Federal Anti-Pyramid Bill HR 3409: Is it good enough?

    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.

    • In its current form, HR 3409 is better than nothing.
    • The current draft codifies case law where it can.
    • The “True North” of critics has landed them in a swamp.
    • The current draft of HR 3409 could be improved to protect more consumers.

    Compromise

    Summary of the Bill

    HR 3409, named the Anti-Pyramid Promotional Scheme Act of 2017, available here, is a proposed federal statute that seeks to end the debate once and for all regarding the definition of a pyramid scheme. The bill closely mirrors similar state statutes already passed in 21 states.

    If you’ve been following this site over the years, you will notice a recurring theme: the industry needs to “define the gray” that distinguishes legitimate network marketing companies from pyramid schemes. When pyramid schemes dance in the gray and masquerade as legitimate network marketing companies, it harms the entire profession. By shrinking the gray, scams would be less inclined to launch and the government could more easily pop the bubbles. While it sounds simple, the idea of “shrinking the gray” forces us to define EXACTLY where the line needs to be drawn that separates good companies from bad. The debate over this line has led to various divisions inside network marketing circles. There are some that want hard-and-fast retail sales requirements, requiring proof that products are moving en masse (50%+) to non-participant customers. There are others that simply want to see a required refund policy, arguing that real consumer harm only exists when consumers get stuck with unusable and unsellable inventory. The DSA, and their HR 3409, falls into the latter camp. Me? I fall somewhere in the middle.

    Enter HR 3409

    HR 3409 is an attempt to shrink the gray. Is it perfect? No. Is there such a thing as perfect legislation? No.

    The bill defines a “pyramid scheme” as

    a plan that rewards people for recruiting other individuals “rather than primarily related to the sale of products or services to ultimate users.”

    The definition of “ultimate user” is a lynchpin that’s been litigated for over twenty years. The bill settles the issue by stating:

    “(c) Nothing in this Act may be construed to . . . define a plan or operation as a pyramid promotional scheme, based upon the fact that participants in the plan . . . receive compensation based upon purchases of goods or services . . . by participants for personal use, consumption, or resale so long as the plan or operation does not require inventory loading and the plan or operation implements a bona fide inventory repurchase agreement.”

    Confusion in the Background

    In my opinion, this bill is a direct reaction to the unpredictability and inconsistency of the Federal Trade Commission. On the one hand, in the FTC’s Staff Advisory Letter, the FTC stated, “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.” They further went on to state that the main question was whether the products were “merely incidental to the money-making venture.” While the FTC has specifically said that internal consumption is fine, they later took a completely different approach in their argument against BurnLounge. In the BurnLounge case, the FTC argued before the Ninth Circuit, “Applying this Court’s teachings in Omnitrition, internal sales to other [distributors] cannot be sales to ultimate users consistent with Koscot.” It was a dirty trick they pulled and the Ninth Circuit did not allow them to get away it. In fact, the Ninth Circuit held the FTC’s argument to “not be supported by the case law.” Ninth Circuit BurnLounge Order, p. 18.

    And then Edith Ramirez happened. Ramirez, former FTC Chairperson, hot off the heels of a big Herbalife settlement, sent a letter to the DSA offering “guidance” for the industry. In her letter, she wrote,

    This guidance makes clear that, to abide by the law, MLMs must incentivize real sales to real customers – specifically, those outside the MLM network. . . Let me emphasize that, to be consistent with the FTC’s and courts’ well-established skepticism regarding “internal” or “personal” consumption, your members are advised to impose reasonable and transparent limits on the compensation paid for any consumption of product by business opportunity participants.

    In the statement above, do you see any sort of requirement from the FTC for network marketing companies to generate 50% of their revenue from retail sales? Me neither.

