FTC Settlement with Herbalife – OMG!!!!

Network marketing is in the midst of a rapidly advancing Orwellian era.

Network marketing is in the midst of a rapidly advancing Orwellian era. It’s been slow to develop, starting in 1996 when the Ninth Circuit Court of Appeals issued its decision in Webster v. Omnitrition, but it’s snowballed in the past two years.  Today the snowball grew exponentially with the announcement that the Federal Trade Commission and Herbalife have reached a settlement agreement.

Watch for detailed updates and analysis on the settlement. We’ll break it down into many little pieces to determine how it will impact your business. But today we just have time for a broad sweep so I’m just going to address some critical topics.

The obvious first question is: “Does this settlement affect my business?” It’s certainly an important question. After all, the FTC was investigating Herbalife and analyzing Herbalife’s program, so why should it apply to any other company? The answer is two-fold. There’s the technically correct answer, and the real-world practical answer. The technically correct answer is that the FTC settlement with Herbalife has no binding impact on any other network marketing business. The real-world answer is quite different.  The changes that Herbalife must implement offer a clear roadmap to the standards that the FTC expects all direct sellers to conform, and those are the standards that it will pursue in future cases against direct sellers.

There’s no law that requires direct selling companies to adhere to all of requirements in the Herbalife settlement. But those who stick their head in the sand and ignore the messages in the Herbalife settlement agreement do so at great peril. By now you’re certainly wondering what the settlement agreement requires. Here’s a high level summary of the most critical issues that will impact every network marketing program:

  1. The FTC has asserted a new basis upon which to attack MLMs under Section 5 of the FTC Act. They claim that Herbalife was “promoting participation in a multi-level marketing program with a compensation structure that causes or is likely to cause harm to participants.”

This is a groundbreaking position. Historically, the FTC has attacked MLM programs as pyramid schemes, but in the Herbalife settlement there’s no assertion that Herbalife is an illegal pyramid (that’s great news for Herbalife!). Rather, the settlement agreement asserts “the compensation structure is likely to cause harm.” This is a new angle of attack that requires a new analysis of compensation plans and programs. The legal standard of what constitutes a harmful compensation plan is not defined in any case law. The Herbalife settlement is the first glimpse we’ve had into what is a “harmful compensation structure.”

  1. Sales to non-participants in the business opportunity remain foremost in the FTC’s consideration of what constitutes a legitimate multilevel opportunity. The FTC acknowledges that some personal consumption of products by Herbalife distributors is appropriate. What’s critically important is that the settlement agreement specifies that no more than one-third of multilevel compensation may be paid from sales to distributors. Conversely, the FTC expects at least two-thirds of product sales to be to customers (i.e., those who are NOT distributors). Also of critical importance is that the settlement agreement very clearly delineates distributors from customers. The argument that distributors who don’t earn anything but who to buy products are “discount buyers” and not distributors will not hold water.
  1. To the extent that the program required distributors to meet minimum quotas to qualify for compensation, the minimum quotas MUST be met through sales to customers who are not distributors. This is a CRITICAL takeaway from the settlement because it stabs directly at the heart of the very common element of multilevel compensation plans that set minimum personal volume quotas necessary to be “active,” which is a prerequisite to being eligible for compensation.
  1. Distributors are PROHIBITED from participating in an auto-ship program. Yes, you read that correctly. Stop and take a deep breath. Now read it again. I don’t need to expound on that one.

There are A LOT of other elements to the settlement that are incredibly significant, and much further analysis needed on the points addressed in this blog. We’ll focus on the many facets of the settlement agreement in the very near future. But the above are such foundational concerns that every company using a multilevel compensation structure must be thinking about how to deal with this NOW. If these are the standards that the FTC will seek to impose on all multilevel marketers (and I fully expect that they are), it will impact EVERY direct seller and the structure of the overwhelming majority of direct selling businesses.

Herbalife to Restructure Operations, Pay $200 Million to Settle FTC Charges

Herbalife States USA Revenues Only 20% Of Total Company Revenues!

Angle Of Justice

Note: See an overview of how this settlement affects network marketers, and watch out blog for detailed analysis and updates.

Herbalife International of America, Inc., Herbalife International, Inc., and Herbalife, Ltd. will restructure their U.S. multi-level marketing business operations and pay $200 million to compensate consumers to settle the FTC complaint that the Herbalife companies deceived consumers into believing they could earn substantial money their products.

The FTC complaint also charged that Herbalife’s compensation structure was unfair because it distributors were rewarded for recruiting others to join and purchase products in order to advance in the MLM program, as opposed to actual retail demand for the product, causing economic injury to many distributors.

