As most of you know, the FTC sued Vemma, alleging the company to be a pyramid scheme. Without a hearing, the FTC convinced a federal judge to shut down the company with a temporary injunction. On September 15, Vemma had an opportunity to be heard, requesting that the court remove (or modify) the injunction. After hearing the testimony and reading the briefs, the Judge rendered a decision on the subject. The contents of the Order can be read here.
We’ve purposely taken our time in writing this. We wanted to invest the right amount of time in understanding the issues before providing education. Therefore, this will be a Two Part series. Part One will explore the “guts” of the opinion and the basis for the Judge’s ruling, while Part Two will discuss its future implications for both Vemma and the Industry.
In summary, Vemma can claim a small but significant victory in the matter. The company got a lot of what it requested. The FTC, on the other hand, ended up with a pretty big black eye. Pursuant to the Order:
1. Vemma can resume operations under a few restrictions
2. It regained control over its assets (the money is unfrozen); and
3. the Receiver, Robb Evans & Associates, lost control over the business.
If you’re curious as to what a Receiver does, their purported function is to “preserve assets” during litigation. But in reality, Receivers often do the exact opposite – they do their best to kill companies so that they are incapable of resuming operations.
We’ve never heard of a company taking back this amount of control after the FTC alleges them to be a pyramid scheme. The bottom line — Vemma is back in business. But . . . it has certainly paid a serious price. Can Vemma succeed given the negative media and the barbs contained within the Judge’s order? Only time will tell.
The Basics: What is a Pyramid Scheme?
We’re going to boil the ocean here and give you a simple explanation: It’s when the rewards are unrelated to product sales to ultimate users. “Ultimate users” are people who purchase products for legitimate reasons, such as for personal consumption. Companies are pyramid schemes when the products are viewed by regulators as “incidental” (unimportant) to the money-making venture.
How do regulators determine if buyers are truly “ultimate users”? They look at a number of factors, including: product value, meaningful opportunities for retail sales, emphasis of the sales culture, consumer protections, the existence of any buy-to-qualify requirements (purchases that are required for distributors to become eligible for certain aspects of the compensation plan), requirements in the compensation plan that promote sales to customers, etc. If a company is weak in these areas, it’s indicative of a pyramid scheme that relies on “opportunity driven demand” more than legitimate market driven demand for the company’s products or services.
Why did the Court conclude that Vemma was “likely” a pyramid scheme?
The Court reached its conclusion primarily due to Vemma’s alleged recruitment bias, as demonstrated through: (1) the lack of customer sales revealed through an Affiliate to Customer ratio (according to the FTC’s definition of “Customer”); and (2) the recruitment/ “buy to qualify” emphasis within Vemma’s culture.
With respect to its factual findings, the Court specifically stated:
While no purchase, payment or fee is required to become an Affiliate under Vemma’s policies and the Affiliate Agreement, in practice, Vemma strongly encourages any person wanting to become an Affiliate to (1) purchase an Affiliate Pack . . . upon which eligibility for certain bonuses is contingent, and (2) sign up for $150 monthly auto delivery of two cases of product to maintain eligibility for bonuses.
From the Court’s perspective, one of the overarching issues is not merely what is or is not technically required. Rather, the larger issue involves the actual practices or “operational realities” of Vemma and its Affiliates. As is articulated from the Court’s findings, some of the operational realities on which it focused included: (1) the “strong encouragement” to Affiliates to purchase an Affiliate Pack; (2) the conditioning of certain bonuses upon the purchase of an Affiliate Pack; and (3) the “strong encouragement” given to Affiliates to enroll in a $150 monthly AutoShip program.
1. Affiliate vs. Customer
The Court also spent considerable time discussing the distinctions between participants and non-participants, or in this case, Affiliates and Customers. In this arena, Vemma was a victim of its own data. In 2013, 86% of its revenues came from individuals classified as Affiliates versus only 14% from individuals classified as Customers. In 2014, 71% of its revenues came from Affiliates as opposed to the 29% derived from its Customers. At some point, Vemma attempted to reclassify the majority of its Affiliates as Customers based on their behaviors. In actuality, Vemma’s logic makes sense. Intentions should be measured by actions. If someone was an “Affiliate” for years and never recruited anyone and continued to buy, they should never be considered a “failed distributor” or a “victim.”
