Initial Impressions from the FTC's settlement with Advocare
Confirming longstanding suspicions held by many since the company publicly announced back in May of 2019 plans to disband its network marketing distribution model, the Federal Trade Commission formally announced an enforcement action and settlement order(s) today with MLM company Advocare. Beyond a $150 million monetary judgment and the company's permanent exit from the direct sales space, the enforcement action featured some important insights into the FTC's regulatory perspective of network marketing companies. It's important to note that this action against Advocare does not serve as binding precedent for the rest of the industry; nonetheless, the FTC's specific allegations serve as important insights that other companies should take note of.
The Return of the P-Word
Under the current administration the FTC has largely stood pat in its pursuit of traditional network marketing companies. Aside from a few lawsuits against clear bad apples (e.g. Digital Altitude, MOBE) the FTC has largely refrained from wading into the waters of pyramid allegations, choosing instead to sue companies primarily for inappropriate income claims. If you go back to the Herbalife settlement in 2016, the FTC stopped short of calling the company a pyramid scheme. In fact, the last time the FTC declared a company a pyramid scheme was Vemma in 2015. After today's settlement this years-long hiatus from using the p-word is over.Plainly speaking, the FTC found Advocare operated as an unlawful pyramid scheme dependent upon distributor inventory loading and recruitment. The FTC found that most Advocare distributors (known as "Advisors," or participants fully capable of earning all available commissions and/or bonuses) personally purchased products for the purpose of qualifying for bonuses, a practice otherwise referred to as inventory loading. In a bizarre but unsurprising twist, the FTC went as far back as 6 years ago for examples where Advocare encouraged its distributors to personally purchase large quantities of product ("[I]n 2013, Advocare instructed Advisors to [purchase orders so] they could generate bigger paychecks by spending more money" and "[I]n November 2014, the plan instructed Distributors to purchase at least $500 yourself").Even when Advocare tried to self-correct these purchasing patterns through measures like the introduction of a Preferred Customer program in 2017, the FTC found this still wasn't enough. "Preferred Customers accounted for just 18 percent of product revenues in 2017." In my opinion, 18 percent of total revenue originating from Preferred Customers alone is a fairly impressive figure in my mind, especially when considering that Advocare launched its Preferred Customer program in 2016.
Much like it did against Vemma, the FTC once again took issue with Advocare's volume requirements. Disclaimer: I'm not intimately familiar with past iterations of Advocare's Compensation Plan, and therefore some of the ensuing analysis is strictly based upon the FTC's interpretation of the model. The FTC held that Advocare Advisor's had volume requirements of 500 PGV and 1,000 PGV to be eligible for overrides and bonuses. The FTC's took issue with the fact that this volume could only come by way of either an Advisor's personal purchases or the purchases of those in their downline, seemingly excluding retail customer purchases from the equation. If Advocare DID NOT, in fact, include retail sales in volume requirements then this was a huge oversight and big mistake.For many years, the FTC has taken an increasingly aggressive position against volume requirements. As to illustrate this point, former FTC Commissioner Edith Ramirez said the following in a speech to the DSA in the fall of 2016:
Any requirements or incentives that participants purchase product for reasons other than satisfying genuine consumer demand – such as to join the business opportunity, maintain or advance their status, or qualify for compensation payments – are problematic.
The FTC honed in on specific examples where Advocare explicitly encouraged distributors to personally purchase products as a means of satisfying eligibility requirements found in the Compensation Plan. Regardless of the fact that many of these specific examples from the company and corporate leadership took place years ago, the FTC pointed to some embarrassing statements as support that Advocare pushed a "buy to qualify" narrative. One example being a former Advocare CEO's comment that "[I'm] unconcerned about retailing the product . . . If you package dirt right and it's got PGV on it, the Distributors will buy it."After Vemma, Herbalife, and now Advocare, companies have to know with volume requirements comes regulatory risk. If an MLM doesn't already include customers with the volume calculations, then they should do so immediately. Furthermore, an outright customer requirement (e.g., 1 mandatory customer sale per pay period) as part of a distributor remaining active and eligible for commissions is by no means a bad idea. I've said this for many years now and will say it again: IT MIGHT BE TIME FOR MLMs TO DO AWAY WITH MONTHLY VOLUME REQUIREMENTS ALTOGETHER. In doing so companies would undercut the FTC's primary arguments around the question of motive -- a distributor buys to qualify for bonuses rather than a personal interest in consuming the product as an ultimate user. With zero volume requirement, the FTC would be hard pressed to argue that distributors are purchasing primarily to qualify for bonuses.
Income Claims Forever Remain a Problem
In line with the Commission's habitual practice of pointing to inappropriate income claims when suing a network marketing company, the FTC found Advocare made numerous income misrepresentations in the presentation of its sales opportunity. For starters, the FTC held Advocare promoted itself as a "life-changing financial solution." The FTC also pointed out deficiencies with the company's income disclosure statement, finding that Advocare noticeably omitted non-profitable Distributors from its overall annualized earnings averages. If this is true, it certainly counts as an unforced error. Similarly, the FTC found Advocare's short-form income disclaimers insufficient on account that they were "in small print and not in close proximity to the claims made".
Top Distributors Are Fair Game
Just as it did in the case against Vemma, the FTC went after top Advocare Distributors. In total, the FTC brought individual charges against four high-ranking Advocare Advisors who acted as husband and wife teams, Daniel and Diane McDaniel ("the McDaniels") and Carlton and Lisa Hardman ("the Hardmans"). With respect to the Hardmans, the FTC ordered the disgorgement of $4 million. However, the Defendants only become obligated to pay the full $4 million if they fail to pay $100,000 within seven days of the Order's entry AND fail to relinquish ownership over a property located in Alabama.
For an industry predicated upon the belief that distributors will refrain from inappropriate product or income claims, the expenditure of significant resources on compliance measures is no longer optional. The days of parading big checks across the stage at corporate events are long over. Network marketing companies would be wise to emphasize a sales opportunity based entirely upon the chance to earn supplemental income. The foundation of any marketing message should predicate upon a distributor's ability to earn a little extra cash.The reasons why the FTC chose Advocare as a target remains a mystery. When asked during the FTC press conference (25:30) on Wednesday, October 2, one of the FTC investigators implied that there was a "flurry" in consumer complaints in the latter half of 2016. This coincides with the publication of a report by ESPN about Advocare, published in March of 2016. Advocare was issued a subpoena from the FTC in November of 2016. If I were forced to make a wager, I'd bet that ESPN's pressure had a lot to do with the FTC's curiosity.Compared to most other network marketing companies that are pursued by the FTC, Advocare was in the enviable position of having over 2 years to prepare its defenses. Instead, for reasons we may never learn, they chose to "skip to the end" by closing down its MLM model and paying a very serious fine. Would the outcome have been different if they chose litigation? We'll never know.The FTC's complaint can be read here.