The Truth Beneath the Pyramid: A Deep Dive of FTC v. Noland
On May 11, 2023, the United States District Court for the District of Arizona announced the long-awaited decision in Federal Trade Commission v. James D. Noland, Jr., et al regarding the future of the network marketing company known as Success By Health (“SBH”). Unlike many both within and without the network marketing industry, I like to withhold my commentary or article writing for a few weeks to read the tea leaves and discuss my thoughts in open discourse with colleagues, distributors, and company executives alike. Through my discussions with individuals across the industry and personal reflections, I have narrowed the Noland decision to a few core themes that, in my opinion, shed light on both the regulatory posture the FTC is currently taking and also how a neutral factfinder (in this case the judge) tossed an olive branch to the MLM world, an olive branch of hope, not necessarily peace. While much of the old guard will discuss “another pyramid ruling,” I see a bright spot for the industry. An industry I remain passionate about and an industry I seek to assist in driving forward to continued legitimacy and improved reputation. There’s a path forward for this industry, and I’m here to help my clients pave the way.
Although most articles have dove ad nauseum into detail about what a pyramid is, I will only briefly discuss this because it seems many companies continue to conveniently forget such details when drafting their compensation plans or analyzing their field and customer purchasing patterns.
Koscot’s definition of a pyramid still rings true almost 50 years later: “A pyramid scheme is 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 sale of the product to ultimate users.” It is important to note that the Noland Court continued with this definition and adopted the Burnlounge balancing test as to internal consumption even quoting that 2015 decision when it wrote, “pyramid-scheme analysis turns on how the company’s bonus structure operated in practice.” The core result from this idea is that the finding of a pyramid does not inherently make all products valueless BUT product with value does not inherently result in the absence of a pyramid either.
In short, SBH failed to track affiliate purchases thus lacking the ability to differentiate between customers and affiliates. With the inability to prove bona fide customer purchases in tandem with a drastic drop in sales following the elimination of the commission structure, the Court was left little wiggle room to counter the FTC’s argument that a pyramid existed and affiliates were purchasing primarily for the heightened earnings potential as opposed to the product value itself.
It’s important to understand at the outset that Noland was under a permanent injunction from a previous endeavor stemming from 2002, thus a large amount of the damages arose from violations of that injunction, i.e., operating a prohibited marketing scheme/pyramid scheme and making false income representations.
The main aspects of the Noland decision that are relevant to all network marketing companies would be FTC rules, notably the Merchandise and the Cooling-Off Rules. These are rules the FTC has created under its rulemaking power founded in Section 18 of the FTC Act with Section 19(b) of the Act permitting the court,
“to grant such relief as the court finds necessary to redress injury to consumers . . . resulting from the rule violation or the unfair or deceptive act or practice, as the case may be. Such relief may include, but shall not be limited to, rescission or reformation of contracts, the refund of money or return of property, the payment of damages, and public notification respecting the rule violation or the unfair or deceptive practice, as the case may be; except that nothing in this subsection is intended to authorize the imposition of any exemplary or punitive damages.”
Due to the Supreme Court of the United States using the AMG Capital opinion to greatly constrain the FTC’s abilities found in Section 13(b) of the FTC Act, the FTC notified the Court that they would only seek monetary damages for rule violations. In this case, the Merchandise Rule and the Cooling-Off Rule.
The Rule makes it a violation if products ordered are not shipped within 30 days unless the delay is specifically presented to the consumer either at the time of purchase or the customer explicitly agrees to such delay and is granted a return and full refund opportunity upon such notice of delay.
The Court states,
“the FTC’s methodology suffers from a fundamental flaw that renders it unreasonable on its face—it assumes that a late-shipped product automatically ceases to have any value, such that there is no need to provide an offset for the value of the product received.”
And then doubled down on this fundamental flaw of the FTC’s proposed approach because
“The flaw here is more fundamental [than the absence of record keeping by SBH]–it is a categorical refusal to account for the inherent value of the product received where the underlying violation is a mere shipping delay and there is evidence that the product had at least some value to some purchasers.”
