| The Anti-Ambit Gambit Also, Industry Trends and How Not to Track Them Ambit Energy Hit with Billion Dollar Lawsuit Ambit Energy has been sued by two distributors for breach of contract, misrepresentation, fraud, deceptive trade practices, defamation, libel, harassment, and discrimination. Basically, the suit alleges Ambit “failed to accurately pay monthly customer residual income and weekly leadership bonuses to the Plaintiffs”, and is seeking redress of $50 million (that must have been one helluva miscalculation). The plaintiffs are seeking $1.16 billion in total compensatory and punitive damaged, including $13 million to cover “attorney’s fees” (they must have one helluva legal team). The complaint can be found here: I’m holding off on making any substantative commentary regarding the merits of the case because Ambit’s response has not yet been made public. I’ve found that no matter how solid the plaintiff’s story seems to be, the picture always changes when I’ve heard from the defense. Ambit’s attorney has asked the court for a conference before submitting a motion to dismiss, claiming the plaintiff’s complaint “fails to put forth even the most basic allegations necessary to maintain a federal suit…”, “fails to satisfy even the most liberal application of the pleading requirements…”, “fail to offer anything more than conclusory statements…”, and the allegations are “so vague” that they are asking the judge to compel the plaintiffs to submit a clearer, more substantive complaint so they know what to respond to. Ironically, the judge has responded that the pre-motion letter itself was too vague and “does not adequately set forth the factual and legal bases of defendants’ anticipated motion”. The defendants have until Monday to make a clearer case as to why the judge should make the plaintiffs present a clearer case. But here’s the “gambit” the plaintiff’s are using, which is a tactic I’ve seen employed in many legal actions by distributors against network marketing companies, that always makes me shake my head. Within their complaint they accuse Ambit Energy of violating Section 5(a) of the Federal Trade Commission Act by deceptively operating a “pyramid scheme”. This begs the question, what if the plaintiffs succeed on this charge? How will they convince a jury to award them unpaid bonuses and commissions from what they’ve just convinced them was ll-begotten gains from illegal activity? In this case the plaintiffs want another $100 million for being deceived by this “pyramid scheme”, so I suppose they can forgo the $50 million for the miscalculated checks. But I’ve seen this “illegal pyramid scheme” count in a number of wrongful termination cases where the distributor is only seeking back pay, and sometimes even reinstatement! This strategy is usually designed to leverage the company into a settlement. No network marketing company wants to defend the pyramid scheme allegation before a jury, regardless of its merits. If the general public can be so easily mislead into believing legitimate network marketing programs are illegal pyramids by a few internet bloggers and their brother-in-law who was in Amway back in 1989, imagine what a good trial lawyer can do. But then, what if the company calls their bluff and doesn’t settle? Now the plaintiff must either file an amended complaint that drops the pyramid scheme charge, or leave it in and try to convince the jury to award them the unpaid income from, and perhaps to even reinstate them in, an illegal pyramid scheme! This gambit can be an even more dangerous gamble when the plaintiff is a top leader who’s been with the company for a number of years. I recently worked on a case where, had it gone to trail (it didn’t) the distributor would have had to explain to a jury how she was completely oblivious to the illegal nature of her opportunity for eleven years, and only discovered it right after she was terminated. Industry Trends, and How Not to Track Them The Industry Trends page at MarketWaveInc.com has been updated. We’re still seeing a substantial rise in online chatter regarding the network marketing industry, both pro and con. We benefited from a 23.1% spike in pro-MLM references since last month, but also suffered a 26.6% increase in negative references. Of the top 100 Google search results for the term “MLM” 86 are now supportive, up from 82 last month. I’ve always believed in the “Wisdom of Crowds”, and that the best “trend analysts” are the thousands of investors that make up what we call “Wall Street”. These purchasers of shares of a company’s stock are, for the most part, looking for those that they believe will increase in value. That is, get bigger, better, and more profitable. These trend analysts are much more pragmatic and much less prone to personal bias than those within the network marketing industry. Like me, for example. I have a personal, professional, and financial interest in finding evidence that supports my pro-MLM agenda. I honestly don’t believe I’m deliberately rigging the data, but I certainly am no less susceptible to “unconscious researcher’s bias” than any other analyst. So, fine. Don’t take my word for it. Let’s see what those thousands of other analysts down on “the Street” think about this industry’s prospects for future growth and prosperity. In the last three months the overall stock market (based on the S&P 500 index) has risen 0.34%. The “MLM Index”, made up of the 12 largest publicly traded network marketing companies, has risen 10.97%. Over the past year these same dozen companies have beaten the overall market 27.63% to 19.53%. Apparently we “MLMers” aren’t the only ones who are optimistic about the future growth of the network marketing industry. What’s one of the worst ways to track growth trends? Web traffic! A company’s Alexa rankings seem to be the fashionable stat of choice now days when gauging who’s hot and who’s not within the network marketing industry. The assumption is, I assume, that an increase in unique visitors to a company’s corporate website, or in its monthly “reach” (percentage of all internet users who visited the site), means the company is growing, or at least that interest in the company is. Conversely, if their Alexa graphs trend downward the company must be shrinking, or interest in the company is waning. That’s certainly one possibility, but one of many. Usana Health Sciences saw a spike in web traffic back in May of 2007, not because of any sudden interest in Usana by prospects or customers but rather all the adverse, high profile publicity caused by Barry Minkow (a short seller who profited by causing Usana’s stock price to drop, and who has just been convicted of fraud for the second time). Over the second half of 2010 Yoli saw traffic to their corporate site trend downward