Direct Sales and MLM

The Federal Anti-Pyramid Law (Summary and Analysis)

By
Kevin Thompson

Congressman Marsha Blackburn, House Representative of the 7th District of Tennessee, has proposed the Anti-Pyramid Bill Federal that aims to clarify the differences between pyramid schemes and legitimate network marketing companies. If you're connected to the network marketing industry, whether as a distributor, executive, vendor or owner, the importance of this bill (or a modified version of this bill) is vitally important.

The Need for Clarity

As many of my readers know, I have aggressively advocated for almost a decade for the need to create cleaner guidelines in the industry. The "ocean of gray" that has separated legitimate direct selling from pyramid schemes has predictably led to some very serious challenges. As I accurately predicted in my first e-book titled "Saving the industry by defining the gray," the fuzzy lines that distinguish legitimate and illegitimate network marketing has greatly contributed to today's problems. In an environment with ample wiggle room, pyramid schemes can operate under the guise of legitimate network marketing. Zeek Rewards, notable ponzi scheme, did this better than all others. The veneer of legitimacy offered by legitimate network marketing allowed Zeek to amass tremendous influence and inflict significant harm. This, in turn, affects the entire profession.

Yes, Bill Ackman’s bet against Herbalife has led to an increase in scrutiny of the industry. And this, in my opinion, has been a relatively good thing (unless you’re Herbalife). The problem was always there, largely beneath the surface. It was like a pimple. With a little pressure, the ugly stuff came out. And due to that pressure, companies across the industry are really starting to get their houses in order. It takes a good challenge to get field leaders to buy into compliance.

While the gray is shrinking after the BurnLounge decision, there's still a lot of room for debate over what constitutes a pyramid scheme. This "room for debate" has allowed critics and regulators alike to mince words to advance an agenda. In my opinion, this bill is a direct reaction to the unpredictability and inconsistency of the Federal Trade Commission. On the one hand, in the FTC’s Staff Advisory Letter, the FTC stated, "In fact, the 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." They further went on to state that the main question was whether the products were "merely incidental to the money-making venture." How do we know when a product is "merely incidental" to the venture? And note, the FTC never said that 51% of revenue from distributor consumption was proof of a pyramid scheme.

So while the FTC has specifically said that internal consumption is fine, they took a completely different approach in their argument against BurnLounge. In the BurnLounge case, the FTC argued before the Ninth Circuit, "Applying this Court’s teachings in Omnitrition, internal sales to other [distributors] cannot be sales to ultimate users consistent with Koscot." It was a dirty trick they pulled and the Ninth Circuit did not allow them to get away it. In fact, the Ninth Circuit held the FTC's argument to "not be supported by the case law." Ninth Circuit BurnLounge Order, p. 18. And for good measure, the Ninth Circuit quoted the FTC's staff advisory letter in the Order (referenced above). This was the equivalent of the court shoving the FTC's own words down their throat.

The Bill

The bill would settle, once and for all, the argument over what constitutes a sale to an "ultimate user." The definition of "ultimate user" in the bill is consistent with what's already encapsulated in case law. As a refresher, the primary element for pyramid scheme analysis is when there the rewards are unrelated to the sale of products to ultimate users. The debate occurs over the definition of "Ultimate User." Distributors and Customers alike can both be considered "ultimate users." But what if 99% of a company's revenue comes via the distributors? Is that proof that the products lack real value? What if the percentage is 70%? At what point does a product become "merely incidental to the money-making venture"? The answer is up in the air. As we learned in BurnLounge, courts can look at several factors to determine if a product is legitimate i.e. retail sales, purchase patterns between distributors and customers, comparable prices in the market, existence of consumer safeguards, etc. But this sort of fact-intensive approach makes it difficult for regulators to investigate and shut down pyramids. Thus, the need for a law.

Specifics of the Anti-Pyramid Bill

The bill is included in full below. There are 4 key parts:

(1) The bill defines a pyramid as: "plan or operation [that pays participants] for the introduction of another person into the plan rather than from the sale of products to ultimate users.

(2) "Ultimate User" is defined as, "a non-participant in the plan or operation, or a participant who purchases reasonable amounts of products . . . for personal use and whose purchase is not made solely for purposes of qualifying for increased compensation.

(3) There's an "Inventory Repurchase" provision that requires companies to buy back sellable inventory if returned within 12 months.

