Direct Sales and MLM

Back to the Basics

By
Clay Brewer

Whenever I sit down to write an article, I find myself trying to come up with some obscure, groundbreaking topic to discuss. Sadly, I do not have these monumental epiphanies as frequently as I would like. But the truth of the matter is that why should we discuss such grand topics, when the industry of network marketing still cannot understand such basic principles. In this article, back to the basics we go.

The industry as a whole has an image problem. Anyone that argues to the contrary is either delusional or the one causing the problems. In the world of multi-level marketing there’s a spectrum I like to compare to the traditional “left-right” idea of politics.

On the far-left side, we have the regulatory beast primarily dominated by the FTC and SEC while, at times, accompanied by their other friends. This regulatory machine consists primarily of true believers who want nothing more than to see the end of the industry and believe that consumers are fully incapable of making any decision on their own. “They’re looking out for the consumer,” so goes the saying.

On the far-right side of the spectrum lie the scam artists. Unfortunately, this far right is where the regulatory beast believes the entire industry rests and where many individuals unfamiliar with the industry likely revert their minds whenever the term MLM is brought to their attention. But can we blame them? You rarely see hit documentaries about a dietary supplement company playing by the rules and slowly enhancing an individual’s life. Because there’s no shortage of greed in the world, there will always be get-rich-quick scams. And sadly, scams sell. And even if the model isn’t a scam, the label sticks and regulators love to point the finger first and ask questions rarely. This label is what the regulatory beast seeks to place upon all who tangentially tangentially touch new concepts.[1]

In saying all of this, there remains, in my opinion, a strong ability to educate the far left that the industry too believes that the individuals/companies on the far right of the spectrum are causing extreme consumer harm and that there are good and genuine businesses to be found. So how do we do this? We return to the basics and grow from there.

The Basics

The law of a pyramid scheme is quite simple and can definitively be described within the case In re Koscot et al. from 1975. The times have changed but the law has remained quite steadfast, despite the different angles the regulatory beast seeks to take. As the Court states, “Such schemes [pyramids] 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.”[2]

The second case that sent reverberations felt across the MLM world took place approximately 20 years later in Webster v. Omnitrition International, Inc. wherein the United States Court of Appeals for the Ninth Circuit took on the question of “what constitutes an inherently fraudulent scheme for purposes of several federal antifraud statutes.”[3] The Court even went on to adopt the FTC’s test of what constituted a pyramid scheme outlined in Koscot.

Courts and the FTC have given the industry the test by which they will be tried. But both decisions were pre-Internet as we know it, pre-social media, pre-marketing at your fingertips and pre-direct to consumer delivery from a simple click of a button. This generational shift in both the nature of MLM organizations and also the makeup of the regulatory agencies have led to, perhaps, ideological changes but minimal, if any, substantive legal changes.

Fast forwarding again roughly 20 years, we find ourselves at the next landmark decision of MLM law: FTC v. Burnlounge in 2015 where we once more find ourselves in the 9th Circuit as we did in Omnitrition. The Court in Burnlounge determined that the company “was an illegal pyramid scheme  . . . because [its] focus was recruitment, and because the rewards it paid in the form of cash bonuses were tied to recruitment rather than the sale of merchandise.”

All of this seems rather simplistic in its nature and easily remedied, but for some reason the industry continues to ignore such simple rules. Companies continue to get cute with mandatory monthly volume requirements or presenting “options” that truly are not options when the compensation plan or other amenities are reviewed in their entirety. It’s important to understand that “[t]he ‘payment of money’ element of a pyramid scheme can be met where the participant is required to purchase ‘non-returnable’ inventory in order to receive the full benefits of the program.”[4] In today’s day and age, the cuteness of how something is framed needs to end. Regulators won’t read the pages of your story to see the concept come to life. They reach conclusions based on what is found on the cover or in the headlines.

This line of argumentation is not a new occurrence, in the ongoing Neora case the FTC alleged, “Since its inception, Nerium has operated as an illegal pyramid scheme. Unlike a legitimate multi-level marketing business, Nerium’s compensation scheme emphasizes recruiting new [Brand Partners] over the sale of products to consumers outside of the organization.” If we try, we can understand where the government is coming from in their approach. They do not care to dive into the minutiae of the numbers or understanding the specific details of the economic realities of any compensation plan, they reach a conclusion based upon a surface-level approach and then run backwards to determine what they perceive to be the realities of any business “since its inception.” Additionally, the FTC stated, “In addition to the upfront investment in a[n Enrollment Pack], Nerium also incentivizes BPs to commit to designated volumes of product purchases each month.”  In our opinion, we think the FTC grossly overstepped their bounds in its lawsuit against Neora and we hope they suffer appropriate consequences once the trial court reaches its decision.

Any successful company needs to have, at minimum, one thing to be successful in this industry. You guessed it, bona fide retail customers. While an obvious fact, this is also where the true dispute arises between regulators and defendants in the recent court battles unfolding across the country. What constitutes a bona fide retail customer? Ongoing litigation has presented us with a few prime examples of the current predicament and the “about face” that regulators are taking against MLM. You all know them well.