after a significant run up the previous six months, which some competitors were quick to exploit as a sign of their pending failure. However, the reason was more to do with Yoli’s introduction of personalized marketing sites based on an entirely separate platform — traffic to which strongly trended upward during the same period. The lesson here is that a company can change the manner in which they use their online assets resulting in swings in web traffic that has little to do with the company’s popularity. Another hypothetical example would be a hot new company that has its reps access their back office via the corporate site who then introduces a new training or marketing site that includes the back office log in. Reps no longer visit the corporate site to access their back office and its Alexa rankings drop, even though the company remains popular. In March of 2010 Amway saw their web traffic almost double, an increase that was maintained until January of this year when another sustained run up of website visitors began. Is Amway suddenly getting hot again? Not really. Amway closed their online subsidiary Quixtar in March of 2010 which drove all their traffic back to Amway’s home site, and early this year Amway opened several new foreign markets and settled a $150 million civil lawsuit accusing them of being a pyramid scheme (which I believe is a record settlement for such a case) just before the new year began. Foreign expansion can be a huge contributor to Alexa traffic rankings since, for example, the traffic to Amway.ru (Russia), Amway.com.br (Brazil), Amway.co.jp (Japan), etc. are all combined. Another example is Longevity Network (which will be relaunching soon, BTW) which was foundering in the United States back in 1999 before launching South Korea, their only foreign market. They grew to over 100,000 distributors in S. Korea by 2001. Little changed in the US while their Alexa rankings skyrocketed. Due to the algorythms used by Alexa to determine their rankings the margin for error increases significantly the less trafficked the site. Alexa openly declares, “Generally, traffic rankings of 100,000 and above should be regarded as not reliable.” If you’re thinking this would only apply to small, irrelevant companies, consider this applicable list: AmeriPlan (100,340), Trump Network (109,377), Watkins (114,022), Evolv Health (117,289), LifeVantage (117,563), Stream Energy (122,066), Neways (138,146), Reliv (156,817), Youngevity (157,904), Life Plus (253,601), Life Force (255,389), Max GXL (259,543), Zrii (283,201), Mandura (379,960), Oxyfresh (418,451), Zija (464,251), Jafra Cosmetics (599,225), Qivana (627,579), Princess House (769,257), and Rain Nutrition (784,741). This is not to say that Alexa is useless in trend analysis. Not at all. I’m just saying their are myriad other factors you’d have to consider to know if the graphs related to web traffic are indicative of growth and popularity trends, and if so to what degree. One great stat that Alexa provides that is indicative of a company’s popularity, at least from the standpoint of prospect and customer interest, is the percentage of visitors to the company’s website that got there by the visitor specifically searching for it. Another is the amount of time the average user spends on the site. Just for kicks, I’ve taken the percentage of site visitors who arrived via a search engine and multiplied this by the number of minutes each visitor spends on the site (both are averages over the past 30 days). Here’s the results related to a sampling of some of the most prominent companies: Avon 0.879 Another good way to track growth and popularity trends is to record the number of new references to the company’s main home page that have been added to the internet over the previous 30 days, then compare it to the same data 30 days from now, and each month going forward. Google provides such search capabilities and I’ve logged the numbers for all the companies listed above. I’ll let you know the results in 30 days. Len Clements |
Alert #179: 6/8/2011
Pyramid, Ponzi, and Investment Schemes
Is One Hiding Behind Your MLM Program?
By Len Clements © 1997
Pyramid, Ponzi and investment schemes disguised as legitimate MLM programs continue to flood the U.S. market. But unlike their predecessors, they’re hiding their true nature better than ever. Many quasi-pyramids and money games today are taking great advantage of the ignorance of most people as to what constitutes an illegal pyramid. Please understand, I do not use the term “ignorance” derogatorily. The term comes from the word “ignore” and many of us are simply ignoring a few basic, simple facts that make up a composite of a typical pyramid or other such scheme. Also, understand that I am not an attorney, an attorney general, or a postal inspector. But I know what questions they ask – and so should you! Also, as I describe the legal definitions of these various kinds of schemes I’m going to use plain English. For example, where the proper legal language might refer to the payment of “consideration,” that being anything from gold dust to chickens, I’m going to assume that it’s safe to just say money. If you want all the verbose legalese, call a lawyer.
Let’s start with the ol’ classic – the Pyramid Scheme.
By definition, a Pyramid Scheme is one where there is some kind of direct financial reward for the act of recruiting another person into the scheme. A blatant pyramid scheme would involve no product at all. You simply pay a chunk of cash to play, and hope you recruit enough others to cash out, usually for several times what you originally invested.The roots of most pyramid/MLM law is founded on the Amway vs. FTC decision in 1979. Perhaps the single most defining characteristic of a legal network marketing company vs. an illegal pyramid scheme came from these hearings. Essentially, the question was asked… “Can the last person in still make money?”
Obviously, the last person in a pyramid scheme will never make a dime. But if you were the very last person to ever sign up as a distributor for Amway, or any number of other legal MLM operations, could you still make money? Of course. By buying the product at wholesale and selling it at retail. The last person in, with no recruiting, can still make money.
If you were the last person to sign up in your MLM program, could you reasonable expect to be able to mark up the product or service and resell it to an end user? That is, someone who only wants the product or service? Are you, and your downline distributors buying the products because you genuinely want them, or are most of the distributors making token purchases simply to satisfy a quota in the compensation plan? Having real products of value to an end user is a key element of a legal MLM enterprise.
