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by on May 22, 2013 Leave a 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 April 25, 2013 3 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 7 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

Filed Under: Distributor Resources, mlm attorney, mlm legal, MLM startup 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 December 14, 2012 1 Comment

MLM Detractor Blatantly Mischaracterizes the Law: Ignores Facts and Precedence

Bruce CraigRetired Wisconsin litigator, Bruce Craig, wrote an article featured on Seeking Alpha titled, “An Investor’s Guide to Identifying Pyramid Schemes.” While the title certainly implies a hint of objectivity, it’s simply false advertising . In a nutshell, the author holds on to his long-standing, 30+ year view that all MLMs are pyramids. Unfortunately, Craig willfully omits several well-known facts that obliterate his entire argument. It’s this kind of willful omission that makes him guilty of the very behavior he claims to be against.

Bruce’s thesis is simple: When analyzing a MLM for legality, retail sales do not matter…at all. In fact, he essentially concludes that all MLMs are illegal. If there’s any sort of recruitment element to a program, it’s “inherently deceptive” due to their “exponential characteristics.” In other words, with no limits on recruitment, epic doom is inevitable. This “all MLMs are pyramids” rationale is made crystal clear in Bruce Craig’s 2009 letter to the FTC when he says, “[The Amway case] has effectively legitimized pyramids, now called MLM’s.”

True North

I always respect people’s right to voice their opinions. While I might disagree with the points, I think good, open dialogue is the only path to progress. But…in the Seeking Alpha article, Bruce crosses a line. He is not providing objective, well-researched information to investors, as implied in the title. He’s making a carefully crafted argument. The article is “Outcome Determinative,” meaning he begins with the end in mind (all MLMs are pyramids) and stitches quotes together in support his argument. While making his argument, he leaves out several material bits of information.

Bruce Craig’s “True North” is ultimately protection of consumers. When he says he cares about consumers, I believe him. But as Abe Lincoln said in the recent movie (“Lincoln”), “What good is True North if you end up stuck in a swamp?” At some point, critics like Bruce need to be practical. Taking the position that all MLMs are illegal immediately removes you from the conversation. Completely. And without influence, there’s no change. The industry is not going away. Instead of drawing hard lines and praying for a nuclear bomb to decimate the entire industry, wiping out even the cleanest of companies, he and critics like him should try to offer suggestions to make the industry better. I have a personal experience of being hammered with the political process. I tried to pass an anti-pyramid bill in Tennessee in 2010. The bill was killed by the DSA. Instead of whining about the political process (as done in nearly every article posted by critics), I joined the DSA. I’m a firm believer that the right ideas win over time. Bruce’s article lacks objectivity, which is why it will only serve to excite the critics and be largely ignored by everyone else, including regulators.

I’m going to address Bruce’s points in no particular order.

Market Uncertainty With Respect to MLMs

When writing about his motivation for the article, Bruce writes, “The recent incident involving David Einhorn and Herbalife (HLF) drew my attention to the stock market and the subject of pyramid schemes. It seemed that the significant drop in Herbalife’s stock price reflected a market uncertainty about the inherent stability and legality of this company.”

This is false. As a quick recap, Einhorn asked a few questions during an earnings call with Herbalife. During the call with Einhorn and shortly thereafter, Herbalife’s stock dropped 20% ($1.7 Billion loss in value). The market was not reacting to uncertainties about Herbalife’s model, the market was reacting to Einhorn. Einhorn is a legend on Wall Street, having successfully shorted multiple companies, including Lehman Brothers and Green Mountain Coffee. The market perceived that Einhorn smelled blood with Herbalife. Herbalife’s stock dropped 10% during Einhorn’s 5 minute conversation on the earnings call. 5 minutes is hardly enough time for analysts to research MLM law and thoughtfully conclude that the Herbalife stock was junk. They were reacting to Einhorn. Despite this “market uncertainty,” the other publicly traded companies in the MLM industry are doing just fine. The average rate of return on the publicly traded MLMs is well over 30%, soundly beating the DOW, NASDAQ and the S&P 500. It’s not even close.

Misleading Analysis on BurnLounge

In his article, Craig referenced a definition in the judge’s final order against BurnLounge. This case represents the most recent case against a pyramid scheme. In the final order, the court defined “Prohibited Marketing Scheme” as:

An illegal pyramid sales scheme . . . in which participants pay money or valuable consideration in return for which they obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users. For purposes of this definition, ‘sale of products or services to ultimate users does not include sales to other participants or recruits or to the participants’ own accounts.

