The FTC Accuses Another Network Marketing Company of Operating as a Pyramid Scheme

    Thomas Ritter is an associate attorney at Thompson Burton PLLC. His practice area focuses primarily on cybersecurity law, which includes an assortment of data protection and privacy-related matters, and a wide-variety of business transactions. He assists diverse businesses from well-established companies to early stage start-ups.

    The Federal Trade Commission continued its recent flurry of activity against network marketing companies with the public announcement of a lawsuit against company Success by Health. This marks the third action against an MLM in the last four months (the Advocare settlement in October of ’19 and the ongoing Nerium/Neora lawsuit filed in November of ’19). The FTC alleges that Success by Health operated as a pyramid scheme with the help of its founders and executive team. The FTC requested that a federal court in Arizona grant a preliminary injunction, among other forms of relief, allowing for an immediate asset freeze of the company and those individuals involved. The Court granted the preliminary injunction earlier this week. Let’s dive right in and examine some of the more noteworthy aspects of the lawsuit.

    Fool Me Once, Shame on You, Fool Me Twice, Shame on Me

     

    Before diving into any particulars, you may be asking why a company that purportedly made only $7 million would become a target of the FTC. The answer seems straightforward, as Success by Health (SBH) founder Jay Noland was no stranger to the FTC. Noland settled with the Commission back in 2002 for his role in the promotion of the business Netforce Seminars. As the FTC sarcastically remarked in its press release:

    The new year has just begun, but the FTC already has delivered its answer to the annual question: Should old acquaintance be forgot and never brought to mind? The answer? If you’re a past defendant in an FTC case, the FTC won’t forget you.

    The 2002 settlement between the FTC and Noland prohibited him from engaging in the same kind of conduct that the FTC now alleges was present in SBH (i.e., the operation of a pyramid scheme and misrepresentations about earning potential). It’s also worth noting that in filings with the court the FTC asserts that Mr. Noland and his wife (also a co-defendant) fled the country after they became aware of the regulatory investigation back in June of 2019. The FTC believes the Nolands now permanently reside in South America.

    Regardless of this fact, a review of the lawsuit reveals the FTC’s main issues with SBH were: pyramiding (strike one); rampant amounts of false income and lifestyle claims (strike two); and aggressive approach towards refund requests and chargebacks (you’re out).

    The Pyramid Charge

    The pyramid charge derives from allegations of rampant inventory loading (“The vast majority of purchases from the SBH website or from Affiliate websites are made by Affiliates”). The FTC goes so far as to claim that “over 95% of SBH product purchases” came from Affiliates. Additionally, the FTC took issue with the fact that the company strongly suggested new enrollees purchase expensive starter packs ($125, $500, and $1,195) and engage in monthly autoship. According to the FTC, these product purchases were in amounts larger than what Affiliates could reasonably consume/sell in a month. “The average purchase amount for Affiliates . . is approximately $300, suggesting that these sales are not for personal consumption, and overall purchases double on the last day of rank-qualification, suggesting that Affiliates only buy products to hit ranks.”

    One aspect of the FTC’s argument that remains extremely murky is its stance on the meaning of an “ultimate user”. Whereas recent actions against Advocare and Neora have demonstrated a strategic attempt to assert that a customer is the only representative of Koscot’s ultimate user, the FTC in this lawsuit seems to concede commissions can and should come from a true ultimate user — a distributor OR customer (“SBH’s commission plan emphasizes and incentivizes recruiting new Affiliates over selling products to ultimate users or consumers outside of the organization“). However, this viewpoint becomes more and more confusing the longer you read the FTC’s complaint. In the section of the complaint detailing pyramiding, the FTC takes issue with the fact that

    SBH promises commissions to Affiliates based only on Affiliate or non-Affiliate product purchases from SBH, rather than sales to users of SBH products. . . . SBH does not separately track sales made by Affiliates to ultimate users of SBH products.

    If anyone can understand what exactly that means, please let me know. It’s unclear why SBH promising commissions based off non-Affiliate purchases would not, in fact, represent sales to users of SBH products. Why else would a customer buy product if not with the intention to use said product? I chalk this up to simple human error on the part of whoever drafted the complaint.

    Income and Lifestyle Claims

    An integral part of the SBH pitch to prospective Affiliates was the claim that one could “replace their job income in six months and become financially free in 18 months”. Inappropriate income claims are the easiest exposure point for regulators to exploit. While explicit money-making claims (e.g., Jim made $12,000 last month) and images of luxurious cars and homes have always been problematic, the FTC is now going a step further in policing even vague income claims. The FTC’s most recent business guidance for multi-level marketing addresses this very thing.

