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Earlier this week, the Direct Selling Self-Regulatory Council (DS-SRC) opened its doors for business. Its objective is to provide independent, impartial, and comprehensive monitoring of direct selling companies on an industry-wide basis, address income misrepresentations (including unsubstantiated lifestyle claims) and false product claims by companies and salesforce members, and enhance the reputation of direct selling.

The DS-SRC will be administered by the Advertising Self-Regulatory Council (ASRC), which operates under the Council of Better Business Bureaus.   This should help the new self-regulatory body achieve its goals, considering the great success of ASRC and the programs it currently administers, including the National Advertising Division (NAD), Children’s Advertising Review Unit (CARU), National Advertising Review Board (NARB), Electronic Retailing Self-Regulation Program (ERSP) and Online Interest-Based Advertising Accountability Program (Accountability Program.).

Peter Marinello, Vice President of CBBB, will serve as Executive Director of the DS-SRC, and will oversee the program and its staff.  Additional staffing will include a senior legal analyst, and a staff attorney. DS-SRC may utilize monitoring services at its discretion, and in consultation with the Direct Selling Association (DSA).

DS-SRC’s will have jurisdiction over the following:

  • Independent monitoring of the direct selling marketplace;
  • Matters referred by the DSA Code Administrator based on a pattern and practice of complaints identified, or pursuant to media reports, or matters identified by consumers;
  • Matters raised by competitor challenges;
  • Inquiries received from distributors, customers and other users of direct selling companies products or services; and
  • Complaints from Better Business Bureaus directed to DS-SRC.

DS-SRC’s legal standards will be rooted in case decisions, FTC guidance, self-regulatory decisions of the National Advertising Division and the Electronic Retailing Self-Regulation Program, the DSA Code of Ethics, and the BBB Code of Advertising.

DS-SRC’s independent monitoring will allow for the review of relevant promotional content created by direct selling companies and their salesforces, including websites and social media.  Any problematic content will be identified, and companies will be provided an opportunity to address the issues.

When a matter is referred by the DSA Code Administrator, pursuant to media reports, or inquiries, DS-SRC will identify content of concern, and the company will be given an opportunity to address these concerns within 15 business days.  In the event that substantiation is not sufficient, DS-SRC may request additional information or recommend corrective measures or remedial instruction to the salesforce.  It will also issue a case report with a summary of issues.

With respect to competitor challenges, DS-SRC will allow companies to challenge the income representations and/or product claims of competitor companies, with a submission addressing the content with a reasonable level of specificity.  A company will also be given the opportunity to address content, and the DS-SRC will issue a decision which will then be reported publicly (so long as it has not been appealed).    DS-SRC reserves the right to not hear a case if the complaint is overly broad, if a party publicizes the case while pending, if the matter is the subject of litigation, or if the content has been withdrawn.

Companies that do not agree to implement corrective measures, ignore the inquiry, or do not participate, may be referred to the appropriate government agency, most likely the Federal Trade Commission.

DS-SRC will issue case decisions within 30 days of the last document received, prepare a case decision, and invite the company to provide a responsive statement.  Should the DS-SRC find that the content at issue is not adequately substantiated, the company will have to submit a response indicating whether it (1) agrees to comply with DS-SRC’s recommendations; (2) will not comply with DS-SRC’s recommendations; or (3) will appeal all or part of DS-SRC’s decision.

Once a case decision has been made, they will be published in Case Reports.  The decision will include a summary of the content at issue, a summary of each party’s position, and the ultimate resolution (including whether a party complied or was unresponsive).

The formation of the DS-SRC responds directly to statements made by FTC commissioners, bureau directors, and senior staff over the years, and should be viewed as a very positive step for an industry that is frequently the subject of regulatory attention.  Expect greater self-regulatory focus on income misrepresentations and lavish lifestyle claims in the months ahead, with the objective of promoting truthful and accurate advertising among direct selling companies and, in turn, raising the credibility of the industry.

Earlier this year, the Federal Trade Commission released new business guidance for direct sellers and multilevel marketers describing the legal principles that it will apply when evaluating practices under the FTC Act. Law360 published the article “What The FTC Said About Direct Selling In 2018,” co-authored by partner John Villafranco and senior associate Donnelly McDowell.  The article discusses the FTC guidance along with recent enforcement actions and staff comments, and poses seven questions direct sellers and multilevel marketers should consider as we close out 2018 and look toward the future. To read the article, please click here.

The FTC released today Business Guidance Concerning Multi-Level Marketing, which offers answers to frequently asked questions to assist multi-level marketers in evaluating their business practices for compliance with the FTC Act.  The Guidance begins by restating the general standard for pyramid schemes set forth in the FTC’s 1975 Koscot decision and then goes on to address more contentious issues, such as internal consumption, retail sales validation, the importance of refund and buyback policies, and income and business opportunity claims.