According to the complaint, Herbalife claimed that people could earn thousands of dollars a month or even get rich in the program. But the complaint alleged that the majority of distributors earn little or no money, with more than half the distributors known as “sales leaders” receiving less than $300 in rewards for 2014. According to a survey by Herbalife itself, Nutrition Club owners spent an average of about $8,500 to open a club, and 57 percent of club owners reported making no profit or losing money.

Those distributors who do make a lot of money, according to the complaint, are compensated for recruiting new distributors, regardless of whether those recruits can sell the products they buy from Herbalife.

As part of the settlement, Herbalife will change its compensation system so that it eliminates recruiting incentives and rewards retail sales to customers. As examples of the changes, the FTC says:

  • Herbalife will differentiate between participants who join simply to buy products at a discount and those who join the business opportunity.
  • At least two-thirds of rewards paid to distributors must be based on tracked and verified retail sales of Herbalife products. No more than one-third of rewards can be based on other distributors’ limited personal consumption.
  • I order to pay compensation to distributors at current levels, at least 80 percent of Herbalife’s product sales must be to legitimate end-users. Otherwise, rewards to distributors must be reduced.
  • Herbalife is prohibited from allowing participants to incur the expenses associated with leasing or purchasing premises for “Nutrition Clubs” or other business locations before completing their first year as a distributor and completing a business training program.

In addition, Herbalife will pay a $200 million for consumer redress, including money for consumers, such as Nutrition Club owners, who purchased large quantities of Herbalife products.

The Wisdom of Jerry Garcia

What Does The Greatful Dead Have To Do With Network Marketing?

I went to a Grateful Dead concert in 1976. The band was at the height of cool at the time as they represented the counter-culture movement from the Haight-Ashbury district of San Francisco. Although I had been to a number of concerts before seeing the Dead, this concert was different because it was the first (and to this day the only) concert where I witnessed security personnel hauling stoned audience members out throughout the show like it was a revolving door, and I saw medical personnel take at least six overdosed people out on stretchers.

This was obviously a common occurrence at Dead concerts. I vividly recall that right after their first number (Truckin’), Jerry Garcia (lead singer for those of you not old enough to have a touch of grey) announced “Hey people, have a great time, but don’t do any stupid sh**!” Such profound wisdom in such a simple statement!

I don’t think Jerry Garcia’s admonition resonated with the audience that night (shocking, right?), but it should resonate loudly with direct sellers. I look back on the FTC’s last four pyramid actions, Vemma, Fortune Hi-Tech, Burnlounge and Trek Alliance, and in each case we can point to stupid things that that landed the defendants in the FTC’s cross-hairs. We can (and will) closely analyze compensation plans, compliance and marketing nuances that the FTC charges render MLMs pyramid schemes. But there’s a place for analysis, and a place for common sense. Let’s put common sense first, because it’s unquestionably the first and best defense against finding your business in the line of regulatory fire.

Let’s start with Equinox and Trek. In both cases distributors (with corporate knowledge) placed ads in the “Help Wanted” sections of newspapers. The ads led readers to believe that Equinox and Trek were seeking to fill employment positions. People applied for the “jobs” and showed up for “job interviews.” In egregious cases the job applicant would purchase an airplane ticket to fly to the city in which the “job interview” was scheduled. When people arrived for their job interviews, they were pitched on the MLM opportunity, sold a starter kit and a large amount of merchandise. This proved an effective recruiting technique, but it doesn’t take a rocket scientist to figure out that it was based on deception and would inevitably elicit complaints to regulators. You guessed it – STUPID MOVE!!!

Fortune Hi-Tech’s compensation plan had built-in stupidity. While FHTM sold some real products and services, FHTM also sold a $199 “training program” to new distributors and paid a multilevel override on the sale. The training program, to the surprise of … NOBODY, was simply a means of funding compensation for recruiting new distributors. Montana was the first state to investigate FHTM, and frankly, they missed this issue. However, enough money was flowing through FHTM that regulators could not help but notice that the growth was driven by recruiting rather than bona fide consumer sales. Once again, stupid reigned supreme and helped lead to the demise of FHTM.

The Burnlounge case was triggered by the incendiary combination of stupidity and arrogance. Burnlounge management and its top earning distributor conducted meetings rife with income claims. They told audience members they could earn $900,000+ in their first year (not even the top earner was making close to that much). A woman in the audience found the sales pitch interesting, so she brought her husband to the meeting the next night. After the meeting the woman’s husband pressed the presenters for information to support the pie-in-the-sky income claims. The presenters didn’t want to be bothered with him (nor did they have any support for their claims) so they told the man to mind his own business. It turned out he was the assistant attorney general for the State of South Carolina. The next day an investigation file was opened on Burnlounge. Ooops! Ring the stupid bell!!!

