Amended DSA Code of Ethics: Are the modifications meaningful?

    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.

    2016Beyond just ringing in a new year, January 1, 2016, also signified the enactment of the Direct Selling Association’s (“DSA”) latest Code of Ethics. Before breaking down the differences that exist between the new and previous versions, my commentary on the subject remains the same: the DSA has a long way to go before providing a Code that offers serious protection for member companies from regulatory issues.

    The Code’s prior shortcoming was epitomized by the FTC’s action this past year against Vemma, a longstanding member of the DSA that was touted for exemplifying ethical and appropriate business practices. Vemma went from being a recipient of the DSA’s Ethos Award in 2013 to getting targeted and sued by the FTC.

    I’ve said it before and I’ll say it again — to really “tighten the screws,” the DSA needs to take the kind of proactive steps that’s bound to upset some people. This would mean implementing stricter requirements that will cause companies to really stretch, improve and adapt.

    Stepping down off my soapbox, how is this newly amended version of the Code any different than before? In short, it updates a few areas to catch up with current marketplace standards. These adjustments reflect the DSA’s awareness of regulators’ recent arguments. My thoughts on the modifications/additions found are as follows:

    Substantiation

    • Under Section 2(a), the DSA amended the Code so as to reflect an advertising standard in which claims are “substantiated by competent and reliable evidence.”

    A favorite source of ammunition, the FTC and FDA have continually sued companies on an allegation that they failed to substantiate claims made within their advertisements. A rather amorphous standard that’s been heavily litigated, the FTC and FDA analyze “substantiation” on the basis of “complete and reliable scientific evidence.” Similarly, the DSA now endorses the use of this same standard. Basically, companies need to be honest and be able to back up their words.

    Income Disclosures

    • In the most heavily modified part of the Code, the DSA adds a lot of verbiage to Section 8 on Earnings Representations. For example, it defines what constitutes an earnings representation and requires such representations to be documented and substantiated.

    In other words, companies are now required to provide their distributors with income disclosure statements. While the Code lacks specific instructions on what is required for the income disclosure statements, there’s ample materials on this site to help companies put those together. We did a 2 part series on the subject. Part 1 of MLM income claims is here. Part 2 is here.

    The FTC’s standards on income representations are clear and relatively easy to follow, as companies must: give clear and conspicuous disclosures indicating the exact percentage of distributors who earn the amount represented; disclose average earnings; and differentiate between active and inactive participants. In a post I did more than a year ago where I challenged the DSA to strengthen its Code, income claims was one area of the Code I thought the DSA really needed to bolster. Kudos to the DSA for tightening the screws here. Late is better than never. And to the network marketing community, you’re welcome.

    Inventory Loading

    • In the commentary below Section 9 on Inventory Loading, the DSA  takes a stand on arguably the most talked about and debated issue that currently confronts the Industry: internal consumption. “The Code recognizes this [internal consumption or self-consumption] as a long-standing and accepted practice in direct selling and does not prohibit compensation based on the purchases of salespeople for personal use.” In taking this stand, the DSA stays away from any controversy by stating, “The Code does not set forth specific standards or requirements that a minimum level of sales take place outside the salesforce.” The Code does, however, add a new snippit on forced inventory loading representing an unfair and deceptive recruiting practice — “It shall be considered an unfair and deceptive recruiting practice for a member company or salesperson to require or encourage an independent salesperson to purchase unreasonable amounts of inventory or sales aids.”

    As I’ve discussed at great length, internal consumption was a big issue between the FTC and Vemma, as Vemma argued that the internal consumption by its Affiliates should’ve been considered as sales to ultimate users. While the BurnLounge and Vemma courts agreed that evidence of internal consumption does not per se make a company a pyramid scheme, a large percentage of the sales derived from internal consumption often means that participants are buying and consuming product for the purpose of qualifying for recruitment incentives, (i.e., a clear sign that something is a pyramid scheme). While I disagree with the Vemma court’s interpretation of “ultimate user,” I understand the importance of clearly distinguishing “retail customers” from “distributors.”

    Regarding the last sentence regarding the purchase of “unreasonable amounts of inventory OR SALES AIDS,” the DSA leaves it wide open for interpretation. What is a reasonable amount of inventory? What is a reasonable amount of sales aids? In the past (and possibly in the present), Amway distributors have been known to regularly purchase over $200 per month in sales aids (sometimes more). Is that reasonable? In my opinion, the word “reasonable” leave a little too much room for interpretation.

    In the DSA’s defense on refusing to establish a bright line standard for how much sales must come from outside the organization, courts, too, have stayed away from mandating such a number or figure. In the BurnLounge case, the Ninth Circuit held, “Because the outcome in [the BurnLounge case] is clear under the Omnitrition test, 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.” One of the questions clients most often ask me relates directly to this idea: “Kevin, what percentage of retail sales do I need?” My answer: It depends (I know, very lawyerly of me). It would be a real positive for the industry if the DSA engaged in an open conversation and ultimately established a standard for how much internal consumption is too much. With technology these days, it’s very easy to provide prospects opportunities to save money on product WITHOUT having them join the genealogy.

    Code Administrator Authority

    Finally, the DSA has chosen to strengthen the Code Administrator’s authority. The idea of the Code Administrator is not a new one. The DSA has used the same administrator for 12 years: Jared Blum. Blum is an attorney with the ability to “crack the whip,” so to speak. In finding that a member company has committed wrongdoing, the independent Administrator can recommend remedies such as: requiring an accused company to reimburse a victim for the money they spent on products, promotional materials and/or sales aids; requiring an accused company to replace or repair a victim’s products; and requiring that an accused company make a monetary contribution towards a fund that will be used for the purpose of publicizing and disseminating the Code. In the past, these actions were all kept private.

    As a new addition to the Administrator’s duties, the Code now states that the Administrator may issue periodic reports that detail the number and types of complaints that were received (Section F(4)). Section F(4) of the Code goes on to state that these reports will not identify individual companies. I’ll be curious to see what these period reports look like and the information that we get from reading them. I completely disagree with the DSA’s choice to have anonymity behind the reports. Public enforcement is crucial for education and deterrence. Imagine if the NFL punished a player and kept it private…it would remove the deterring effect. By not allowing people to see the who, what, and why behind an investigation, the DSA defeats some of the very purposes, like accountability and transparency, behind why it claims the Code even exists. Also, the Code requires companies to prominently display a link to the complaint filing process (making it easier for consumers to find and use).

    Conclusion

    The DSA’s revisions to the Code are incremental steps towards acknowledging the present challenges that exist in today’s direct selling landscape. Candidly, the Code needs further enhancements when it comes to understanding and integrating the current regulatory realities. With this being said, I understand the DSA is one large committee and getting any sort of movement is near-impossible. I would never expect substantive changes to the Code overnight. I’m hopeful there’s more incremental improvements year by year. To answer the question posed in the title on whether the changes are meaningful, the answer is yes. Progress is good. As the saying goes, “inch by inch, it’s a cinch. Yard by yard, it’s too hard.”

      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.