If you were to read this definition out of context, it would certainly seem that it’s illegal to pay commissions on product consumption generated by distributors (known as internal consumption). In fact, if interpreted literally, this sort of definition would spell the end of the network marketing industry, period. Bruce takes advantage of this quote and contrasts it with a seemingly contradictory statement the FTC made in 2004. In the FTC’s Advisory Memo to the DSA, it said, “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.

There are 3 key facts that Bruce fails to mention:

1) The definition in the BurnLounge order is IDENTICAL to the definition found in another case against a pyramid scheme twelve years ago (FTC vs. Equinox). The FTC’s advisory memo quoted by Bruce came well after the Equinox case. The FTC made its position clear: Paying commissions on internal consumption is fine.

2) The definition that Bruce quoted was specifically limited to the BurnLounge case. First, it’s clear when it reads, “For purposes of this Final Judgment….the following definitions shall apply.” Second, Bruce failed to reference the other part of the FTC’s memo…the one that clearly says that the definitions found in the Orders do not represent the “general state of the law.” It’s pretty important…and he left it out. The memo says,

[T]he FTC often enters into consent orders with individuals and companies that the Commission has determined have violated the FTC act. To protect the public from those who demonstrated unwillingness follow the law, these orders often contain provisions that place extra constraints upon a wrongdoer that do not apply to the general public. These ‘fencing-in’ provisions only apply to the defendant signing the order. . .”.

It’s crystal clear. Despite what Bruce was suggesting in his article, the FTC was not contradicting itself in the BurnLounge order. It’s doing exactly what it’s been doing over the past twenty years. Bruce Craig is not a disinterested reporter looking to provide help for investors. He’s an opportunist taking advantage of media generated by David Einhorn to lob a grenade at an industry he clearly hates.

3) Bruce fails to reference the BurnLounge Statement of Decision. Prior to the Final Order, the judge wrote a 31 page opinion where he stated his conclusion about BurnLounge. I summarized this BurnLounge Statement of Decision on my site. While Bruce argues that retail sales have no place in pyramid scheme analysis, the judge in BurnLounge dedicated almost 10 pages to the value of the BurnLounge product (or lack thereof). He ultimately concluded that the products had SOME marginal value; thus, he discounted the amount of consumer harm. If everything hinged on the “exponential characteristics” of the marketing plan, as submitted by Bruce, there would be zero need to discuss the product. Bottom line: retail sales DO matter. If the products have legitimate value as demonstrated by retail sales, it’s indicative of a legitimate program. Speaking of retail sales, even the FTC’s own economist, Peter VanderNat, wrote about the importance of retail sales when distinguishing legitimate MLMs from pyramids. There’s just no way around it: retail sales matter.

The rationale that led Bruce Craig to reference a single sentence out of context while ignoring the 31 page Statement of Decision is beyond me.

Tolman Case

While Bruce was eager to reference two pyramid cases from over 35 years ago, he ignores a case that was published in 2004. In Tolman, the court held that paying commissions on downline purchases “does not, by itself, render a multi-level marketing scheme an illegal pyramid.” Paying commissions on internal consumption is perfectly legal.

Bottom Line

Critics are desperate. It’s not just Bruce Craig. There have been a number of negative reports lately, all having commonality on a certain line of thought: “MLMs say that everyone can win….and since people fail, it’s fraud.” They’ll use words like “destined to collapse” without referencing a single case of market saturation. And they’ll never reference the technology tools available today that eliminate all geographic barriers for distributors; thus, negating their saturation arguments. They simply hate the space and they want it gone. And now they’re growing angry because they’ve been largely ignored by the FTC over the past several years. It’s not a surprise: their position is logically, politically and economically untenable.

The space needs to improve. I agree on that point. I’ve written exhaustively about my ideas to improve the MLM space. The industry is not perfect, but it’s still a great space. And whether the critics like it or not, the business model is accelerating. Peer to peer advertising is a much more cost effective and efficient means of distributing unique products and services. While I agree that the space needs to improve, I take exception when another lawyer makes an argument while leaving out material information. It’s just poor form.

