I’m not one to report the news. I’m a lawyer, not a reporter. When I write about current events, I write from the context of providing education. I try to take my time and pull out the lessons. Here, I’m reporting on the news. While there’s a lot to be learned from this hearing, those lessons will be shared AFTER the judge makes a decision on the issue. As most of my readers know, the FTC sued Vemma, alleging them to be a pyramid scheme. Without a hearing, the FTC got the company shut down with a temporary injunction. On September 15, Vemma had an opportunity to be heard, requesting that the court remove (or modify) the injunction. At the hearing, both sides were able to cross-examine the other side’s witnesses.
I have a lot of thoughts on what I saw in the courtroom. I will admit, I’m cautiously optimistic. With that being said, I recognize that the FTC has won its past 16 efforts for this kind of injunction.
— Truth in Advertising (@TruthinAd) September 16, 2015
Summary of the FTC’s Allegations
(1) Vemma is operating as a pyramid scheme; and
(2) Vemma utilizes false and misleading income claims in its promotional materials.
This is the FTC’s first lawsuit after the Ninth Circuit’s BurnLounge decision. I get the sense that this Vemma case is sort of a test drive where the FTC is exploring the fringes of its power. If successful, this opens up a lot of possibilities for the FTC in the MLM space. If unsuccessful, it will suck a lot of air out of their tires.
What is an “Ultimate User”?
After BurnLounge, this is the key question for purposes of determining the existence of a pyramid scheme. Pyramid schemes exist when there are rewards “unrelated to product sales to ultimate users.” In BurnLounge, the court said that participants themselves can “self-consume” the product and be ultimate users IF the product consumption was for the right reasons (value driven, not opportunity driven). Understand, the mere fact of selling some product to ultimate users is not enough. How much is necessary? And how does the court even determine if someone is buying product as an “ultimate user” (legitimate consumption) or as an inconvenient tax to participate in a pyramid scheme (illegitimate consumption)? These were the two big issues addressed at the hearing.
Issue #1: How much revenue needs to come from ultimate users? In BurnLounge, the court punted on this issue, saying “Because the outcome in this case is clear . . . we do not need to decide the degree to which rewards would need to be unrelated to product sales in a case presenting a closer question.” At the Vemma hearing, the FTC took the position that the majority of revenue needs to come via Ultimate Users. According to the FTC, if the majority of revenue comes from people simply seeking to qualify for commissions, it’s proof of a pyramid. While there’s no precedence for this position, it makes sense.
At the original hearing where the FTC requested an injunction (when Vemma was NOT present), the FTC made a big promise. The attorneys for the FTC said, “We believe that, ultimately, when we obtain the company’s records, we are going to determine that the vast majority of the purchases . . . were what we consider cost of the business participation, which would be the $600 Affiliate Pack and the $150 a month auto-delivery. . . We believe that most of the sales volume is going to be traceable to that activity.”
At the hearing, the FTC did not deliver on that promise. As it turned out, about 47% of revenues came via affiliate pack sales and monthly auto-ships (far short of the “vast majority” promised by the FTC). Faced with this problem, the FTC appeared to pivot its argument, focusing more on the “emphasis” of the marketing materials. Dr. Stacie Bosley, appearing as an expert witness for the FTC for the first time, stated that the consistency of the recruiting message in Vemma’s materials led her to believe that the main motivation driving consumption was for qualification. Regardless of Vemma’s data (which she disputed), it’s her position that Vemma’s recruitment bias is proof of a pyramid scheme.
Issue #2 (the big one): How does the court determine if someone is an “ultimate user”? This is where the parties argued their points over the definitions of “customer” (i.e. ultimate user) and “affiliate” (business builder). According to the FTC, affiliates that purchased product in an amount that equaled or exceeded the monthly volume requirements were not “ultimate users.” Vemma’s expert, Dr. Emre Carr, stated that people were customers if they (1) never purchased an affiliate pack; (2) never enrolled another affiliate; or (3) never earned a commission. With this definition of “customer,” the data showed that the majority of revenue came from customers. In my opinion, this logic makes sense: motivation can be measured by actions. If people do not buy the affiliate pack OR if they’re unable to recruit a single person, this lack of activity would indicate a desire to simply tag along and buy product. The FTC argued that those “customers” were likely failed distributors and should not be counted towards as “ultimate users.” There were at least two friends of mine at the hearing that have been Verve customers for years. According to the FTC’s logic, since they’re also Affiliates, they’re victims / failed distributors.
In my opinion, the FTC lacked the smoking gun evidence of a pyramid scheme. Notably, there was very little reference of retail sales by the FTC. This is a new thing in the post-BurnLounge universe. The FTC understands that affiliate consumption is relevant. The key is in determining the motive driving the consumption.
The FTC showed a few videos that contained strong income claims. The income disclosures were weak.
There was a lot of confusion in the courtroom by all parties. The lawyers and the judge were all trying to navigate around this nebulous issue of legitimate network marketing vs. pyramid schemes. Due to a lack of standards, the FTC is able to morph its arguments case by case. I think if the FTC prevails, it’ll prove bad for the industry. Their arguments are incredibly broad. There are some that think the case will likely go the FTC’s way, just by nature of the history of how these things go. There are others that think it was a slam-dunk for Vemma. Friend and CEO at Life Matters, Richard Brooke, has a strong opinion: “[The FTC] did not have a case nor did they have a clear grasp of the issues of how our model works in general. They came from a position that recruiting is not supposed to happen and even a $150 autoship is inventory loading…none of which is supported by case law. . . You all may wonder why this happened. Simple. The YPR group and Powell groups in Vemma offended the public and the media with their brash, arrogant and insensitive recruiting tactics and their celebration of their unique earnings.”
It is true that the FTC did not produce any evidence of consumer harm or inventory loading. They focused mainly on the emphasis of the program.
The judge was sharp. He stood THE ENTIRE TIME and paid attention to every detail. He said he’ll make a decision by no later than 2:00 on Friday. One of three things will happen: (1) The injunction will remain; (2) the injunction will be modified; or (3) the injunction will be dissolved. Wait and see.