FTC issues 2018 guidance on MLM pyramid schemes

New year, new guidance from the FTC on MLM pyramid schemes.

Sort of…

In a January 4th “offer of business guidance concerning multi-level marketing”, the FTC has attempted to clarify common questions and concerns related to MLM and pyramid schemes.

For some reason the FTC inexplicably goes to great lengths not to mention “retail sales” in their guidance, but they do refer heavily to “ultimate users”.

This is a bit confusing, as ultimate users” can refer both to affiliates and retail customers.

The FTC’s 2018 guidance is rooted in the 1975 Koscot decision,

which observed that such enterprises are “characterized by the payment by participants of money to the company in return for which they receive

(1) the right to sell a product and

(2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users.

As we’ve seen with the Moolenaar Amendment (HR3409), this has led to lawmakers backed by the MLM industry attempt to legitimize a 100% internal consumption model – otherwise known as affiliate autoship recruitment.

That is to say you sign up as an affiliate, pay a monthly autoship fee, said fee qualifies you to earn residual commissions and you then get paid to recruit others who also pay a monthly fee.

Ironically, the current FTC commissioner is opposed to the Moolenaar Amendment, which makes the ongoing lack of concrete clarification on retail sales frustratingly perplexing.

The FTC’s guidelines on an “unfair or deceptive” compensation plan that “harms consumers” is as follows:

An MLM compensation structure that incentivizes participants to buy product, and to recruit additional participants to buy product, to advance in the marketing program rather than in response to consumer demand in the marketplace, poses particular risks of injury.

Where such an unlawful compensation structure exists, a participant is unlikely to be able to earn money or recover his or her costs through selling product to the public.

In such circumstances, participants will often attempt to recruit new participants who will buy product, and pressure existing recruits to buy product, with little concern for consumer demand.

Where an MLM has a compensation structure in which participants’ purchases are driven by the aspiration to earn compensation based on other participants’ purchases rather than demand by ultimate users, a substantial percentage of participants will lose money.

“Consumer demand” can be from affiliates or retail customers.

The issue however is when legitimate consumer demand from affiliates (by way of autoship or a manual monthly spend) also qualifies affiliates for residual commissions (typically a monthly Personal Volume (PV) requirement).

As we saw in both the Herbalife and Vemma busts, in the absence of significant retail activity, the FTC weighs compensation qualification over genuine consumer demand in these instances.

Why the FTC can’t just come out and state “autoship is fine so long as you have retail sales”, I have no idea.

Instead, we get lengthy paragraphs that in all likelihood just confuse consumers looking for actual regulatory guidance.

How does the FTC distinguish between MLMs with lawful and unlawful compensation structures?

At the most basic level, the law requires that an MLM pay compensation that is based on actual sales to real customers, rather than based on mere wholesale purchases or other payments by its participants.

In evaluating MLM practices, the FTC, in accord with established case law, focuses on how the structure as a whole operates in practice, and considers factors including marketing representations, participant experiences, the compensation plan, and the incentives that the compensation structure creates.

The assessment of an MLM’s compensation structure is a fact-specific determination that the FTC makes after careful investigation.

TL;DR: The FTC looks for retail sales and if it doesn’t find any, that compensation plan is “unlawful”.

The FTC is likely to consider when evaluating an MLM’s payment of compensation that is premised, in part, on participants buying product that is not resold.

First, the FTC staff is likely to consider whether features of the MLM’s compensation structure incentivize or encourage participants to purchase product for reasons other than satisfying their own personal demand or actual consumer demand in the marketplace.

Second, the FTC staff is likely to consider information bearing on whether particular wholesale purchases by business opportunity participants were made to satisfy personal demand.

The persuasiveness of this information in any particular case will depend on its reliability.

TL;DR: Affiliates purchasing product each month and no equivalent retail activity? Pyramid scheme.

To be clear, while it might sound like I have some sort of bias against affiliate autoship, I do not.

I’m fine with affiliate autoship in and of itself, so long as it’s not the primary source of revenue generated by an MLM company.

If it is, then it means the company is full of affiliates purchasing products each month to qualify for commissions (irrespective of whether they are ultimate users of the product or not), therefore classifying that company as a pyramid scheme.

How much or how little affiliate autoship in and of itself is not an issue – a viewpoint I share with the FTC.