(4) There's also an "Inventory Loading" provision that prohibits companies from employing inventory loading practices. Inventory Loading is defined as a plan that encourages participants to purchase "inventory in an amount that unreasonably exceeds that which the participant can expect to resell to ultimate users, or to use or consume, in a reasonable period of time."

Analysis of the Bill

When it comes to politics and policy, better is better than nothing. Is the bill perfect? No. But it represents an improvement over the current situation. And in this environment, I'll take better over nothing. The spirit of the current bill is simple: if an adult buys a product, and the product comes with a 12 month refund policy, we can assume that s/he is buying for value. If they use the product, they derive value. It’s not complicated. It boils down to a "buyer knows best" mindset.

Criticism of the Bill

Critics, energized by the FTC's victories in the Vemma case, are now calling for a bright-line rule requiring that companies generate 51% of their revenue via retail sales (or else it's a pyramid scheme). However, in the BurnLounge case and in the FTC Staff Advisory Memo (both mentioned above), the degree to which rewards need to come via retail sales is not set in stone. As stated by the court in BurnLounge: "Because the outcome in this case is clear, we do not need to decide the degree to which rewards would need to be unrelated to product sales in a case presenting a closer question." In other words, BurnLounge was so obviously a pyramid scheme, the Court did not waste time in figuring out whether 51% was an appropriate number that separates pyramid schemes from legitimate network marketing. It's pretty simple to understand: If the law required 51% from retail sales, the Ninth Circuit would've said it. They didn't.

It has always been my opinion that requiring a magic percentage is a ridiculous requirement. The crux of pyramid analysis boils down to one thing: value.

If participants are buying product primarily to qualify for bonuses, it indicates the product lacks legitimate value; thus, it's a pyramid. If, on the other hand, participants are buying for value reasons, it's indicative of a legitimate company.

The magic percentage argument is a bad one that fails for multiple reasons: (1) the idea that the difference between a pernicious, fraudulent pyramid scheme and a legitimate company can be 1% is absurd; (2) participants in the company could be buying with zero desire to build a downline. In that scenario, they're still not factored by the FTC into the retail sales percentage. This logic is unfair. It's impossible to argue that people are buying primarily to qualify for bonuses WHEN THEY'RE NOT QUALIFIED FOR BONUSES. This certainly occurs when people order quantities LESS than the monthly volume requirements, or when they order product while they're ineligible for commissions. Still, regulators argue that those people belong in the "victim" category i.e. people that joined and failed to recover their starter costs; (3) it assumes that product has value if 51% of the company's revenue comes via retail sales outside the plan. But what if the company is a $5B company? Does it need to sell $2.5B to prove legitimate value? This seems to be excessive. Would $100M in retail sales suffice to prove that the product has legitimate market value? (4) It's not a check against market saturation. The idea of market saturation is a proven mathematical fallacy, one already dismissed in prior cases.

Conclusion

This bill, or some variation of it, needs to pass. I have one suggestion that makes the bill more palatable for critics: Prohibit companies from having monthly personal volume requirements. I've written about this for years, and it was one of my proposed updates to the DSA's code of ethics. The general practice of distributors subscribing on autoship primarily to qualify for commissions (ordering the bare minimum of inventory) leaves companies vulnerable. The FTC said it themselves in their Staff Advisory letter when they wrote, "The most common means employed to [construct a pyramid] is to require a certain level of monthly purchases to qualify for commissions." Any sort of bill that fails to address that issue is going to have challenges. If it comes time to haggle over terms in the bill, this is a compromise that the critics might actually support.

Again, perfection is never, ever a realistic goal. Compromise is critical for progress. President Obama summarized the importance for compromise beautifully in a 2016 commencement speech at Howard University. He said, "Democracy requires compromise, even when you are 100 percent right. This is hard to explain sometimes . . . If you think that the only way forward is to be as uncompromising as possible, you will feel good about yourself, you will enjoy a certain moral purity, but you’re not going to get what you want. And if you don’t get what you want long enough, you will eventually think the whole system is rigged.” This quote describes the critics’ predicament fairly well. Regarding the DSA, I’m hopeful they can bend a little in an effort to get something on the books. Otherwise, it’s got a tough road ahead of it.

HR 5230 (Federal Anti-Pyramid Bill)

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