Having said that, one of the most common, and least accurate questions you can ask in determining if something’s a pyramid scheme is simply asking, “Is there a product.” Almost every pyramid out there today has thrown in some kind of token product knowing you’ll ask that question. Some extremists will go so far as to tell us that the “service” they provide in exchange for your fee is their administration of the intake and outgo of cash. Some will claim you are paying to have your name added to a mailing list. Of course, the typical chain letter leads you to believe you are paying for a report of some kind. However, there are literally dozens of schemes out there that are not nearly as obvious. Some offer what appears to be an abundance of bona fide, tangible products. But again, the focus should be on value and motive.
One of the best examples I can recall was a program called The Ultimate Money Machine. For $350.00 you were to receive such items as luggage, a 35mm camera, and a seminar on cassette tape valued at, of course, hundreds of dollars. Well, the camera was a cheap, plastic job that probably had a value of less than $10.00, and the luggage you unrolled from a tube. Total cost to the company forall of these products was probably less than twenty bucks!
A program called Euro-Round required a $100.00 payment in exchange for nothing. Later, to “make the program legal,” they added a little book.
Schemes like Investor’s International, CommonWealth, Global Prosperity, Delphin, and it’s various other incarnations, would have you buy some literature and a few cassette tapes, with a material cost of around ten to twenty bucks, for usually about $1,250. There rationalization is that “Information is priceless!” Okay. Let’s (reluctantly) give them that. But such schemes usually withhold a larger and larger portion of your income to qualify you in subsequent stages, or cycles, and these funds are allegedly for the purchase of, usually, a live seminar on some Caribbean island. At the top stage you might end up paying as much as $100,000 for a seven day seminar in Belieze. It better be catered!
A few companies today still offer product vouchers or certificates that can be spent on items out of a catalog or from various local merchants. They are actually only offering the funds to purchase these products. There is usually a commission paid once the certificate is purchased, even if it is never redeemed. The result? Nothing but paper, most of it cash, being exchanged. There is a great deal of recent legal precedent in this area. The upline shouldnever be paid out of any kind of down payment, layaway, voucher purchase, or any other similar transaction that does not involve an immediate acquisition of a product or service of value. In other words, no one should get paid until an actual product gets shipped.
As to “motive,” again, are you and others buying the product because you want that product or can sell that product, or are you buying it because you have to to make money? For example, if a company pays commissions on sales aids or distributor training, which several are doing as of this writing, this creates a legal vulnerability. Obviously, you can’t mark up a product brochure, distributor manual, or distributor training course, and resell it to someone who’s not a distributor. Obviously, you would never have purchased any of these items if you weren’t a distributor yourself. These are sources of income that can only be derived from recruiting because recruits are the only ones that would ever purchase them.
So don’t just ask if there is a product involved. Question whether the product is even close to being worth the overall price paid. You don’t have to be an economics genius to know the answer. Just ask yourself this question: “Would anyone realistically ever purchase this product or service without participating in the income opportunity?” Thousands of people purchase products from such companies as Nu Skin, Watkins, Herbalife and Amway every day without becoming distributors. They just want the product. This is true for most of the MLM companies out there. But certainly not all.
So, now how exciting is that big ad you just saw that boasted “NO SELLING!” Consider it a big red flag.
Now let’s discuss Ponzi Schemes.
First of all, no, a Ponzi is not the same thing as a Pyramid, although Ponzis are often referred to as a pyramid. In a pyramid scheme, you pay in X, the pyramid promoters keep, let’s say, 20% of X and use the other 80% to pay all those who “cash out.” Not unlike legitimate MLM operations, a distributor can earn far in excess of what they personally paid in, but the MLM company itself never pays out much more than 40-50% of every wholesale dollar that comes in.
In a Ponzi scheme, you pay X to the promoter who promises that you will receive a certain specific return, say 2X (twice your investment) back in a few days. The promoter accomplishes this by finding another sucker who’ll buy into the same promise, and he then uses the second suckers investment to pay off the first’s.
As an example, let’s use Carlo Ponzi himself. Back in the early 1920’s, Ponzi offered a $1,500 return on a $1,000 investment. When sucker A paid him $1,000, he then got sucker B to believe the same pitch and invest another $1,000, then took $500 from B’s money to add to A’s original investment, and paid A back his $1,500! Of course, a modest “service charge” was retained by Ponzi. With only $500 of B’s investment still in hand, Ponzi now needed to find sucker C so he’d have another $1,000 to add to the $500 he already had, and then pay sucker B his promised $1,500. Now, he had to find yet two more suckers to have the funds to pay off sucker C. And so on, and so on.
Ponzi accumulated millions. He died a penniless ex-con.
Ask yourself this question about the program you are evaluating: “If all recruiting stopped today, would this company still be able to pay monthly commissions in the months ahead?” Although there may be no pyramidal hierarchy involved, a Ponzi Scheme does involve the need for a never ending flow of new participants making the initial investment. This also falls, once again, on the value of the products. If not one new person is ever again enrolled as a distributor, could sales volume realistically continue to move through the organization?
But there’s more to consider. Let’s say a company has great products that people love and would continue to purchase even if they didn’t make money. However, for every wholesale dollar they pay to the company, the company pays $1.05 back to the distributor force in commissions and bonuses. In other words, their compensation plan has a 105% pay out! Technically, if they really did pay out more than 100%, this would be a Ponzi Scheme. The company must sell one more product to be able to cover the compensation for the previous sale (otherwise, they’d be 5 cents short). And there are a number of MLM deals today that claim to have such exorbitant pay outs. In reality they most likely do not. Probably not even close. For example, one MLM program claims a 112% pay out, but the percentage is based on the point value of each product (called BV, or Bonus Value), not on the actually dollar amount – and the BVs average about 68% of wholesale dollars. Another company promotes a 109% pay out, but usually forgets to mention their 75% BV ratio, and the fact that the 60% they pay on the first two levels (15% and 45% respectively) is only on the first $300 purchased by each distributor during the month. The pay 5% on all the volume over that. Yet another company claims a pay out that actually exceeds 200%! The catch is, they pay a higher percentage on those you personally sponsor, and the pay out they display in their ads is based on the wholly absurd scenario that every single person in your downline is personally sponsored.
