The Court eliminated all confusion regarding Omnitrition as it completely ignored the widely referenced dicta that consumption from participants cannot count as sales to “ultimate users.”

On June 2nd, 2014, the Ninth Circuit published its long awaited BurnLounge Opinion. Within hours, both sides of the Herbalife battlefield issued statements claiming victory about the decision. I’ve taken the week to process the opinion. During this time, I’ve tried to keep up to speed with the online chatter regarding various interpretations. One thing is clear: the gray space in MLM law separating legitimate direct selling companies from pyramid schemes has been minimized considerably.

On the one side, Bill Ackman’s Pershing Square spun it as validation of its argument that commissions in the Herbalife plan were derived primarily by opportunity driven demand (recruitment rewards) instead of legitimate product consumption. On the other side, the MLM industry (myself included), breathed a sigh of relief, submitting that the decision validates a lot of our main points in responding to common criticisms of the model. This article is intended to cull out the key nuggets in the BurnLounge decision and interpret what it means going forward.

End of Excerpt

Click here to read the rest of the article on Seeking Alpha.  Seeking Alpha is a news site dedicated to publishing content about publicly traded companies.  The article took me quite a bit of time to prepare.  I hope you find it informative.

PRESS RELEASE FROM THE FTC: “When it comes to pyramid schemes, don’t be in denial”

If you’re reading this via email, please click the image above to view my video on the subject. 

The FTC is finally starting to talk, and we better pay attention. The FTC has recently announced a “Stipulated Order for Permanent Injunction” in its case against Fortune Hi Tech. There’s no surprise here…the founder of FHTM has recently passed away and there was not much to fight over once the initial injunction was in place.  The injunction is what we’ve been expecting: the company is prohibited from operating as an MLM and they’re ordered to pay cash to the government.  

In its announcement, the FTC communicated in plain English. Instead of giving you my perspective, I’m going to share their statement in full. It’s easy to read and it’ll give you an idea of what they find offensive. If I were to summarize (I know I told you I wouldn’t give my perspective, but I can’t help it), I’d say there were three things that caught the FTC’s attention regarding FHTM: (1) aggressive income claims with inadequate substantiation; (2) the emphasis of the marketing pitch was on recruitment instead of product value; (3) (you’re not going to deduce this from their statement below, but it was certainly a factor) the majority of the pay plan was driven by the volume from new participants i.e. front loading.

BEGINNING OF PRESS RELEASE, included in full

Promotional materials and live presentations for Fortune Hi-Tech Marketing used a lot of organizational jargon to recruit new people.  The first step:  Shell out start-up fees and monthly charges.  Next:  Recruit enough “independent reps” so you can work your way up through the ranks to Regional Sales Manager, Executive Sales Manager, National Sales Manager, Platinum Sales Manager, and ultimately “Presidential Ambassador.”  But the FTC and the State AGs of Illinois, Kentucky and North Carolina have another term for FHTM’s convoluted system of recruiting and compensation: They call it a pyramid scheme.

Last year, the FTC and the states sued FHTM, related companies, and individual defendants, alleging they deceptively claimed people would make big bucks by signing up to sell FHTM’s health and beauty products and services from other vendors.  What kind of bait did they dangle before would-be entrepreneurs?  According to one video, “Four months in . . . I had actually quadrupled what I have ever made as a Registered Nurse.”  One of FHTM’s Platinum Sales Managers said in a video that people who reach the upper levels were making between $30,000 and $70,000 per month.  During a recorded conference call posted on a team website, an FHTM Presidential Ambassador claimed that a colleague involved for only six months “earned over $50,000 in one month” and “millions and millions beyond that.”

Ultimately, more than 350,000 people enrolled, but the FTC and State AGs say the bottom line was a far cry from FHTM’s bluster.  After conducting its own investigation, the court-appointed receiver concluded that FHTM’s main business was recruiting new members and not selling stuff  – a key factor in differentiating a pyramid scheme from a legitimate multi-level marketing plan.  For example, 98% of participants lost more money than they made and at least 88% didn’t even recoup their enrollment fees.  To the extent people made any money, 81% of the payments to FHTM participants came from recruiting new members, not from sales.

To settle the case, the defendants have agreed to a lifetime ban from multilevel marketing.  The stipulated order imposes a judgment of more than $169 million, which will be partially suspended when they surrender certain assets with an estimated value of at least $7.75 million, including property from the estate of defendant Paul Orberson, who died while the case was pending.  What kind of valuables are we talking about?  A farm in Kentucky, a Florida condo, a house in South Carolina, a BMW, a Jeep, two boats, a sports memorabilia collection, coins, and bullion.  The jet skis?  They’re going, too.

What can bizopp buyers and sellers take from the case?