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Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM News, MLM startup Tagged With: , , , , , , ,
by on October 29, 2012 Leave a Comment

FTC Business Opportunity Summary – MLM

This is a guest post from top MLM consultant, Jay Leisner. Jay is the President of Sylvina Consulting. Compensation plan design, business performance reviews, and software consulting are three of Sylvina’s specialties. Jay is also a partner with me for the Direct Selling Edge conference for MLM startups. While Jay is not a lawyer, I have yet to see a better summary of the Business Opportunity regulation than this one. I could not have written a better summary than the one prepared below.

There’s a lot of uncertainty surrounding this new business opportunity regulation. In my opinion, 99% of the traditional MLMs out there have nothing to worry about. However, with the newer internet based companies that rely heavily on lead generation, the regulation poses a significant challenge. I hope you find this article informative.

——
Begin

This month, I attended the 2012 Global Regulatory Summit held by the Direct Selling Association in Washington, DC. It is an annual event attended primarily by lawyers and employees of direct selling companies who are responsible for legal compliance.

In March 2012, the Federal Trade Commission or FTC promulgated a significant new Business Opportunity Rule known as Rule 16 C. F.R. Part 437 (click here to download a full copy of the regulation). Direct selling companies are not specifically or explicitly excluded from this rule.

If your company is subject to this rule, potential buyers of your business opportunity must be given a one-page disclosure statement at least seven calendar days before the prospective buyer signs an agreement or pays any amount of money for the business opportunity.

If you have a direct selling company with independent representatives who recruit others to sell and recruit, anything that slows down the recruiting process isn’t good for recruiters or your company because during the waiting period, some new recruits will change their minds and opt not to enroll! Fortunately, there are things you can do to not be subject to this new rule.

Before explaining these things, I’d like to tell you about the one-page disclosure statement referenced above. It must include full disclosure of any civil or criminal legal actions that the company or any of its key personnel have been the subject of within the last 10 years (regardless of the outcomes). This means that if your company was sued by an independent representative and you were the prevailing party, you would still need to disclosure this legal action. The disclosure statement must also include the names and telephone numbers of at least 10 people who have purchased this business opportunity from the seller. If the seller has sold the business opportunity to less than 10 people, then all of them must be listed. In addition, the person receiving the disclosure statement is notified that if he or she purchases the business opportunity, that person’s identity may be disclosed to future prospective business opportunity purchasers.

Rule 16 C.F.R. Part 437 defines a business opportunity as a commercial arrangement in which:

  1. A seller solicits a prospective purchaser to enter into a new business; and
  2. The prospective purchaser makes a required payment; and
  3. The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will
    1. Provide locations for the use of operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or
    2. Provide outlets, accounts or customers, including but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or
    3. Buy back any or all of the goods and services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to payment for such services as, for example, stuffing envelopes from the purchaser’s home.

A new business means a business in which the prospective purchaser is not currently engaged, or a new line or type of business.

A required payment is all consideration that the purchaser must pay to the seller or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the business opportunity. Such payment may be made directly or indirectly through a third party. A required payment does not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.

Providing locations, outlets, accounts, or customers means furnishing the prospective purchaser with existing or potential locations, outlets, accounts, or customers; requiring, recommending or suggesting one or more locations or lead generating companies; providing a list of locator or lead generating companies; collecting a fee on behalf of one or more locators or lead generating companies; offering to furnish a list of locations; or otherwise assiting the prospective purchaser in obtaining his or her own locations, outlets, accounts, or customers, provided, however, that advertising and general advice about business development and training shall not be considered as “providing locations, outlets, accounts, or customers.”

The first two elements of a business opportunity as defined above clearly apply to you as your direct selling company offers a new business for which a required payment is made. It is the third element that may or may not be relevant, that is, whether your company suggests or provides customers or lead generating companies to the purchasers of your business opportunity.

Some direct selling companies provide leads to their representatives or suggest the use of lead generation companies. If a company refers prospective customers or representatives to existing representatives, will this practice cause a direct selling company to be subject to this new business opportunity rule? If a company has a relationship with a lead generation company and encourages its representatives to buy leads from this third party, will this similarly be a problem? Does it matter whether these practices are disclosed by your company to new representatives at the time they join? Does the number of leads provided as compared to the total number of new customers or representatives enrolled have any relevance? If leads are given only to representatives who have achieved a specific rank or higher in your compensation plan, does that matter?