    See the problem here? It’s all a mess. Instead of legislation by legislators (the preferred method in a democracy), the FTC settled on legislation by litigation. And clearly, they’re not happy with the results. Since they were unable to convince a court to adopt their skeptical view of internal consumption, they resorted to another approach: The “legislation by giving speeches and writing letters to the DSA” approach. It’s sort of a sad reality. Jeffrey Babener, a fellow MLM attorney, said it well when he wrote, “Opponents of H.R. 3409 see it as a bill . . . that is really intended to rob the FTC of its flexibility to chase after pyramid scoundrel [by way of their vague and shifting interpretation of the rules] . . . In other less democratic countries, critics refer to such styles of governance as “a government of ‘men’ as opposed to a government of ‘laws.’

    Babener further described the FTC’s strategy by writing, “Did industry leaders feel ambushed? Well, that is a “charged” word…but, yes. Direct selling executives were rooted in the stability of historical case authority and state legislation respecting the role of personal use and . . . the BurnLounge standard that rejected the FTC argument against recognition of the validity of personal use and opted for a case by case factual analysis of “primary intent” of distributor purchasing rather than a lock step rigid rule.”

    Clearly, it’s time for a federal statute to get on the books. The shifting sands over the past few presidential administrations, from Bush to Obama to Trump, has led to inconsistent signals from the Federal Trade Commission.

    Criticism of the Bill

    The bill has a few critics, and not just the usual cast of staunch oppositionists outside the network marketing industry. The gist of the criticism can be summarized in a letter written by a collection of MLM critics (letter here). It states, “[HR 3409] relieves distributors of any responsibility to sell to retail customers, other than those that they recruit to pursue the business opportunity, who in turn recruit others for the purpose. This would relieve direct selling businesses of the need to operate a viable retail business, as opposed to a fraudulent or deceptive recruitment scheme.”

    Even industry-insiders have offered up objections. Jeff Bell, CEO of MLM LegalShield, joined in on the criticism when he wrote, “And, while there may be room to debate whether and how purchases to participants should count towards compensation, creating a blanket rule that would legitimize every internal sale is imprudent, and just not good business.” Unfortunately, Bell offers up no proposed enhancements to the bill.

    Frank VanderSloot, founder of Melaleuca, shared Bell’s sentiment arguing that the bill makes it easier for pyramid schemes to thrive.

    Politics

    In politics, as I’ve learned over these past several years, it’s unwise to take extreme “I’m right, and you’re wrong!” positions when it comes to any sort of policy discussion. In the movie “Lincoln,” there was a scene where Lincoln was chatting with the staunch abolitionist, Thaddeus Stevens. Stevens wanted Lincoln to draw a firmer line with respect to slavery. Lincoln’s remark:

    A compass, I learned when I was surveying, it’ll… it’ll point you True North from where you’re standing, but it’s got no advice about the swamps and deserts and chasms that you’ll encounter along the way. If in pursuit of your destination, you plunge ahead, heedless of obstacles, and achieve nothing more than to sink in a swamp… What’s the use of knowing True North?

    The critics have landed themselves in a swamp. Giving themselves a pat on the backs for their good and noble intentions, they fail to propose any sort of modification to make the bill better. The long-standing MLM critics will never propose a modification, short of a bill that bans all network marketing activity. Modifying an “anti pyramid scheme” would require them to acknowledge that there’s a difference between legitimate network marketing companies and pyramid schemes. The majority of them will never make such an admission; thus, their influence is greatly reduced. The industry-insiders that criticize the bill seem to prefer the “flexibility” approach championed by both the FTC and critics of the industry, arguing that the FTC should have broad discretion when suing companies. This sort of approach assumes that the FTC will operate consistently, from one presidential administration to the next, which is something history tells us will not happen.

    The older I get, the more I realize that 70% of something is better than 100% of nothing. In its current form, HR 3409 is good enough. At the very least, the bill makes it more difficult for countless online scams to masquerade as network marketing companies. Absent a refund policy, the bill will make it far easier for the FTC to sue the larger scams that plague the country. The FTC sues so few companies each year (less than 1) because of the requirements for a “fact intensive” approach. With clear law on the books, they can dissolve countless scams like cotton candy. Albeit, the bill would make the more notable companies largely immune from prosecution, which is where the critics have a real problem. They prefer to pass up dollars to pick up the nickels.