The Guidance memorializes and expands on several principles embodied in recent FTC settlements with multi-level marketing companies and makes clear that FTC Staff will look to these principles in assessing whether a company has committed unfair and deceptive acts or practices in violation of the FTC Act.  Key points include the following:

  • Internal consumption (i.e., purchases from participants in the business opportunity) may in some cases be permissibly counted as genuine retail sales, but this will be a fact-specific inquiry.  The Guidance cites the Herbalife settlement as an example of a marketing plan that appropriately permits payment of compensation based on internal consumption, but “subject to specific limitations and verification requirements.”  While emphasizing that the validity of internal consumption will depend on a “comprehensive analysis of a variety of factors,” the Guidance highlights two of the foremost factors FTC Staff will consider: (1) whether the compensation plan incentivizes participants to purchase unrelated to demand (e.g., to qualify for bonuses, advance in the marketing plan or obtain a greater discount); and (2) fact-specific information about a purchase bearing on whether it seems demand-driven (e.g., whether the purchases are within typical consumption habits).
  • Multi-level marketers are not expressly required to retain and validate receipts, but should ensure sufficient documentation to ensure that actual sales are made to real customers.  Again, the Commission here emphasizes that there is no single correct way to validate retail sales, and that one approach – or a combination of approaches – may work for one company and not work for another.  The Guidance does, however, explain that staff will be most interested in “direct methods” used to verify that retail sales are made to real customers, and that “indirect methods – such as policies requiring participants to attest they have sold a certain amount of product to qualify to receive reward payments – are less likely to be persuasive, with unsupported assertions being even less persuasive.”
  • Buyback provisions are helpful but not dispositive in preventing inventory loading and unlawful conduct.  The Guidance affirms that allowing participants to return unsold products can help reduce potential consumer harm by decreasing the risk of losing money for those participants who take advantage of the buyback policy.  However, the Guidance cautions that “money-back guarantees and refunds are not defenses for violations of the FTC Act” and that unfair and deceptive acts may still occur notwithstanding the existence of those policies.  The section appears intended to address pending congressional legislation, H.R. 3409, which would include a controversial carve-out for multi-level marketing companies with inventory repurchase programs.
  • Claims that convey lifestyles or earnings that are only attained by a small subset of participants are likely to be misleading.  The Guidance explains that all business opportunity and earnings claims must be supported by a reasonable basis, and that claims that present atypical earnings as typical will likely be misleading.  For example, the Guidance explains that images of expensive houses, luxury automobiles and exotic vacations attained through the multi-level marketing program are likely to be deceptive if those results are not generally achieved by others and properly qualified.  Similarly, representations about full-time income and the capacity to “fire your boss” or “become stay-at home parents” are likely to present compliance issues.  Even hypothetical scenarios (e.g., you can make $1,000 if you recruit 30 people and sell X products) may pose compliance risks if those hypotheticals make assumptions that are untrue for the typical participant.
  • Developing and implementing a compliance program is important.  Finally, the Guidance makes clear that it’s not enough to nominally adopt these policies or even ensure that the company itself complies with the policies.  Rather, MLMs should develop and maintain a successful compliance program that includes monitoring of participants to ensure they are also complying with applicable policies and procedures, particularly those related to claims, sales validation, and other consumer protection-oriented policies.

While the principles set forth in the Guidance will not come as a surprise to most MLMs, they serve as an important reminder that MLM compliance inquiries are multi-faceted and full of gray areas.  Companies would be well-served to evaluate their business practices and compliance programs in light of the Commission’s new guidance and prior related settlements.

VemmaThe FTC announced today that it had settled charges with multi-level marketer and seller of health and wellness drinks Vemma over allegations that it operated a pyramid scheme.  The FTC initially filed the action in August 2015 in federal court in Arizona, alleging that Vemma encouraged participants to buy products to qualify for bonuses and to recruit others to do the same.  The settlement puts an end to the litigation, which saw the FTC and Vemma go to battle over the extent of revisions necessary to Vemma’s marketing plan to ensure that Vemma operated legitimately and not as a pyramid scheme.

Ultimately, the stipulated order looks a lot like those entered in previous FTC pyramid cases like BurnLounge and Fortune Hi-Tech Marketing, with a few important distinctions, including:

  • Compensation based on sales and not purchases.  The order prohibits linking or tying a participant’s compensation, or eligibility to receive compensation, to that participant’s purchase of goods or services.  See Section II(B).  While included in the preliminary injunction order, this provision has not previously been included in FTC pyramid orders like BurnLounge and Fortune Hi-Tech Marketing.
  • Compensation derived primarily from non-participants.  The order prohibits paying a participant compensation unless the majority of the total revenue generated during such period by the participant and others within the participant’s downline is derived from sales to non-participants.  See Section II(C).  Again, while a similar provision was included in the preliminary injunction order, previous pyramid orders have not included this provision.  The language in the permanent order also makes clear that the determination must be made in connection with a “fixed pay period.”
  • Additional disclosures of material information.  The order requires certain disclosures in connection with any claim concerning earnings, profits, or sales volume, including: (1) the number and percentage of participants who have made a profit through their participation in the program; (2) the beginning and ending dates when the represented earnings, profits, or sales volume were achieved; and (3) the average and median amount of profit made by each participant.  See Section V(A).   These disclosures have not been required in previous pyramid orders, although they were required in the preliminary injunction order.