Most importantly, in my opinion, is the fact that the Court refused to permit a de facto ruling that the products were inherently valueless and thus presented automatic consumer harm by nature of being sold in a pyramid. This was critical to the Court’s conclusion because “Such an approach would create a backdoor to obtain the sort of monetary remedies under 13(b) that Congress has declined to authorize.” Of course it goes without saying . . . don’t be a pyramid. That’s not my point here. My point is that the Court followed where the data and the law took it as opposed to manifesting an idea the FTC attempted to float.
The consumer redress centered upon the actual harm individual consumers experienced because “the Merchandise Rule violations at issue here were not deceptive, pre-purchase misrepresentations.” Consumers were sold what they thought they were buying. As a result, the Court limited the FTC’s recovery under the Merchandise Rule to the total of $6,829 which arose from the 5 actual consumer requests for refunds. The Court agreed with these specific transactions because the request for a refund was sufficient proof to determine that the only consumers requesting a refund no longer found value in the products.
The Rule gives consumers the right to cancel within three business days any purchase of $130 or more in goods or services that occurs at a location other than the merchant’s place of business and the Rule requires merchants to provide written and oral notice and to provide a form of Notice of Cancellation that the buyer may use to cancel.
The FTC in Noland utilized the Cooling-Off Rule specifically for the SBH’s sale of event tickets because SBH marketed the events as means for purchasers to gain wealth from their attendance and sold the tickets as non-refundable. Similarly to the Merchandise Rule analysis, the Court resorted to actual consumer harm, not perceived. In the Court’s words,
“Identifying the revenues associated with transactions that violated the Cooling-Off Rule, as the FTC has attempted to do, is simply the first step in the analysis. This is because, as with the Merchandise Rule violation described above, the Cooling-Off Rule violation was simply a failure to provide certain information about refund rights. Thus, determining whether consumers were injured by the violation requires a further evaluation of whether consumers would have requested a refund within three days if aware of their right to do so and whether the service that consumers ultimately received (here, attendance at a training session) had any inherent value that might require an offset. The FTC has done neither, which means that it failed to meet its initial burden of providing a “reasonable estimate” of damages (and, thus, no resulting burden ever shifted to Defendants).”
Again, the Court resorts to the idea of no damages if no consumer harm is demonstrated. No consumer harm, no avenue under Section 19 for the court to make any remedial actions.
Big Takeaways for the Industry
First and foremost, protect your salesforce and keep clear records of what’s happening internally. If there’s no consumer harm, then it puts a dent in a regulator’s argument that something needs to be remedied. The protection of your salesforce and the presence of sound recordkeeping stems from transparency. Regulators and consumer protection organizations don’t come out of thin air, they stem from . . . you guessed it, COMPLAINTS.
In my view, there are three important steps to ensure such protection and one bright light from the FTC v. Noland decision: (1) Eliminate Monthly Volume Requirements; (2) Promote Customer Acquisition and (3) Be Transparent with Consumers, while also (a) understanding that courts are no longer rubber stamping the FTC’s statements. But you have to have supporting data to counter the FTC’s claims otherwise the courts will have no choice but to believe the party with the information, rightly or wrongly.
All three of these takeaways really aren’t that difficult and are easy fixes in the event a company adopts strategies to ensure their ability to counter regulatory action. We’ve been discussing for years that the industry has a reputation problem, yet the same mistakes continue to reverberate.
As the Court stated, “ultimately, the outcome turns on the burden of proof–it was SBH’s burden to develop some reasoned or quantifiable way to account for that value in the offset calculus and they failed to do so.” SBH had no records to refute the FTC claims, so, of course, that–along with the witnesses’ questionable credibility (the Court’s words, not mine)–would lead a neutral decisionmaker to reasonably conclude that the FTC’s presentation of events and an FTC’s economist would de facto rule the day.
The issue here was shoddy management and unbelievably poor marketing and transparency, not industry specific. The Court’s 131-page opinion lays out what SBH could have done to assist in the Court’s analysis and outlined in grave detail what absolutely killed SBH’s case. It’s not an insurmountable hurdle and is far from a death sentence to the industry that “FTC Finds Another Pyramid” headlines would cause a casual observer to believe.
I’m constantly in the trenches with companies and distributors alike and can sense the ongoing angst that engulfs the passion of this industry. Let’s take this decision as a blueprint to move forward together as an industry along the lines of what both Kevin and I have been preaching for years.