    • Right on the money?  Some bizopp sellers argue that earnings claims are just harmless puffery.  Wrong.  If you state – or imply – that people will achieve certain results, you need competent and reliable evidence to back up those promises.  And don’t think that one person’s unusually successful outcome will be sufficient to support a general money-making claim.  Save the cherry-picking for the pie.
       
    • United we stand.  The FTC and State AGs stand shoulder to shoulder to protect consumers from questionable money-making ventures.  Sometimes the cooperation is behind the scenes; other times we’ll file a case jointly.  Either way, we work together to ferret out fraud and deter deception.
       
    • A ruse by any other name.  The evidence showed that the FHTM defendants targeted Spanish-speaking consumers and members of immigrant communities for their shady pitch.  Deception is deception, regardless of the language or demographics.
       
    • A word for entrepreneurs.  View business opportunity pitches with a skeptical eye, especally if the person making the promises stands to make money from your participation.  Before investing so much as a nickel, run it past someone with proven business savvy who isn’t trying to sell you something.  The FTC has free resources in English and Spanish to help you evaluate the options, with specific advice on multilevel marketing.  One possible tip-off to a bizopp rip-off:  If the focus is less on selling the product and more on recruiting new members.
END PRESS RELEASE

If you’re reading this via email, click here to review the Stipulated Order for Permanent Injunction.

We Got it Done. DSA Model Legislation Passes in Tennessee

We got it done. I’ll be honest with you. Four years ago, when I originally tried to pass MY version of the anti-pyramid bill, I would never have guessed that I would’ve successfully collaborated with the DSA to get a bill passed. The DSA and I were on opposite sides of the aisle at that time. But…people grow. We grow wiser, experience things, we learn and we develop. The DSA Model Legislation was passed in my home state (Tennessee) with an overwhelming majority in the state house and senate. The DSA announced the good news today (and I got a little ink…as a Supplier Member, that’s a big deal;)

Click here for the full text of the Tennessee Anti-Pyramid Bill.

I’m going to share with you what led me to pick up the phone and reach out to Joe Mariano about this effort. I was watching the movie “Lincoln” starring my favorite actor, Daniel Day Lewis. There was a scene where Lincoln was chatting with staunch abolitionist Thaddeus Stevens. Stevens wanted Lincoln to draw a firmer line with respect to slavery. Lincoln’s words made sense to me:

“A compass, I learned when I was surveying, it’ll… it’ll point you True North from where you’re standing, but it’s got no advice about the swamps and deserts and chasms that you’ll encounter along the way. If in pursuit of your destination, you plunge ahead, heedless of obstacles, and achieve nothing more than to sink in a swamp… What’s the use of knowing True North?”

In life, it’s unwise to take extreme “I’m right, and you’re wrong!” positions. This is especially true with politics when it comes to language in a bill. Is the bill PERFECT? No. But legislation is not about perfection. Legislation / politics is about compromise. It’s about identifying shared goals with parties with unique interests and working towards those mutual goals, regardless if your personal preferences are fully met. 80% of something is better than 100% of nothing. At this juncture in the industry, it’s more important now than ever that PEOPLE WORK TOGETHER. This bill legitimizes the practice of paying commissions on internal consumption. It also has requirements for solid consumer protections i.e. 12 month buyback policies.

In this industry, battle lines are drawn between companies, vendors, distributors and Wall Street investors. With so many contrarian views, it’s impossible to pull out anything actionable that we agree on. At a time such as now, we all need to support a consistent vision that network marketing, when done appropriately, is a legitimate and viable means of distributing goods and services. The “when done appropriately” part is the part that trips us up. What’s appropriate? What distinguishes good from bad? There’s no consensus and, in my opinion, there’s never going to be a consensus without federal guidelines. In the meantime, groups in the industry need to LEAN IN and take some positions. At a minimum, people need to get behind the idea that paying commissions on internal consumption is legitimate provided that consumer safeguards are in place. Companies MUST refrain from encouraging/incentivizing distributors to load up on inventory they don’t really want in quantities they can’t really justify.

With other leaders in the industry, I want you to take a position. Don’t just talk about “elevating the profession.” I challenge you to propose some concrete ideas about how you intend on making it happen. As a unified front, there’s no stopping from advancing. But as a dispersed band of competitors, we’re weak.

Conclusion

I was pleased to get this effort going in Tennessee. And without the DSA communicating support, the effort would’ve died. Jeremy Durham, one of the bill’s sponsors said, “I was happy to work with Kevin Thompson and the DSA on this bill. Kevin’s credibility and expertise on the subject made it easier for us to get the support we needed for the bill. I’m always happy to serve my constituents and I’m very pleased with this result.”

Special thanks also goes out to Senator Jack Johnson who co-sponsored the bill from the State Senate. One of the reasons Tennessee is tearing it up economically compared to the other states: we’ve got great, pro-business leaders.