Party plan representatives may offer a hostess who signs up on the night of the party to be a consultant the opportunity to be credited with this party as her own, that is to say, she may offer the party and its customers and sales to the joining consultant as an incentive to purchase the business opportunity. Could this practice cause the party plan company to be subject to the new business opportunity rule? If a company doesn’t encourage this practice, does that make this practice irrelevant to the business opportunity rule?

I wish I could tell you the answers to these questions, but I can’t because the rule is new and we just don’t know exactly how it will be interpreted and enforced. With this information, you can choose to change nothing and just wait and see what happens, or you can take steps now to respond to the new rule in town. The most conservative approach would be to (a) not recommend the use of lead generating companies, (b) not provide leads or customers to representatives, and (c) not suggest that representatives “gift” a party to a hostess. All of these steps are achievable, although they may be a change to how you’re doing business today.

End article
——

See below for the FTC’s short summary of the regulation.

Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM startup Tagged With: , , , , , ,
by on October 15, 2012 2 Comments

Front Loading: excessive orders upon enrollment

In the past, I wrote a detailed article exploring the boundaries of inventory loading. In that article, I gave a few conflicting definitions used to define inventory loading. The courts have their definition, the FTC has its definition and the Direct Sales Association has its own. Without boring you with the minutia, inventory loading basically exists when distributors purchase product in bulk quantities they can never reasonably sell or use in a month. Why do they do this? They do it mainly to qualify for commissions. The courts add another layer to this definition that muck it up a little: inventory loading can occur when distributors are purchasing a minimum amount of product in an effort to qualify for bonuses. FTC vs. Omnitrition

Due to people’s zeal to make money fast, we’re seeing more programs launch that rely on inventory loading. And to be more specific, we’re seeing more FRONT LOADING in programs today. “Front loading” occurs when the new reps are required or financially incentivized to buy an extraordinary amount of product upon enrolling. Legally, the purchase of inventory must always be optional. This is crystal clear, MLM Law 101. So you might be asking, “If the initial purchase is made voluntarily, what’s the problem?”

The answer lies with one word: MOTIVATION

Regulators try to analyze the motivation driving people to purchase the product or service. If the motivation is pure and distributors are purchasing product due to a sincere want or need, the program is in great shape. If, on the other hand, distributors are purchasing product primarily to qualify for additional bonuses, it’s a problem. This is known as “Opportunity Driven Demand.”

Here’s the question

If we know that regulators want to see consumers / distributors purchasing product for the right reasons, why do some companies continue to provide distributors with financial incentives to buy a lot of inventory upon enrollment? It’s a long question, I know. I’ll break it down into two parts:

  • Regulators want to see people buying product for the right reasons; therefore,
  • why are some companies offering extra rewards to encourage people to buy more product?

BurnLounge got roasted for doing this. If you need a refresher, I wrote a summary on the BurnLounge case. In BurnLounge, participants were required to purchase an expensive, $400+ product product to qualify for a particular bonus. The court concluded that it was the additional financial incentives that ultimately led the distributors to purchase the premium products.

Gerry Nehra recently wrote an article on the subject, titled Where Have All The Products Gone?. He and I both see a dangerous trend: the products are becoming less relevant in an age where people are looking to make easy money with clever pay plans. In his article, Gerry summed it nicely:

The argument that purchases are for intrinsic value is seriously weakened if the purchases are:

Required to be made to be allowed to sign up as a distributor.
Required to be made by a distributor to “open a product center.”
Required to be made by a distributor to qualify for a compensation plan payment.
Required to be made by a distributor to advance in the compensation plan.
Required to be made by a distributor to “re-enter” the same or a different “phase” or “cycle” of the compensation plan.
Required to be made by a distributor to “buy in” to a higher compensation plan title or pay level.

emphasis mine.

I highlighted the sections that are more relevant for this article on front loading. If we know that regulators want to see pure motivation driving product consumption, companies need to stop adding sweeteners for bulk orders. An example would be when a company offers to pay a distributor at a higher rank for a year IF the distributor purchases a builder pack, usually consisting of a lot of inventory costing between $1,000 and $4,000. I understand the logic of having it: “We want them to get started right” or “We want to reward the ‘serious’ builders.” The real reason why we see the extra sweeteners: they want to create a “fear of loss,” putting the distributor in a position to make a long-term decision. New distributors ask themselves, “Do I buy the minimum and forgo the extra money, or do I go ‘all in’ and maximize my earning potential?”

