MLM Special Deals / Business Development Agreements: Disclosure Requirements (Part 1)

    Kevin Thompson is an MLM attorney, proud husband, father of four and a founding member of Thompson Burton PLLC. Named as one of the top 25 most influential people in direct sales, Kevin Thompson has extensive experience to help entrepreneurs launch their businesses on secure legal footing. Recently featured on Bloomberg TV and several national publications, Thompson is a thought-leader in the industry.

    ftc-endorsement-twitterIn December of 2014, I wrote an article titled “MLM Special Deals: The Fraud Ends Now.”  The article was about “Business Development Agreements” / confidential deals used by MLM companies to attract networkers.  The more success in prior companies, the sweeter the terms.  After reaching a deal, the networkers publicly announce, “After some serious due diligence and deep reflection, my heart has led me to join Company ABC….I find their products to be best in-class and their compensation plan to be the most rewarding I’ve ever seen.”  And since the private deals typically require aggressive volume goals, it naturally leads networkers to raid their prior organizations (or cut private deals of their own).  

    Two things: (1) It’s fraud.  It’s a material fact that, if known, affects the credibility of the networker. Absent a disclosure, it’s fraud. (2) It has led to a massive feeding frenzy within the industry.  There are some (dozens) that throw their hands up saying, “It’s just how business is done these days.  In order to be competitive, you’ve got to pay the experienced networkers under the table so they’re motivated to recruit the non-experienced.”  I find this rationale pathetic. The path to riches does not need to be an overnight journey. (3) It leads to non-sensical terminations and massive manipulation in the genealogy. In order to entice a networker, a real spot with real volume is oftentimes given. And if there’s no position available with real volume, fake volume is created. And when the fake volume runs dry with no new volume to take its place, there’s pressure on the company to do one of two things: (a) continue to create fake volume (which costs real money); or (b) find real volume that belongs to someone else, terminate and transition the volume to the networker. With option (b), the company takes a measured approach and thinks “If we terminate, what are the odds they’ll file a lawsuit? And if a lawsuit is filed, what’s the ultimate cost.” This calculation ignores the enormous cost incurred by the distributor and his or her family, devastated by the rapid loss of income.

    The Problem

    In an environment where there are no consequences for this conduct, owners are engaging in a risk / reward analysis that steers them towards compromising on basic principles of decency. If you look historically at the companies that have been aggressive with deals, there’s always a massive POP followed by a massive DROP. Who gets hurt? The average distributors that joined under the pretense that success was easier with Company ABC. Being surrounded by “successful networkers,” they think surely this piece of real estate is more valuable than others. When they learn the truth, they leave feeling like failures.

    In a perfect world, the DSA would demonstrate leadership over this issue and create some standards.  There’s a chance changes are coming on this front. I’ve seen statements from the DSA regarding their desire to be more transparent with code enforcement actions. DSA Chairman Joe Mariano has said, “As expectations for consumer protection evolve, so does our Code of Ethics . . . Later this year, we will further strengthen these best-in-class consumer protections by introducing greater transparency around enforcement and enhancing protections against false earnings claims.” In NASCAR, when people cheat, they get fined. h/t to Troy Dooly for the NASCAR analogy. With the Code of Ethics, I have yet to speak with a single person that’s familiar with a single Code of Ethics violation. I’m hopeful this changes in the near future, and I’m hopeful the penalties are serious.

    Currently, in the absence of such leadership, there’s a growing number of people that want to see improvements NOW.  This group of professionals, both distributors and company owners alike, would like to see some consistent standards when it comes to business development arrangements. I’m not suggesting that deals should stop. I’m not naive enough to think this is even possible. This industry attracts a special breed of owners. There are always going to be deals. I get it. And if done right, perhaps there’s a place for them. If someone wants to spend money and “invest in their business” by cutting deals, they can do it. But, the deals need to be disclosed. Irrespective of the requirements under the law, cutting private deals should defy a person’s common sense of decency. In network marketing, networkers leverage their reputations and goodwill to recruit other participants. These enrollees are real people that TRUST their sponsors. When companies pay networkers for their allegiance, they’re essentially leveraging this goodwill by creating faux allegiance with trusted distributors.

    Justifying deals, I’ve seen networkers compare this practice to that of paying professional athletes. After all, if Darrelle Revis can “change a jersey” in exchange for $70M, why can’t a networker change a jersey for a fee? This sort of analogy is like comparing Apples to Airplanes…there’s zero similarities. Darrelle Revis is not being paid to recruit other football players. Darrelle Revis is not saying “I’m choosing the NY Jets because their style of play is better.” Darrelle Revis’s fan club is not saying “Darrelle is making more money with the NY Jets because they’re better than everyone.” And…this is the sticky part…Darrelle Revis’s deal is fully disclosed. While some networkers have skill, and that skill might be worth some extra money, there’s no excuse for the networker to pretend that they’re building under the same set of rules like everyone else. It’s just not true. I’ve also seen statements like “As a private company, they can do what they want.” True, so long as the activity is legal. And confidential deals are not.

    How should deals be disclosed?

    First, in my opinion, if companies were forced to disclose these deals, the deals would stop. Once the illusion is gone, there’s less of an incentive to create the faux allegiance / excitement.

    Second, assuming I’m wrong and a company is actually ok with disclosure, part 2 was written to cover specific strategies. But before you skip ahead to the strategies, it’s important to understand the concepts.

    The Rule

    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.

    Example 3: During an appearance by a well-known professional tennis player on a television talk show, the host comments that the past few months have been the best of her career and during this time she has risen to her highest level ever in the rankings. She responds by attributing the improvement in her game to the fact that she is seeing the ball better than she used to, ever since having laser vision correction surgery at a clinic that she identifies by name. . . . The athlete does not disclose that, even though she does not appear in commercials for the clinic, she has a contractual relationship with it, and her contract pays her for speaking publicly about her surgery when she can do so. Consumers might not realize that a celebrity discussing a medical procedure in a television interview has been paid for doing so, and knowledge of such payments would likely affect the weight or credibility consumers give to the celebrity’s endorsement. Without a clear and conspicuous disclosure that the athlete has been engaged as a spokesperson for the clinic, this endorsement is likely to be deceptive.. .

    Assume that instead of speaking about the clinic in a television interview, the tennis player touts the results of her surgery – mentioning the clinic by name – on a social networking site that allows her fans to read in real time what is happening in her life. Given the nature of the medium in which her endorsement is disseminated, consumers might not realize that she is a paid endorser. Because that information might affect the weight consumers give to her endorsement, her relationship with the clinic should be disclosed.

    The examples above speak for themselves. If a doctor selling retail products is required to disclose the existence of a revenue sharing arrangement….and if a tennis player talking about her eye surgery is required to disclose her contract with the clinic, networkers (without question) are required to disclose the existence of extra pay that’s not generally available to the public i.e. special deals.

    The original article I wrote about MLM special deals has been by far the most trafficked article I’ve ever written.  The market was clearly primed for the message.  There was significant frustration from both networkers and owners. As a result, the article spread. But, there were some that said, “Now what?” They also asked, “When does a deal need to be disclosed?” Part 2 of our MLM Deal Disclosure series is intended to address those questions.

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      Kevin Thompson is an MLM attorney, proud husband, father of four and a founding member of Thompson Burton PLLC. Named as one of the top 25 most influential people in direct sales, Kevin Thompson has extensive experience to help entrepreneurs launch their businesses on secure legal footing. Recently featured on Bloomberg TV and several national publications, Thompson is a thought-leader in the industry.