The industry should prepare an appropriate answer that would permit companies to adequately resolve the current dichotomy between MLM reality and regulatory scrutiny. Let’s first present the problem as I see it and then follow with potential steps forward to get the ball rolling for industry innovation.

Are preferred customers bona fide retail customers? Are distributors who purchase and consume product bona fide retail customers? I would argue absolutely yes, but regulators have not taken this stance. One of the most glaring problems the FTC focuses in on when alleging a pyramid scheme centers to some extent around how regulators interpret the sale of product to distributors enrolled within the opportunity. This one glaring problem may be broken into four individual categories that are essentially manifest in every compensation plan known to man.

Let’s call these the Big Four:

(1) Fast Start Bonuses

(2) Monthly Volume Requirements

(3) Preferred Customers

(4) Sales to Distributors

The central argument regulators take in their pyramiding analysis is the presence, or lack thereof, of bona fide retail customers and use the Big Four as ammunition when going after companies. These four items must be addressed in a meaningful way for any MLM company to move forward. Kevin Thompson has previously written[5] about moving in this direction, especially when it comes to monthly volume requirements. Frankly, if the company cannot survive without these “forced sales,” then they shouldn’t be in business. Not that monthly volume requirements are inherently bad, but if the industry is being honest with itself, the reason for these requirements is to maintain a certain level of sales however manufactured.

It’s ideas like this that further assist regulators in their claims of pyramiding. It’s much easier to recruit 3 people and click a one-time button that activates autoship to reach your monthly numbers, than it is to find bona fide customers on the street. Regardless of the optionality on paper, we all know what direction distributors take.

The time of industrial change is here. And the perfect place to start is through modifying and/or eliminating the core attributes of the Big Four that present the most inherent risk of pyramiding. Why do companies consistently insist on making regulator’s jobs easier?

So what do I propose?

First, eliminate fast start bonuses unless they are tied to customer acquisition. There should be NO bonus, however nominal, linked to recruitment. Sure, we can so that the risk is minimal because it’s a one-time thing, but a bunch of small risks compound into one big one. The only reasonable path for fast start bonuses to remain should be linked to bona fide customer sales, not distributor-customer sales. What I mean by this is that a bonus should NEVER be paid on the purchases of a new recruit because we all know why those purchases are being made. A new recruit will be convinced to purchase an enrollment pack because they’ll join with the expectation that they will be able to keep the chain going and do the same.

Second, all together eliminate monthly volume requirements. Just don’t do it. Take the simple approach away and make customer acquisition the goal. Do not even make it a possibility for a distributor to buy their way into qualification.  If there’s a monthly volume requirement, we’ve suggested in the past that at least 50% of the requirement to come from retail sales.

Third, establish a compliance method that makes the data easily decipherable and presentable when it comes to who is a customer and who is a preferred customer. Incentivize preferred customer enrollment with product discounts and other nice amenities instead of having such sign-ups drive the compensation plan. If people love the product you are selling, then they will continue to buy it monthly. Do not make the compensation plan conditional upon such preferred customer acquisition over regular customer acquisition because then it becomes a compensation shtick over genuine marketing and selling. We all know how it feels when that person comes along.

Fourth, we need to find a way to convince regulators that distributors who purchase products are, in fact, genuine customers as well. This has become a massive target for regulators in their most recent cases against MLM companies because they do not consider purchases by anyone associated with the opportunity to count as bona fide retail sales. This makes sense to some degree, but there is a middle ground that we need to find. And arguing technicalities is not the solution. The FTC’s case against Vemma in 2015 is where we come across this rule in its full force.

The solution is likely to be unpopular for the industry, but it’s a way forward to help escape this mess that both the good and the bad actors alike have created. There’s no one person or group to blame. So what’s the step forward? Remove the commissionable incentives that promote, or even hint at promoting, the fact that distributors are able to purchase their way, to some degree, to higher earnings. These would all relate back to the Big Four. It’s best you start there.

[1] We’re seeing a similar approach now with the SEC’s arrow in the dark approach towards crypto and bona fide companies such as Coinbase and Kraken. A topic for another article that is next in the pipeline.

[2] Read the whole case history here if you get bored: https://www.ftc.gov/sites/default/files/documents/commission_decision_volumes/volume-86/ftc_volume_decision_86_july_-_december_1975pages_1106-1202.pdf

[3] You may have noticed from the case’s name that this is a matter brought by individual distributors and not the FTC or any other regulatory agency whereas the FTC brought the matter in Koscot.

[4] In re Amway Corp. (1979).

[5] https://thompsonburton.com/mlmattorney/2019/12/12/monthly-volume-requirements-its-time-to-reconsider-this-concept/

This is some text inside of a div block.

More Insight

March 21, 2024
By
Clay Brewer
Direct Sales and MLM
Thoughts A Brewin' Newsletter 9: The Direct Sales Protocol
Learn more
Learn more
March 5, 2024
By
Clay Brewer
Direct Sales and MLM
Thoughts A Brewin' Newsletter 8: The Impending Threat of Employee Classification
Learn more
Learn more
February 26, 2024
By
Clay Brewer
Direct Sales and MLM
Thoughts A Brewin' Newsletter 7: The California Risk
Learn more
Learn more
Chat with an AI version of Kevin Thompson to research issues.