So, just because someone says they pay out more that they take in (over 100%), doesn’t necessarily mean they are running a Ponzi Scheme. There’s very likely a catch. Still, considering state and Federal regulator’s penchant for taking on a guilty ’till proven innocent attitude (they attack first and ask questions later), I’m curious as to why these companies would want to even create theillusion that they are paying out more than 100%. Why would they even want to pretend they are a Ponzi Scheme?
Lastly, let’s discuss “Investment” Schemes.
The three regulatory agencies we need to be concerned with the most, from an MLM opportunity stand point, are the Federal Trade Commission (FTC), Food & Drug Administration (FDA), and the often underconsidered Securities & Exchange Commission (SEC). From a personal, independent contractor stand point, you have the IRS to worry about as well. But that’s another article. You’ll likely never have to contend with either the FBI or FCC – unless, of course, that “sense of well being” you get from your herbal product is derived from a South American poppy, or you enroll Howard Stern as a distributor.
Getting back to the SEC…
“Securities” are basically things you invest money in, like stocks, bonds, mutual funds, commodities, and so on. You have to register the securities you sell with the SEC and you have to have a license to sell them. Skip either step and you might be going away for a little while.
In 1946 (as part of the SEC vs. W.J. Howey Co. decision) the Supreme Court defined an investment contract as one where “…the scheme involves an investment in a common enterprise with profits to come solely from the efforts of others.” (The word “scheme” is used here, and throughout this paragraph, in a basic, non-derogatory sense). So, there’s three things to consider: First, is there money being paid into the scheme (an investment)? Second, are there a lot of other people paying money into the same scheme (a common enterprise)? Note that, so far, every MLM operation appears to meet the first two criteria. But the third test is where we depart, or should depart, from a security – is the money you make from the scheme derived “solely from the efforts of others?” Well, I don’t know about you, but I work my tail off about 50 hours a week building and managing my downline! Sure, your time investment ideally forms a bell shaped curve (part time, then full time, then eventually back to part time), but there should always be a mandatory effort on your part to build, manage and support your organization.
This, of course, does not bode well for schemes (I’m using the negative connotation now) where you pay a “downline building service” to build your downline for you. It appears to be undebatable that all three aspects of the “Howey test” apply to such a deal. You pay money to the same promoter that many others are, and they openly promise to do all the work for you and you simply sit back and cash the checks. No, there has not been a lot of legal action against such schemes because, well, they have a 100% failure rate all on there own!
In closing, I want to make it clear that this article is not necessarily based on the author’s opinion of the way it should be. Much of this discussion is based on years of precedent, not just my laymen’s interpretation of the law. It’s simply the way it is. For the record, I am a Libertarian. Personally, I believe we, as adults, should be allowed to do what ever we want with our own money as long as there is full disclosure and we are made aware of all the risks involved. We’re spending the half our government lets us keep. It’sour money! In fact, I’ll go so far as to say I personally feel pyramid schemes should be legal. Not providing full disclosure about the risks and lying about the potential benefits should be against the law – and, in fact, already are! If all this information is provided, then we should have the right to be stupid with our own money.
Having said that, rules are rules. And until someone changes them, we’ve got to play by them.
My soap box is cracking. I’ll step down now.
Regulatory Red Flags
How Many Is Your Company Waving?
By Len Clements © 1997
This industry is over half a century old. There is nothing new. Pretty much everything has been tried and what you see today are just variations and enhancements of the same thing that’s already been done. So, if you want to know how well a certain type of product fairs in the MLM marketplace, or how a certain compensation plan gimmick will effect distributor earnings, or if a certain aspect of an MLM program will raise the ire of a state or federal regulator, all we have to do is look back at all the companies who have tried it in the past and see what happened to them.
Here are some examples of a few not so new ideas that are either hot, or making a comeback. By the way, not being an attorney, judge, or agent for any regulatory body, I must make clear that I am not declaring any of these acts to be illegal. What I am saying (suggested wording complements of my literary attorney) is that, in my laymen’s opinion, they may cause the company to be legally vulnerable.
Now that I have the C.Y.A. provision out of the way, let’s begin…
TRAINING BONUSES
While some companies have masterfully depicted their “coding bonuses” as not coming from any distributor training fee, others are openly bragging about their “Huge up front training bonuses.”
Why is this a red flag? Let’s go back to the FTC v.s. Amway decision in 1979, when the FTC accused Amway of being an illegal pyramid. Amway won that case (fortunately for all of us) and the test which they past, which is right in the language of the decision, was simply, “Can the last person in make money?” In the case of Amway, the court said, Sure, the last person in, who has no downline, can still make money by buying the product at wholesale, marking it up, and reselling it to someone who is not an Amway distributor. This is, to this day, the defining criteria of a legal network marketing opportunity.
Okay. So, can you buy a $495.00 distributor training package, mark it up even more, and resell it to someone who is not a distributor? Obviously, this would be absurd. The only ones who buy the training packages are distributors, therefore the only way you can earn bonuses from this volume is by recruiting more distributors. As even the most novice MLMer surely knows, you can’t earn money from recruiting! No, not even indirectly.
Now, if you were to ask a distributor who represents an opportunity that does offer training bonuses how they can do that (and oh yes, I have, many times) they will usually quote the company’s rationalization of, “Well, we have all these other products too — and you certainly can retail those to non-distributors.” Which is kind of like saying, Hey, it’s okay that I rob banks because I give a lot of my loot to charity. Just because you have a lot of legal ways to earn commissions and bonuses doesn’t make the possibly illegal ways any more legal.