Within the MLM Industry, Vemma is unique in that it’s free to become an Affiliate. The decision not to have Affiliates face a “penalty” for joining resulted in a database in complete disarray. Vemma’s expert, Dr. Carr, defined “Affiliate” and “Customer” based on individual behaviors (and the FTC’s definition in the lawsuit). If a person failed to recruit another participant or chose to purchase an Affiliate pack (costing approximately $500), he coded them as Customers. This approach flipped the ratio dramatically in Vemma’s favor, whereby 70% of its revenues came from Customers. If Vemma began first coding participants in this fashion in 2013, we might have a different outcome. However, the Judge was not persuaded by Dr. Carr’s logic, stating, “Defendants have offered no evidence to support a finding that a Vemma participant who intended to be just a Customer accidentally identified himself or herself as an Affiliate.” Ironically, our firm is sitting on a few hundred affidavits from both Affiliates and Customers outlining their true motivations behind their purchasing of the products.
The Customer data proved critically important because of its relation to recruiting. As logic would indicate — the more Customers a business has, the more it will be “sales-based” and the less it will be “recruitment-based.” In an article Kevin Thompson wrote calling for revisions to the DSA’s Code of Ethics last year, he challenged the DSA to require that companies engage in proper Customer coding. A simple way for companies to do this would be to offer Customers the option of receiving product discounts without the requirement that they join as distributors. In doing so, companies could more easily prove buyer motivations in a way that avoids blurring the lines between participants and customers. While Vemma allowed for customers to receive the same product prices as affiliates, its failure to make a clear distinction between customers and business-builders early led to some trouble. As Vemma illustrates, the failure to consistently and uniformly define a participant versus a customer is the kind of mistake that can come back to haunt you.
2. AutoShip and Eligibility Emphasis
The FTC repeatedly argued (and the Court agreed) that Vemma’s emphasis on in its marketing materials of “buying to qualify” was indicative of the true motivation leading Affiliates to buy products. Translated into English — The Court concluded that Affiliates were buying primarily to qualify for bonuses because Vemma’s culture emphasized a strong “buy to qualify” mentality.
As stated above, Affiliates can be “ultimate users” when they purchase products primarily for their intrinsic value and/or for personal use and consumption. The Court carefully threaded this needle, acknowledging the need to determine if the Affiliates were ultimate users. The Court wrote,
[U]nder the current bonus system there is no way to unbundle the Affiliates’ intent to consume Vemma products as ultimate users from their desire to remain qualified for bonuses. . . But their intent in purchasing Vemma products must be viewed in light of Vemma’s program design as well as its training and marketing materials, which explicitly provide that Affiliates should enroll in auto-delivery for the purpose of remaining qualified for bonuses.
In its findings of fact, the Court even cited a speech by BK illustrative of the emphasis on eligibility and auto-delivery. In it, he stated, “. . . you need to get on auto-delivery order . . . that is like your trump card. That makes sure you’re qualified.” Because of this type of emphasis on buying to qualify, the Court refused to consider Affiliates as “end users.”
The Court’s displeasure with Vemma’s emphasis on autoships was an issue Kevin Thompson spotted last year in his article on proposed additions to the DSA’s Code of Ethics. (FOR THE RECORD, that makes two proposals he directly identified that the Court used to conclude Vemma is likely a pyramid scheme. In the article, Thompson discussed personal volume requirements. While personal volume requirements and autoships aren’t illegal per se, Vemma proves it can be deadly for any company when coupled with an aggressive message of “automatic qualifying.” This is why he recommended the need to do away with volume requirements. It’s a controversial idea that hasn’t generated much support. Thompson feel it’s important to standardize this policy because without standardization, companies will continue to play Russian roulette in exchange for more revenues.
With all of these issues in mind, this case might boil down to a very simple fact: Regulators, parents, college officials…they all got pissed off with Vemma growing substantially on college campuses (particularly in Arizona). While Vemma was no saint, the punishment did not seem to fit the proverbial crime. Still, Vemma left itself vulnerable in a few spots and the FTC exploited those weaknesses. Regulation via litigation is a very blunt and imprecise instrument. It’s surgery by sledgehammer. If we want to continue with the “we can self-regulate” theme, we need to be prepared to deal with the unpredictable consequences. It’s one of the reason why the industry needs to support an effort to pass a Federal statute that deals with this very issue.
Now having a greater understanding of some of the issues within the Court’s order, we’re prepared to answer the question in the back of everyone’s mind — Moving forward, what does this all mean? We’ll give you a hint: It’s not that complicated. Companies can either put their heads in sand, pretending this is an isolated problem for Vemma. Or…they can get intelligent and revisit some of their promotional strategies and assess how personal volume requirements are implemented and taught.
With what you’ve read so far, do you have any questions or comments?