The order imposes a $238 million judgment against Vemma, which will be partially suspended upon payment of $470,136 and the surrender of certain real estate and business assets.  A separate order was entered against Vemma affiliate Tom Alkazin and his wife, Bethany Alkazin, which imposes a judgment of more than $6.7 million, although it will be partially suspended upon payment of $1.2 million.

The settlement comes two months after Chairwoman Ramirez spoke to the Direct Sales Association (DSA), the trade association representing many multi-level marketing and direct selling companies, about business opportunity and income representations and ensuring that compensation plans ensure that sales are primarily to consumers who are not pursuing the business opportunity.  We covered that speech here.  As part of that speech, Chairwoman Ramirez signaled that the FTC would be issuing further guidance on MLMs in the near future.  We’ll continue to monitor and post developments relevant to MLMs and direct selling companies here.

Last week, FTC Chairwoman Edith Ramirez spoke at the Direct Sales Association (DSA) Business & Policy Conference in Washington, D.C.  In her comments, Chairwoman Ramirez acknowledged that the direct selling industry was a $36 billion industry that “has the capacity to provide consumers with valuable goods and services and an opportunity to try an entrepreneurial experience.”  At the same time, Ramirez acknowledged a “negative public perception about how the industry operates” and highlighted three areas of potential improvement for industry to address concerns by enhancing transparency and credibility across the industry.

  • Self-Regulatory Initiatives.  Ramirez commended the DSA for recent improvements to the DSA Code, including the establishment of a mechanism to address consumer complaints in connection with DSA member companies and the publication of information related to those complaints.  Ramirez also praised the recent inclusion of lifestyle representations in the definition of earnings claims in the DSA Code.  While Ramirez commented that more improvements were possible, she indicated that she was encouraged that DSA appeared to be receptive to addressing concerns raised by the FTC.
  • Business Opportunity and Income Representations.  Ramirez highlighted false and unsubstantiated earnings claims as a top priority of the Commission and suggested that the FTC’s “law enforcement experience shows that many MLMs continue to misrepresent the amount of money participants are likely to earn.”  Ramirez suggested that, because only a small percentage of MLM participants earn significant income or make career-level income, “testimonials from these rare individuals are likely to be misleading because participants generally do not realize similar incomes.”  This means that companies should both refrain from making such representations directly and take reasonable steps to monitor and ensure that participants are also not making misleading claims about the business opportunity, according to Ramirez.
  • Verifiable Retail Sales.  Ramirez highlighted MLM structures that “are not focused on real sales to real customers” as “the second main problem” in the MLM industry and posited that “real customers” means that products sold by a legitimate MLM “should be principally sold to consumers who are not pursuing a business opportunity.”  This has been one of the most hotly contested issues within the direct sales industry, with some industry players arguing that there’s no reason to conclude that purchases for internal consumption are not motivated by real product demand without additional evidence.  Ramirez, on the other hand, controversially suggested that “the law has always taken a skeptical view of paying compensation to someone based on the presumed ‘internal consumption’ or ‘personal consumption’ of recruits who are pursuing a business opportunity.”  Ramirez highlighted the requirements imposed under Herbalife’s settlement with the FTC – including the differentiation between “preferred customers” and business opportunity participants, related multi-level compensation limits, and prohibitions against targets and thresholds met by product purchases rather than sales – as one possible approach to ensure that an MLM is compensating sales to real customers.   Finally, Ramirez asserted that “real sales” must both be profitable and verifiable in order to be valid and cross-referenced the requirement in the Herbalife settlement for collection and verification of retail receipts.

As a closing point, Ramirez cautioned that it was not enough for direct selling companies to rely on the so-called Amway policies highlighted in the Commission’s 1979 Amway decision, calling such a reliance “misplaced” because those findings were highly fact specific and because the 10 Customer and 70 Percent Rules “offer, at best, weak and attenuated evidence of a business focused on real sales to real customers.”

There’s a lot to unpack in Ramirez’s speech, which is particularly noteworthy given it is the first time Ramirez has publicly spoke on multi-level marketing issues since announcing the Herbalife settlement on July 15.  Moreover, Ramirez suggested that her remarks “provide an important foundation” for structuring MLM business practices and signaled that “the FTC will be issuing further guidance for MLMs” in the future.  So, while a formal guidance document may still be forthcoming, the FTC may consider industry on notice based on Ramirez’s recent remarks and the Herbalife settlement.