Or, they might respond by telling you about how they’ve already been investigated by the FTC or some AG. This response was given to me recently by a distributor for a company that is about four years old, which added training bonuses just three months ago. So it’s very likely the “code” didn’t even exist the last time any regulatory agency looked at them. Plus, investigations usually are very specific in their intent. If an investigator goes in looking for evidence of misleading income claims or front loading, then that’s what they look for — not indirect rewards for recruiting. What’s more, such a retort may even raise yet another red flag since it could easily be interpreted as an indirect claim to regulatory approval of their training bonuses (a BIG no no).
Recent cases that provide precedent would be, for example, the Final Judgment in the case of California v.s. Destiny Telecom. Here in (part 5, section g) the state demanded that there be no commissions paid on anything directly or indirectly related to sales aids or training (ironically, to my knowledge, Destiny never did either of these things). In the case of the FTC v.s. World Class Network, it was determined that a training package on how to be a travel agent, which was arguably a product that could have actually been retailed, was not a commissionable product via an MLM system of compensation (WCN can still direct market the product). The state of North Carolina has ruled in more than one case that only verified retail sales to non-distributors can produce commissionable volume. Yes, it’s true that this essentially makesevery MLM company illegal in that state, but none-the-less you certainly would have a hard time convincing the NC AG that you can retail even one of your distributor training packages to non-distributors, let alone all of them. Recently the Pennsylvania Attorney General’s office filed suit against Nu Skin due primarily to their Big Planet division selling and paying commissions on their $300.00 training packages (this issue has since been resolved). And if there were any doubt left, the Federal Trade Commission recently closed down FutureNet due mainly to their up front training packages. This action has since been resolved with the FTC and the “Final Judgment and Permanent Injunction” signed my FutureNet should eliminate any possible argument over this issue. In the “Definitions” section, part F, “Compensation related to recruitment” is defined as “…compensation paid to participants in a multi-level marketing program as a result of or relating to any type of training provided to either new or existing participants.”
PAYING ON PRODUCT VOUCHERS/DOWN PAYMENTS
When you pay money to your MLM company for a product or service, you must take possession of that product or service before any commissions or bonuses can be paid to your upline on that sale. For example, if you send $200 to the company as a down payment or layaway towards a product, let’s say a gold coin, and then the company pays your upline from that $200 payment, but you haven’t actually received the gold coin yet, what has happened? That’s right — nothing but an exchange of cash. You paid money in, the company sent part of your money to your upline, and you didn’t get anything in return for your money. Kind of like a pyramid scheme, isn’t it? Sure, you may pay off the product and eventually get it, but that’s not for certain. The only safe way to administer this would be to hold the commission until the product is paid off and actually shipped.
Along the same lines, a company should not be paying commissions on product vouchers or certificates until the vouchers are actually redeemed for real products. Otherwise, all you have is paper going back and forth — and most of that paper is money.
Examples of precedent in this case would be American Gold Eagle (vouchers), Club Atlanta Travel (travel certificates), Gold Unlimited (layaways), Passport to Adventure and International Metals & Trade (down payments towards product certificate), and many others. Each of the above was attacked by either a state or federal regulator specifically on this issue (and in some cases on other issues as well).
When I bring this issue up with MLMers who represent such systems, they usually site the few remaining companies that use a similar system without consequence (so far). Well, Jessie James robbed 36 banks. So, using the same logic, I could have pointed to Jessie right after bank number 35 and used him as an example of why I believed robbing banks was legal. “Hey, Jessie’s doing it, and no one is stopping him!”
COMPANIES THAT PROMOTE “NO SALES”
Again, an MLM opportunity must have a product that people can resell to others who just want the product. If the distributors themselves are the only ones buying the product, then the only way you can make money in the program is to recruit distributors, right? Remember, can the last person in still make money? If no one ever recruits another person, and you don’t sell the product and make a profit, then you simply can’t make money.
Not only that, but any network marketing venture absolutely doesinvolve selling, in many other ways than just retailing the products (like, selling people on the idea that MLM is an honest, respectable way to earn a living, or that they should choose your MLM program over the 1,200 others out there, etc., etc.). So, to claim otherwise could be considered misleading or even fraudulent.
MEDICAL OR ANTI-AGING CLAIMS
MLM companies have tried for years to play semantic games with their product pitches to make them safe from FDA, of FTC, attack. But, at every new turn of phrase there was Big Brother standing in the road waiving his index finger slowly back and forth and shaking his head (and with what appeared to be just a hint of a smile on his face and a thank you note from a doctor sticking out of his pocket).
Today, quite simply, nothing is safe to say anymore. Nothing.
Many companies and distributors are still trying the approach where they claim a certain substance has a certain benefit, and that their product has this substance in it, but they are not claiming that their actual product has this benefit. In other words, A=B and B=C, but they are not claiming A=C. To no one’s surprise, the FDA and FTCare doing the math!
Even the personal testimonial, once considered safe haven when relating the benefits of a product, is coming under attack.
You would think with the number of major, well publicized hits some MLM companies have taken over the last few years that we as an industry would be toning down our product pitches considerably. Yet in just the last few weeks I’ve seen ads that claim everything from “effortless” weight loss to “cures” for cancer, arthritis and AIDS! One tape I just listened to — a corporate produced tape — has a woman on it claiming one of their products “reverses the aging process.” No, she didn’t say the appearance of aging, but the actual aging process! Some companies now are claiming they have a product that will reverse the aging process by as much as 20 years! This an be especially dangerous when given to a 19 year old.