Is it still correct, as stated in the 2004 “FTC Staff Advisory Opinion – Pyramid Scheme Analysis,” that “the amount of internal consumption in any multi-level compensation business does not determine” whether the FTC will consider the MLM’s compensation structure unlawful?

Yes. Personal or internal consumption – meaning product participants purchase and consume to satisfy their own genuine product demand – does not determine whether the FTC will consider an MLM’s compensation structure unlawful.

Note that this is not the same as affiliate autoship volume weighted against retail sales.

The 2004 letter should not be misconstrued as suggesting that an MLM can lawfully pay compensation on wholesale purchases that are not based on actual consumer demand by characterizing such purchases as “internal consumption.”

In granting a preliminary injunction against Vemma Nutrition Company, the court rejected the argument that individuals who had joined as business opportunity “Affiliates” only wished to purchase product for their own consumption, finding that this claim was “not based in fact.”

In that context the percentage of company revenue generated via affiliate autoship very much matters.

One of the key components of the Moolenaar Amendment is a buyback provision, guaranteeing unsold product be bought back at 90% of the original cost.

The idea here is that it’ll be OK for MLM companies to run autoship pyramid schemes, provided they offer to buy back product purchased to qualify for commissions.

This doesn’t work because often affiliates don’t bother (they’re too embarrassed, ashamed, whatever), and/or additional criteria is implemented that makes returning product extremely difficult.

Thankfully the FTC is clear on this point;

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.

Allowing participants to return product, however, does not in and of itself shield an unfair or deceptive compensation structure from law enforcement.

As a general matter, money-back guarantees and refunds are not defenses for violations of the FTC Act.

Even where such policies are offered, dissatisfied participants may not seek a refund for a number of reasons, including because they are unaware of their right to a refund, the refund process is too complicated or obscure, or they blame themselves for not being able to sell the product.

Basically what I said above.

Perhaps the most perplexing component of the FTC’s guidelines is its recommendations to MLM companies regarding marketing.

A company must have a reasonable basis for the claims it makes or disseminates to current or prospective participants about its business opportunity.

A “reasonable basis” means objective evidence that supports the claim. If a company lacks such objective supporting evidence, the claims are likely deceptive.

Some business opportunities may present themselves as a way for participants to get rich or lead a wealthy lifestyle.

They may make such representations through words or through images such as expensive houses, luxury automobiles, and exotic vacations.

If participants generally do not achieve such results, these representations likely would be false or misleading to current or prospective participants.

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.

Even truthful testimonials from the very small minority of participants who do earn career-level income or more will likely be misleading unless the advertising or presentation also makes clear the amount earned or lost by most participants.

In addition, a hypothetical earnings scenario – such as “if you recruit 30 people who each sell $1,000 of product each month, you will earn $1,500 a month” – may imply that the assumptions made (e.g., the number of people recruited, the amount sold by each recruit) are consistent with the actual experiences of typical participants.

If the assumptions are not, the earnings scenario likely would be false or misleading to consumers.

An MLM’s compensation structure may give its participants incentives to make representations about the business opportunity to current or prospective participants.

As a consequence, an MLM should (i) direct its participants not to make false, misleading, or unsubstantiated representations and (ii) monitor its participants so they don’t make false, misleading, or unsubstantiated representations.

Truth In Advertising has been documenting explicit examples of violations of the above for years. Sadly for the most part, nothing is done about it.

Can you recall the last time the FTC went after an MLM company for deceptive advertising outside of a broader complaint?

Yeah, neither can I.

Most infuriating of all however, is the refusal of the FTC to stand by any of its own guidance.

If you make it through the entire 2018 guidelines and feel you’ve got a better understanding of FTC regulation of MLM pyramid schemes, think again.

Are the answers in this document legally binding?

No, this is an FTC staff business guidance document. It does not necessarily represent the views of the Commission or any Commissioner and is not intended to, and does not, create any rights or obligations with respect to the Commission, the FTC staff, or the public.

Why issue industry specific guidelines you’re not willing to stand behind?!

I know this sentiment is a broken record but we are easily a few decades overdue for specific, clear and concise guidelines.

Otherwise we get what is interpreted as knee-jerk reactions, and companies continuing to push the boundaries of legality in a murky regulatory environment.

As the gate-keepers of that environment, not good enough FTC. Not nearly good enough.

Let’s block ads! (Why?)

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