Most recently Vemma was shut down by the FTC. We don’t have to look very hard to see where dumb came into play. Several highly visible Vemma distributors built their businesses on college campuses. They would aggressively pitch the Vemma business to college students, telling themn that they didn’t need a college education or that they should use their tuition money to build a Vemma business. Could anyone have foreseen how that might lead irate parents to ignite a firestorm of complaints? Ummm … yeah …

Whenever an MLM is attacked by law enforcement, other MLMs want to scrutinize the defendant company’s policies and compensation plan and parse every phrase in court filings, orders and opinions and quickly make changes so that the same fate does not befall their company. But it’s a COLLOSSAL MISTAKE to assume that the critical flaws all reside in the compensation plan or policies. The first step should be to identify every element of STUPID (and arrogant) in your business and fix it. The company may have turned a blind eye to the stupid practice for years or thought because a practice is not specifically illegal, it’s okay. Most commonly, the stupid practice is effective at growing the business, so they try to rationalize that it’s acceptable. But guess what? Even if it’s not illegal, it’s still stupid! And it’s STUPID that most often brings MLMs into regulatory crosshairs.

So the first rule in avoiding legal problems; heed the advice of Jerry Garcia and don’t do stupid sh… stuff!

The Vemma Ruling Is Out

What Do The MLM Attorneys Think About The Vemma Case?

The U.S. District Court in Arizona just released its order on the Vemma TRO/asset freeze and receivership. Here’s the quick summary, but the analysis has many angles and moving parts that invite much analysis and interpretation.

  1. The Temporary Restraining Order. The court found that there is a substantial likelihood that Vemma was running a pyramid scheme. However, the court also found that there were parts of Vemma’s business that were being operated legitimately. Therefore, the court amended the TRO and allowed Vemma to continue to operate those parts of its business that were being run legitimately, but enjoined Vemma from engaging in those practices that it viewed as illegal. As it relates to Vemma’s sales and compensation program, the court enjoined Vemma from incentivizing distributors to buy products to become eligible, or maintain eligibility, for compensation rather than for resale or personal use. (Emphasis added – this is HUGE!). This is seemingly contradicted by another statement in which the court prohibits Vemma from paying compensation related to the sale of products unless the majority of compensation is derived from sales to buyers who are not members of the Marketing Program. (Emphasis added).
  2. Vemma remains enjoined from paying commissions on the sale of Affiliate Packs and on the sale of products to distributors if such sales accumulate sales volume that qualifies the purchasing distributor for compensation. This provision directly impacts Vemma’s autoship program; we will analyze this in much greater detail in upcoming analyses.
  3. The Asset Freeze. Vemma’s assets and the personal assets of the defendants are unfrozen. The court found that the FTC did not present sufficient evidence that the assets were at risk of being dissipated.
  4. The Receivership. The court found that because Vemma is prohibited from engaging in illegal practices, it was unnecessary to have the business run by the receiver. However, the court recognized that Vemma had engaged in numerous illegal actions, so it re-cast the receiver as a court appointed monitor to oversee the defendants’ management and operation of the business. This is a significant step as it puts Vemma’s management back in charge of the company. Of course, the problem is that the company is a mere shell of its former self since the receiver fired most of its employees.

The content of the court’s order simply begs for analysis, and we will be breaking it down into dozens of individual issues for you. However, it’s important to understand that while this is a considerably stronger outcome than other MLMs have experienced in the past following FTC action, the company has been devastated so the FTC still has its “win” (although it certainly has egg on its face for other reasons that we will discuss in subsequent posts). But as I pointed out in my last blog, we have much work to do.

In my opinion, today’s ruling is yet another scenario of another governmental entity acting under the color of the law overstepping its bounds. The FTC misled a federal judge to convince him to grant an order that effectively killed Vemma’s business. Then, before Vemma had a day in court, the FTC’s receiver overstepped the bounds of the Court’s order by firing the majority of Vemma’s employees. Vemma received no hearing until weeks after the FTC had done everything it could do to effectively kill the company.

In reading between the lines, today’s court order indicates that the court viewed the FTC’s action as overreaching. Notice that I said “overreaching,” and not that Vemma was innocent of the charges. That’s a key distinction because in so doing the court sent a message that the FTC went too far in convincing the court to issue the draconian relief set forth in its original order that froze Vemma’s assets, turned the company over to a receiver, and shut the business down.