Conclusion

If you’re a company that’s considering offering an additional bonus for bulk orders, be careful. To misquote one of the greatest philosophers of all time, “Check yourself before you wreck yourself because excess inventory is bad for your health.” – Ice Cube.

Front loading by itself does not render a program illegal. However, rest assured it’ll be part of the kitchen sink that gets thrown at a company if the company upsets the wrong regulator.

Filed Under: mlm attorney, mlm legal, MLM News, MLM startup
by on September 18, 2012 2 Comments

Letters to a Young Networker

Three months ago, I made a commitment to Richard Brooke that I’d have content prepared for a book by September 3rd.  Well, September 3rd has come and gone and there’s still not enough content.  I accept responsibility for the shortcoming.  I flubbed on it.  I’ve only got excuses, which are a dime a dozen.  I was interviewed on CNBC, which threw me off for a week, I started a law firm with my partner Walt Burton and the Zeek Rewards disaster lit my hair on fire.  But who cares about excuses? The bottom line: I failed to honor a commitment.  

But…

I’m 40% done.  The title is: Letters to a Young Networker: Separating fact from fiction in direct sales.  The book is comprised of a series of questions and answers between our protagonist, Kate, and myself.  I’ll be publishing excerpts from the book periodically, asking for feedback.  See below for the Table of Contents.  I’ve highlighted the completed chapters in bold.  If you have specific questions that you’d like addressed in the book, please leave me a comment.  This is going to be an iBook, which means it’s only going to be available on iOS devices.  I plan on adding a few videos, images and powerpoint presentations.  There will eventually be a text edition, but first things first.  

Table of Contents (tentative)

Forward from the author

Introduction

Is network marketing even legal?

Has the FTC approved of our business? No news is good news, right?

What constitutes a pyramid scheme?

Can I be held liable when I make product claims?

Can I show off my checks to a prospect?

Can you explain the 70% rule? I’ve read somewhere that 70% of my company’s volume must come from outside customers. WTH?

Guest Chapter: What are the differences between party plans and network marketing companies?

I’ve got friends that have enrolled in multiple positions in the compensation plan? Is this ok?

The MLM critics talk about “market saturation.” Do they have a point?

When I approach a prospect, should I lead with the product or opportunity?

Should I be concerned when I hear of MLMs experiencing challenges in other parts of the world?

Can my current company really sue me if I leave and go somewhere else?

Filed Under: Distributor Resources, mlm attorney, MLM News, MLM startup Tagged With: ,
by on August 19, 2012 2 Comments

Zeek Rewards Recovery

It’s been a busy few days in the MLM industry, to say the least. We recently had one of the fastest growing companies in MLM history, Zeek Rewards, come crashing down after being shut down as a ponzi scheme by the SEC. On my site, I summarized the SEC’s action and wrote about the implications for the MLM industry in general. The article can be found here. After writing the article, I was literally flooded with hundreds of messages from people that were affected by this disaster. The stories were remarkable. People left their jobs, cashed in on their retirements and drained their savings in an effort to maximize their earnings with Zeek.

The funds in Zeek Rewards have been voluntarily placed with a court appointed receiver. Zeek is not contesting the allegations in the SEC’s complaint. The receiver is now obligated to take stock of the assets and distribute funds back to the investors. Given the volume of victims, it’s going to be a very long process, in our opinion. Due to the volume of investors in Zeek, which is projected to be close to one million, we’re not sure how the receiver is going to effectively communicate with the class of investors. In an article on Forbes.com, the author put it into perspective when he wrote:

“While investor losses pale in comparison to those experienced by Madoff or Stanford investors, the sheer number of Zeek investors is on a magnitude that has never been dealt with before in a receivership or bankruptcy context. To illustrate, assuming Zeek had one million investors, a simple 1-page summary for each investor summarizing contributions and withdrawals, stacked together, would be 101.3 meters high, or roughly 300 feet. The staggering number of victims suggests that investigation of the fraud and establishment of a distribution process will likely be a drawn-out process involving hundreds, if not thousands, of people.”

Given my expertise in dealing with MLM law, and my partner’s experience with receiverships, our firm is uniquely positioned to communicate with the receiver on behalf of Zeek victims. Instead of getting lost in the stack, we can build numbers and collectively get a seat at the table.

If you invested in the Zeek program, please fill out the form below. If the form is not showing up in your inbox, please click here. There are no obligations after filling out the form. We’ll be publishing an action plan on Friday.

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