And, by the way, don’t think that federal regulators only go after companies that make fraudulent claims about their products. Rarely, in fact, do they claim the company’s product benefit claim is not true — they just claim that there is no, or not enough, substantiation. So, the product might actually do what they claim it does, but the MLM company just doesn’t have enough scientific proof.
In other words, even if your product works you can’t say it does.
INCOME CLAIMS OR PROJECTIONS
Like product claims, there’s no really safe ground here as well. You might think that revealing your income would be okay as long as you could prove the income was factual. Not only is this not true, but the act of displaying a commission check as evidence of earnings is considered one of the most taboo acts in this industry (although its practice is making a comeback of late). What’s more, there is at least one case that I know of where someone was prosecuted on a federal level for revealing his actual income. And let’s be clear on this: he was not prosecuted for providing inaccurate or fraudulent information — he was prosecuted even though he was telling the truth!
Recently, some state and federal actions have resulted in MLM companies prohibiting their distributors from making “false or misleading” income claims and prohibited income “projections” all together. Okay, so what exactly is a “misleading” income claim? If I said I made $50,000 last month, and I was truthful, then is that misleading? Perhaps, if you’ve implied that income is easy to achieve or misrepresented the time and effort it took to achieve it. So, what exactly do I have to say to not do that? How many disclaimers do I have to include? At what income level is all this disclosure not necessary? If I only claimed to have made $50 last month, do I even have to say anything else? If not, then where between $50,000 and $50 is the line drawn?
Do you see the dilemma here?
What confuses the issue even more is that answers to these questions are being determined totally arbitrarily by regulators and usually on a state-by-state basis.
Since your prospects can’t pay their bills with theoretical dollars, nor from their upline’s income, the whole subject of current earnings and projections shouldn’t even be an issue. It’s best to just keep your discussion to the mechanics of the pay plan, the value of the products, and to what your prospect is going to do to achieve their own personal income goal.
ONE TIME PAY PLANS
These are deals where you make a one time out of pocket purchase and then, supposedly, you never have to order anything again to stay qualified for commissions from that point forward.
In reality, a portion of a future commission check is retained by the company and products are then sent to you. For example, you make a one time $100 purchase and begin building a downline. When you reach a certain point (usually it’s the completion of the first “cycle” in a binary plan), you earn, let’s say, a $1,000 check. But the company keeps $400 of that and applies it towards a product purchase, and they send you the products and a $600 check. The $400 qualifies you for the next pay cycle. At a certain point enough others beneath you follow you into the second cycle with a $400 share of their first check, and you earn perhaps $5,000. But, the company keeps $1,000 of that and sends you $4,000 plus $1,000 in product. The $1,000 then qualifies you for the third cycle, and so on.
So, what is really happening here? Well, remember that first $1,000 check? That was your money. All of it! What occurred is the same as if you received the whole $1,000 check, deposited it in the bank, then sent the company a $400 product order — with your money! So, yes, you do make more product purchases than just the first one.
What really raises the red flags, besides the fact the very claim of a “one time” purchase is fraudulent, is that, once again, the last person in can’t make money. Ask the question this way: If all recruiting were to stop today, could this company continue to pay overrides to all of their distributors? Well, if no more “one time” payments were received to keep new money flowing through the cycles of the plan, then overrides would dry up within one pay cycle and the whole scheme would come to a grinding halt.
Not only that, but the company may be hard pressed to convince state AG that the $1,000 product purchase to enter cycle three was for the purpose of obtaining product for personal consumption and retail to non-distributors. In reality, of course, the $1,000 purchase is almost transparent to the distributor. They accept it as an automatic part of the system because that’s what has to happen for them to get paid more money from the next cycle.
DOWNLINE BUILDING SCHEMES
When you pay someone to build your downline for you, and they promise to place any number of distributors in your downline for that fee, there are two possible violations of law. One involves securities law, and the other involves basic laws of mathematics.
Isn’t it obvious that if a company were to promise even one person in every participant’s downline, they’d have to have an infinite number of enrollments? What do you think happens when the absolutely inevitable point is reached when the organization has fanned out so far that there are hundreds, perhaps even thousands, at the base all waiting for their big, free downline? It becomes mathematically impossible to provide it, so they quit. The organization begins to unravel upward as fast as it was formed (and the unfortunate MLM company the scheme was attached to get’s deluged with product returns – which is why most responsible companies forbid the promotion of such deals). This event is so predictable that there is a name for it. It’s called the “Window Shade Effect.” It describes what has occurred in literally every single downline building scheme that has ever existed. Which is why such schemes have a 100% failure rate throughout MLM history.
Yet, I see more such schemes popping up today than every before.
Where securities law comes into play can be explained by a review of the Howie vs. SEC decision (1948). From this decision came a clear definition of a security, which has three aspects: 1) an investment of “consideration” (in this case, plain ol’ money); 2) a “common enterprise” (a lot of people all paying money into the same scheme); and 3) there is income to be “derived solely from the efforts of others.” So, all MLM programs would seem to meet aspects one and two. However, most of us work our butts off building and managing or downlines, and moving product (right?!). So, we are not offering a security (like stocks, bonds, mutual funds, etc.). But, what if we all paid money into a deal that will build our downline for us, and all we had to do was sit back and wait for the check?
Several reps for such schemes recently defended this issue by claiming this downline building service was only an “option.” You didn’t have to have them build it. Okay. I see. So, only some of their distributors might be selling unregistered securities without a license. That’s not comforting.
It should be noted that, to my knowledge, no such scheme has ever been targeted for violating securities law, in spite of being so wide open to such attack. Very likely this is due to the simple fact that they go away so fast all on their own. Why bother?