    Trial by Ambush

    One of the critics’ favorite points when they argue against HR 3409 is this: When the FTC sports an undefeated record against the targets of pyramid scheme cases, what need exists for added clarity via federal legislation? First, I’ve already explained above why this “give the government more flexibility” approach is a bad idea. Second, the fight doesn’t take place on equal footing. If you forced Usain Bolt to drag a parachute behind him, I can beat him in the 100 meter dash TODAY! In pyramid scheme cases, the FTC prefers to go to court and get an injunction in place BEFORE the defendants are even notified. Fighting from an inferior position where the business is shut down, staff is laid off, assets are frozen and all hell is unleashed online, the network marketing companies do 1 of 2 things in that situation: they dissolve or they settle. The FTC has said they prefer this method as it leads to the closure of companies “with minimal outlay of federal resources.” Translated into English: It’s litigation by bullet to the head. The FTC prefers this approach.

    With specific law on the books, the FTC might be more inclined to try different arguments when suing illegal schemes, similar to what they used against Herbalife. In the FTC’s lawsuit against Herbalife, the FTC never specifically alleged Herbalife to be a pyramid scheme. It’s a popular theory that during negotiations with the FTC, Herbalife got the FTC to avoid using the “p” word. Without the pyramid allegation, the FTC was still able to craft theories that demonstrated Herbalife operated “deceptively and unfairly” i.e. illusory opportunity, inappropriate earnings claim, etc. The downside for the FTC with this approach, however, would be that they lose the ability to shut a company down without a hearing i.e. they lose the Trial by Ambush approach.

    Conclusion

    This bill, or some variation of it, needs to pass. That said, I offer a suggestion that makes the bill more palatable for critics: Prohibit companies from having monthly personal volume requirements. I’ve written about this for years, and it was one of my proposed updates to the DSA’s code of ethics. The general practice of distributors subscribing to autoship as a way to qualify for commissions (ordering the bare minimum of inventory) leaves companies vulnerable. The FTC said it themselves in their Staff Advisory letter when they wrote, “The most common means employed to [construct a pyramid] is to require a certain level of monthly purchases to qualify for commissions.” Any sort of bill that fails to address this issue is going to have challenges. If it comes time to haggle over terms in the bill, this is a compromise that the critics might actually support.

    Again, perfection is never, ever a realistic goal. Compromise is critical for progress. President Obama summarized the importance for compromise beautifully in a 2016 commencement speech at Howard University. He said, “Democracy requires compromise, even when you are 100 percent right. This is hard to explain sometimes . . . If you think that the only way forward is to be as uncompromising as possible, you will feel good about yourself, you will enjoy a certain moral purity, but you’re not going to get what you want. And if you don’t get what you want long enough, you will eventually think the whole system is rigged.”

    It’s time for people to start talking with one another and see if there’s a way to reach an agreement on this bill. In the meantime, I suggest you contact your elected representative in the House and explain your views. The DSA has a resource page here.

    What do you think? Think the bill is good? Think it could be better? Leave a comment below.

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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.

      • Richard Bliss Brooke

        As usual great discussion Kevin. I agree this bill is better than nothing. The FTC arbitrarily and under false declaration to a federal judge destroyed Vemma. This bill will help draw some boundaries. And ultimately it would be so simple to require a ratio of active customers to active distributors…even 1 to 1. Define a customer as anyone buying the product that is completely outside the comp plan…not earning any income. And require a company to prove their numbers if asked. Simple..and the impact would be that most MLM companies would not be able to adhere as they only sell products that are only purchased by distributors. While I do not find that illegal I do find it perpetuates the stigma about our profession…less than credible.