    Business opportunities may also claim that participants, while not necessarily becoming wealthy, can achieve career-level income. They may represent through words or images that participants can earn thousands of dollars a month, quit their jobs, “fire their bosses,” or become stay-at-home parents. If participants generally do not achieve such results, these representations likely would be false or misleading to current or prospective participants.

    This was the attitude of SBH. The FTC cited numerous examples where Mr. Noland and other executives touted life-changing income. Moreover, the FTC found that even when the company used a disclaimer in connection to income and lifestyle claims, the disclaimer was ultimately buried and undermined the very statements it sought to renounce. “SBH’s presentation has a small-print, inconspicuous statement that income is not ‘guaranteed’ . . . [ and disclaimer] statements appeared in two-millimeter type, at the bottom of a page. . “.

    Lastly, SBH executives tried to take a creative approach to circumventing the FTC’s restriction on inappropriate income claims. Instead of making specific income claims, the company encouraged a marketing approach predicated upon “lifestyle enhancements.” The FTC found Mr. Noland’s lifestyle enhancement marketing strategy was a way to avoid government scrutiny. “Instead of telling people how much [money] we make, we just go, okay, last week, I made enough to buy that Maserati cash.” It goes without saying that this lifestyle enhancement approach is not some ingenious way of outsmarting regulators. Unfortunately, companies in the industry far too often think this way and employ equally ineffective tricks to income claims that nonetheless amount to unlawful conduct.

    Shipping Delays, No Refunds, and Chargebacks

    In my opinion, one of the FTC’s biggest gripes against SBH that seemed entirely justifiable: The Company struggled with product fulfillment, and yet refused to refund purchasers their money and punished those who sought chargebacks (i.e., refunds through their credit card company). SBH had the audacity to even include a liquidated damage provision in the company Terms and Conditions that sought to punish consumers who violated the no refund policy or filed a chargeback. What’s more, the Company even sued nine Affiliates in Nevada who had filed 12 chargebacks. When a company fails to fulfill product orders, the last thing they should do should be to sue consumers that are simply trying to recover their funds. There’s really no other way to categorize this sort of decision-making as anything but an egregious mistake.

    In this industry, a strong refund policy is not optional. Refunds act as a safeguard against people losing different sums of money, and regulators label people who lose sums of money “victims,” fair or not. As the FTC says in their business guidance for MLMs, “As in any business opportunity, it can be a beneficial practice if an MLM allows participants to return unsold product to the MLM because the ability to return product can decrease the risk of losing money for participants who take advantage of that policy.”

    A weak or stingy refund policy can serve as one of the biggest reasons for why a company comes onto the radar of state and federal regulators. Frustrated consumers file complaints, and these complaints serve as the basis of an investigation. At the end of the day, direct selling companies MUST have conservative return policies. SBH did not and it cost them.

    Closing Thoughts

    Before drawing too many conclusions that the case against SBH represents the FTC’s continual assault against the direct selling industry, it’s important to remember some elements at play seem to have created an almost perfect storm. A past target of the FTC once again pops up on the radar. Concrete examples of aggressive income claims exist — the same behavior that prompted a slap on the wrist once before. And corporate decision-making around anti-consumer business practices only serves to irk regulators even further. You combine all of these things and it’s a recipe for disaster.

    There is one action of the FTC’s in this case, however, that is new and worthy of review. Taken from the Court’s order granting the FTC injunctive relief, the company, and those “acting in concert with the company,” are prohibited from sharing customer/distributor information with anyone. The purpose behind this request and relief comes from two different motivations. First, as is all too common when companies have been busted in the past, distributors keep the genealogy intact and seamlessly transition to another company. The FTC has watched companies do this, learned from it, and now made this much more difficult to do. Secondly, this request would prevent a soon defunct company from attempting to sell the treasure trove of personal data to an interested third-party. After all, the FTC is the chief federal agency also in charge of protecting consumer information. This “prohibition on the release of customer information” will become a standard practice for the FTC moving forward.

    If you learned something in this article, please pass it along.

      Thomas Ritter is an associate attorney at Thompson Burton PLLC. His practice area focuses primarily on cybersecurity law, which includes an assortment of data protection and privacy-related matters, and a wide-variety of business transactions. He assists diverse businesses from well-established companies to early stage start-ups.