Allow me to state for the record that some of what you’ve just read as it pertains to legal issues I personally do not agree with. I’m not implying any of this is right or the way it should be. So please, don’t yell at me if you disagree with the concepts. Hey, I’m a registered Libertarian. I believe we should do what ever we want with our own money. I think pyramid schemes should be legal as long as there is full disclosure and you know what the risks are. We have a right to be stupid with our own money. It’s our money! In fact, I find it so infuriatingly ironic that my state will declare a company an illegal pyramid, wipe out the incomes, and in some cases the livelihoods, of thousands of innocent distributors, simply because they purchased an overpriced prepaid calling card for $100 that they have no plans to resell. But, if I pay $100 for state lottery tickets, which I have a far, far greater chance of losing, they’ll take my money, smile, wink, slap me on the back and encourage me to come back next week and try again.
Opps, I hear my soapbox cracking. I better step down.
By looking at the past we can see the future. We can all learn from those before us what’s safe and what we should stay clear of. Yes, the legal climate is changing and the rules are getting a little blurry. All the more reason to leave yourself a good margin for error. Give any red flag a wide birth. Don’t, as some companies are doing today, drape yourself with it and dance in front of a snorting bull.
Sure, some companies have been waiving these red flags for years with no consequence. Some, when recognized, will simply be asked to please put away the red flag (eliminate the offending aspect of the plan). Others may be forced to make changes, get beat up a little, then get on with their business. I’m not at all suggesting that every MLM opportunity that employs any of the aspects discussed here is doomed.
Not all ticking bombs go off. But I still wouldn’t want to be sitting on one.
Personal Consumption and the 70% Rule
Recent Regulatory Misinterpretations Can Be Harmful to Distributors
By Len Clements © 1999
The serious challenge that has arisen in recent years involves the interpretation of the 70% Rule. Previously, the “or consumed” provision in the above definition has received little or no resistance. In fact, this has been generally accepted without incident or harm for the entire 20 year period since the Amway decision. However, for some unknown reason (although many theories abound) several actions have been taken recently in which the “or consumed” aspect has been thrown out. The judge or regulatory body has demanded that 70% of all previous wholesale purchases be retailed to non-distributors only. Furthermore, they have ruled that no commission, bonuses or overrides be paid on product personally consumed by the distributor!
Perhaps the most publicized case involves the Ninth Circuit Court of Appeals decision against Omnitrition. A class action suit was filed (by two disgruntled ex-distributors) and the suit was originally dismissed in Omnitrition’s favor by summery judgment (it didn’t even go to trial). When the class appealed this decision, the Ninth Circuit Court not only ruled in favor of the class action (demanding only that the lower court must hear the case), the court uncharacteristically offered a detailed opinion as to why. The court proclaimed that personal purchases were not applicable in satisfying the 70% Rule and therefore there was a legitimate case to be made that, in fact, Omnitrition was operating an illegal pyramid (again, this decision only required the lower court to go forward with the case and did not actually declare Omnitrition a pyramid scheme). The outcome of the lower court trial is still pending.
Having spoken with numerous individuals within the offices of Attorney’s General (yes, that is the proper pronunciation) throughout the country over the years, I had ample opportunity to quiz them as to their position on this “or consumed” issue. Only onestate, Michigan, offered the clear and specific opinion that “personal consumption does not satisfy the 70% rule in this state.” Ironically, this is the home state of Amway itself which has evolved into the epitome of transfer buying and personal consumption within this industry. (And, again, without incident or harm to anyone). In fact, Amway recently went counter to the regulatory trend and reducedtheir ten customer requirement to five customers! And, in spite of this verbal declaration given to me over the phone, I can find no specific action taken by the Michigan AG’s office in which they’ve challenged the personal consumption aspect.
Most recently, California and North Carolina have boldly and clearly declared that personal consumption does not (no longer?) satisfy the 70% Rule and that no commissions or bonuses can be paid to distributors on personally consumed product. One recent case involves Destiny Telecom and the state of North Carolina. This case is especially disturbing in that the state not only demanded that Destiny verify to the state, on a monthly basis, that 70% of all wholesale orders by distributors are being retailed to non-distributors, but further demanded the following: “Should a North Carolina retail customer subsequently establish such a connection by becoming an ‘Independent Representative’… any prior salesmade to that customer shall be considered an internal sale from the time of sale and shall not be considered a retail sale for any purpose at any time” (underline emphasis mine). Understand, this startling and bizarre provision is declaring that, for example, if you are strictly a retail customer for an entire year, then you decide to simply sign a distributor application, even if it’s just so you can get the products at wholesale and you have no intentions of working the business, Destiny will not be able to count, nor will North Carolina accept, the entire previous year’s worth of sales as retail sales!There is no legal, ethical, or logical explanation for such a demand to be made on a network marketing company.
But there’s more.
Immediately following the above statement (found on pages two and three of the Consent Agreement between Destiny and NC), the agreement goes on to demand that “Destiny shall immediately revise its records to ensure that the benefits provided to all relevant participants are adjusted accordingly.” In other words, all the commissions and bonuses that were previously paid on this year’s worth of retail volume (based on the above example) must be deducted from those distributors next check! Amazing.
California’s AG’s office, within their Final Judgment against Destiny, has ruled that any type of sales aid or live training is not commissionable. Curiously, Destiny never paid commissions on either of these items — but several major competing companies do! While the judgment was somewhat ambiguous as to the personal consumption issue, nothing was left to the imagination in the consent decree issued by California against AuQuest. Herein they ruled that commissions may only be paid on sales to the “ultimate consumer.” However, they went on to define “ultimate consumer” as “Persons who are not a part of the AuQuest Marketing Plan.”
