This post is Part 1 of a two-part series on Nerium’s push-back against the FTC’s pervasive (and shifting) authority over how it defines pyramid schemes.
In an unprecedented move the likes of which has never before been seen in the history of the network marketing industry, the FTC and Nerium filed competing lawsuits against one another on Friday. The FTC and Nerium engaged in back-and-forth conversations for more than three years after the initiation of a private investigation before talks eventually broke down. When the prospects of the FTC filing a lawsuit became more and more apparent, Nerium took matters into its own hands and instead went on the offensive. Nerium’s lawsuit counters that the FTC’s recent enforcement actions against MLMs amount to a “fencing in” strategy devoid of any proper rulemaking and constitutional authority. In fact, Nerium proffers that the FTC’s recent behavior completely undermines a recently issued Executive Order by the President which prohibits administrative enforcement in the absence of firm legal footing. Nerium’s lawsuit can be found here.
Both lawsuits offer intriguing, competing viewpoints. To understand the basis of Nerium’s counterpunch, it’s necessary to take a look at how the FTC’s definition of pyramid has evolved over the years to unprecedented lengths. Therefore, this blog will discuss the rapid expansion of pyramid treatment and look at specific pyramid allegations made by the FTC against Nerium.
FTC’s Rapidly Shifting Pyramid Test
Towards the tail end of the Obama administration, the FTC’s actions against MLMs reflected almost a bright-line standard. That is, the majority of a company’s overall revenue (51%) had to come from customer sales. Subtly included within this larger discussion on a percentage of retail sales was a new definition of an “ultimate user”. Since the original pyramid case first brought by the FTC (In re Koscot Interplanetary, Inc.) a pyramid scheme characterization only truly arose when a program’s rewards came from recruitment rather than the sale of products to ultimate users. Naturally, the question then became what constituted a sale to an ultimate user? Could distributors’ own personal purchases of inventory (known as “internal consumption”) legally contribute towards commission payouts? The FTC’s initial answer to this question was unequivocally yes. In a 2004 Advisory Opinion, the FTC flat out said “[T]he 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.”
Ironically, the FTC then conveniently contradicted its own position ten years later in its case against BurnLounge. To support its theory that BurnLounge operated as a pyramid, the FTC incorrectly posited that “ultimate users” could only represent external customers and not a company’s internal sales force. The 9th Circuit dismissed this line of thinking and confirmed that distributors themselves can act as ultimate users. While the 9th Circuit found BurnLounge operated as a pyramid scheme, the Court did so on the basis that an ultimate user was one who purchased a product for its intrinsic value as opposed to a means to qualify for bonuses (“In practice, distributors may themselves consume some inventory, and thus a program that permits internal consumption is not per se a pyramid scheme, [but] evidence that distributors purchase and consume product for the purpose of qualifying for recruitment incentives is evidence of a pyramid scheme.”).
Ever persistent, the FTC slightly tweaked this recharacterization of an ultimate user but did so without any concrete legal support. Rather than outright say an ultimate user was and only could be a retail customer, a tactic the FTC unsuccessfully tried in BurnLounge, the Commission in the Vemma case found an ultimate user to be a person “who would have purchased a product even in the absence of the income opportunity.” This mumbo-jumbo was just another way for the FTC to say that a “true” ultimate user was a retail customer. Shortly after Vemma in the fall of 2016, then Chairwoman Edith Ramirez reiterated this newfound and legally unsupported definition in a speech to the Direct Selling Association. “A legitimate [MLM] must be focused on, and must pay compensation that is based on, real sales to real customers, not wholesale purchases by its sales force.”
In time, this moving of the goalposts has had the cumulative effect of the FTC now trying to inhibit MLMs from paying ANY commissions from internal purchases. The Advocare and Nerium actions illustrate this very point. A pyramid scheme is no longer one where commissions are from recruitment rewards; in the FTC’s eyes a pyramid is now a program where compensation comes from something other than “real sales to real customers”, period. This, in my view, is the FTC committing its own version of fraud.
FTC’s Pyramid Case Against Nerium
In the complaint, the FTC makes a rather bold and unprecedented statement: Since its inception, Nerium has operated as an illegal pyramid scheme. If you’re like me, you may be thinking, “Wait, WHAT?” The support for such a hyperbolic statement comes from the FTC’s viewpoint that “Nerium’s business model makes it unlikely that [Nerium distributors, or ‘Brand Partners’] can earn money by selling product to outside consumers.”
The FTC goes on to state that more than half of the company’s total revenue comes from internal consumption. This would be problematic if Nerium had to operate under what I’ve referred to in the past as the Vemma and Herbalife overlay (i.e., restrictions which prevent an MLM from paying commissions to distributors unless a certain percentage of sales originate from retail customers). The thing is the Vemma and Herbalife stipulations are not binding on other MLMs like Nerium. The FTC has even said so itself.
The FTC makes some additional statements in the pyramid portion of its complaint best described as extremely puzzling. Take this one for example: BPs do not receive compensation from Nerium for sales from their personal inventory, but they can retain any profit from products they are able to sell out of their own inventory. What the heck this even means is anyone’s best guess. Another statement that is hard to believe at face value is the FTC’s assertion about Nerium’s percentage of retail sales. “According to Nerium, less than 1% of all rewards paid by the company consist of commissions paid on the sale of products to Retail Customers.” This is incredibly hard to believe, and, without question, vehemently disputed by Nerium in their lawsuit against the FTC. As support for the notion that Nerium’s business heavily predicates upon the recruitment of new participants, the FTC takes issue with the purported high attrition rate of Nerium distributors. The FTC points to statistics in which more than 92% of consumers who signed up as Brand Partners ceased working with the company past 2017 as indicative of “a perpetual focus on recruiting”. These random statistics seem to reflect the government’s belief that the ends justify the means.
Nerium Takes a Stand
Less than one month after the FTC’s settlement against Advocare saw one of the more well respected MLMs in the entire industry forgo future distribution of its products by way of multi-level marketing, Nerium decided against a similar course of action. Much like Herbalife did, Nerium’s made the decision to push all its chips to the table and question the sincerity of the FTC’s position “that multilevel marketing continues to be legal” or “that there’s nothing inherently unlawful about the direct selling model” (positions FTC attorney Andrew Smith expressed to the Direct Selling Association’s Legal and Regulatory Seminar in Washington, D.C. less than 1 week after the Advocare settlement announcement).
The FTC is not interested in protecting consumers here. The FTC is simply interested in winning. And they’ll use whatever tool that’s available to effectuate that end. In my opinion, the FTC has acted quite pitifully in this situation. After investigating Nerium for THREE YEARS, seeing nothing terribly wrong that would have warranted a shutdown, the FTC runs to NEW JERSEY to file its own lawsuit on the same day Nerium files its lawsuit in Chicago. Bear in mind, the FTC started the investigation….in Chicago. They’re obviously forum shopping and, quite frankly, it makes the FTC look desperate. This coupled with the fact that the FTC failed to include their motion papers requesting a Temporary Restraining Order, something they do in EVERY pyramid scheme case when they file a complaint…they were obviously unprepared.
In Part 2 of this two-part series, we’ll explore in greater detail Nerium’s legal arguments for why it believes the FTC’s actions represent an attempt to change the law through unconstitutional behavior. Stay tuned.