At first glance the state of Arizona, in their consent decree with TeleSales, Inc. (another prepaid phone card deal) seems to have used a little common sense in the matter. They ordered that commissions must be based on “retail sales,” but defined this as being sales to persons who “are not part of (the) marketing program” but also sales to “persons who, although desirous of becoming or who are part of (the) marketing plan or distribution system, are buying for their own personal or family use.” There is a subtle nuance in this definition that may have been missed. Arizonadid not say that a distributor’s own personal consumption is commissionable to his or her upline, but rather a “sale to” anotherdistributor for their personal consumption! This, of course, begs the question, Why would a distributor buy at retail from another distributor when they can buy at wholesale direct from the company via their own distributorship? (Arizona also fined several of what TSI reported to them to be “major” distributors $25,000 each, which begs the question, What is a “major” distributor? Exactly how big does someone’s downline have to be before they stop becoming the victim and become the perpetrator? Five hundred? Five thousand? What!?).
What these rulings requiring commissions be paid only on retail sales to non-distributors does, in effect, is place the selling distributor in a very precarious position from an ethical standpoint. They would now be motivated to hide the fact from their customer that they can simply sign up as a distributor, likely at no charge, and get the product significantly cheaper. When the retail customer inevitably discovers this option, they surely will question the selling distributor as to why this option was never presented to them. They’ll probably be at least a little POed — and rightfully so. To place a distributor in this position is the real crime here!
These regulatory people’s job is to prevent us all from getting hurt. Isn’t creating a strong motivation to keep retail customers out of the distributor scrolls, thus causing them to pay 30-40% more than they need to be paying for their products, harming that customer?
What’s more, it can cause harm to the distributor as well. Think about it. Who, in the 53 year history of network marketing, has ever been harmed by purchasing only the amount of product that they can comfortably consume themselves? No one! Who has been harmed by buying more than they can consume, or even sell? Thousands! What the 70% rule effectively does, when personal consumption is not factored in, is require by law that the distributor purchase over three times as much product as they can personally consume! If Mary only wants to purchase $100 worth of products for herself and her family, the 70% rule (sans personal consumption) requires that she purchase $333 worth of product — then be forced to sell the extra $230 worth within 30 days, or be forced to lie about it just so she can get the products she wants the next month (typically, companies are not suppose to let you order more products unless you’ve met the 70% rule).
Not only that, but if Mary does only order $100 worth, this screwy interpretation of the 70% rule would require that she sell $70 of it, leaving her with only $30 for herself. So, she must then order another $70 in product to get the $100 worth that she truly desires. But wait! Now Mary has purchased $170 in product total. She needs to retail $119 of it to satisfy the personal consumption-less 70% rule. So she retails another $49 to satisfy the rule — leaving her $21 short of the $100 worth that she really wants for herself. So, she orders another $21 from the company. But, alas, she’s now ordered a total of $191, and $14.70 more product must be retailed.
Isn’t this just a little ridiculous?
In an effort to make our industry less financially risky, thus lessvulnerable to media and regulatory attack, most MLM companies have enacted a free sign up system where even the “at cost” distributor kit is an optional purchase. But, by doing so we’ve now totally blurred the lines between “customer” and “distributor.” It makes no sense for someone to be paying retail prices for something they can get at wholesale by simply calling an 800-number and “signing up.” So, now retail customers all appear to be “distributors” in the company’s database. Our efforts to make ourselves less vulnerable has made us more vulnerable! What’s more, the absurd way in which some regulators have defined the law in this situation actually puts us and our customers back into a situation of spending significantly more money than we were originally requiring. All in an effort to protect us!
The true spirit of the 70% rule was to simply eliminate front loading and stock piling. In years past it was routine to find many people “buying into” a certain position in the compensation plan with an up front several thousand dollar purchase. This is where the term “garage qualified” came from. And to keep qualified for that position, they’d order hundreds or thousands more each month. These purchases were not because they wanted the product or had the retail client base to sell it to, but rather it was simply a token act to keep qualified in the plan. The 70% rule was designed to eliminate this practice. Well, by counting personal consumption towards the 70% rule it still effectively accomplishes this! And, once again, by not counting personal consumption the distributor/consumer is force by law to actually purchase more products than they wish to!
Arguably, companies like Destiny, AuQuest and TSI were worthy targets due to the lack of any significant amount of retailing and the great emphasis placed by their distributors on recruiting and “buying into” a higher pay level in the plan. Other recent targets, such as Fortuna Alliance, Gold Unlimited, and Boston Finney, also demonstrate that regulators are picking their spots. Very likely noMLM company is truly retailing 70% of their sales volume to non-distributors. Yet the Amways, Shaklees, and Herbalifes continue to do business, unchallenged, in even the most MLM-unfriendly states. As it should be.
On an even more positive note, three states, Texas, Oklahoma, and Louisiana, have recently passed model legislation that specifically declares personal consumption as a valid sale and applicable to the 70% rule. Several other states will be considering similar legislation in 1999 as well.
The greatest fear we should have is that, someday, there is federal regulation of the network marketing industry — and theydemonstrate the same utter lack of understanding of how this business works and what’s best for it’s participants. On a case-by-case, state-by-state basis, we can survive and even thrive. But if Big Brother ever decides to cop the same attitude as a few state AG’s, well, better thank you lucky stars for the Amways, Shaklees and Herbalifes.
Personally, I’m hoping for federal regulation. And I hope that it will be based on the precedent set in the FTC case against Amway back in 1979 and require all companies provide full disclosure and allow for personal consumption to apply towards the 70% rule.
Let us hope.