Vemma was not an altar-boy, and the court’s order recognizes that. Indeed, the court’s order indicates that it believes that the FTC will successfully prove that Vemma was operating an illegal pyramid scheme. I’m not commenting on whether or not that is true, but nobody can credibly argue that Vemma and its distributors were not too aggressive in some practices. But did Vemma’s transgressions justify the FTC’s initial actions in killing the company? Or are we faced with a situation in which the FTC, as the top-cop in the consumer protection arena, is exhibiting and exercising a bias against direct sales?

I am not one to espouse conspiracy theories, but how many consumer (and OSHA, and EEOC, and on and on …) complaints have been filed against WalMart, McDonalds, or any other high-profile business? Does the government shut them down, freeze their assets, and appoint a receiver to liquidate the company? Does the government shut down an auto company when the company builds cars knowing that they have flaws because they calculate that the lawsuits from the ensuing accidents will cost less than fixing the problems? I have yet to hear of an asset freeze or ex parte shut-down of a tobacco company, although the harm they cause to individuals, our health care system, and society at large dwarfs any harms alleged to have been caused by Vemma.

Obviously these are extreme examples, but they are fitting. Let’s face it, the government does not kill businesses in other fields, even though their transgressions are far more devastating in terms of life and property than the harm that can be caused by a flawed direct selling company.

Let me be clear. I am not defending pyramid schemes. There is NO ROOM in the direct sales distribution channel for pyramid schemes. I am however shouting loudly about the bias that the FTC has for the direct selling industry. The court’s action in amending the Vemma TRO highlights that less draconian remedies are appropriate and suitable to address problems within our industry while legal proceedings wind their way through the courts. The Vemma case highlights this fact very clearly. The FTC identifies a target with an objective to shut the company down, conducts a flawed investigation, presents highly selective evidence to the court, and kills the company, all without due process of the law. What other industry gets such treatment? I can think of none.

So what do we do? One thing is for sure; we DON’T sit back crying boo-hoo, we’re such poor victims of the big, bad FTC. Direct selling is built on high-energy, high-output people who get things done! So these are my recommendations:

  1. Make sure your house is in order. This is KEY! There’s no sense in trying to fix a system if each of us cannot fix ourselves. My guess is that every company knows, or at least has a good idea, of where it’s pushing the envelope. Find out if you’re overstepping the bounds, and let’s clean up our act.
  2. Get in contact with your federal government officials. Contact your Senators and your Congress-person. You have a voice. Use it.
  1. Work together. Sure, every company is in competition with one another. But on industry-wide issues such as the FTC’s abuse of power against direct sellers, a unified voice will have far greater effect than everyone working individually.

I anticipate that change will be slow, but let’s get the conversation started!

Today’s the Day. . .

Vemma Court Decision Expected Today

We’re expecting the court’s decision today in the Vemma action on whether the Federal Trade Commission’s temporary restraining order will be lifted, modified, or remain in place in the form of an injunction. There are MANY lessons to be learned from the FTC’s action, and we will be addressing them one-by-one in the coming weeks, so stay tuned. (Note: The order from the hearing is here.)

But as we wait for the immediate outcome, one thing of which we can be certain is that if the court completely lifts the TRO (highly unlikely), Vemma as we know it is done. The FTC’s favorite receiver did such a hatchet-job on the company that he killed it long before Vemma saw the light of the court room. Employees were dismissed within days after the raid, and while Vemma certainly had a cadre of loyal distributors, many more have departed given the specter of the FTC’s action.

The FTC’s playbook in pyramid cases is to freeze the corporate and personal assets of the owners, get an ex parte TRO, and have a receiver liquidate the company. The receiver in the Vemma case, Robb Evans and Associates, is the FTC’s go-to receiver in numerous actions, including the Trek Alliance and Burnlounge cases. Interestingly, a motion has been filed in a pending lawsuit in Utah to sue Robb Evans and Associates alleging that Evans is the FTC’s lackey, doing the FTC’s bidding because the Commission stamps his meal ticket, and in doing the FTC’s bidding he overstepped the bounds of the court’s order in the case. A recent article in the Salt Lake Tribune reports on this motion at http://www.sltrib.com/home/2953787-155/utah-companies-want-to-sue-court-appointed.

While I am certainly in favor of stopping pyramid schemes dead in their tracks, the FTC’s brazen disregard for Constitutional due process is appalling, and the direct selling distribution channel is at the receiving end of the FTC’s spear. I regret to say that in my opinion the industry itself is partially to blame because we have not been sufficiently proactive at the federal level. Let’s face it, although the FTC is charged with prosecuting pyramid schemes, the Commission is incapable of providing a comprehensible definition of a pyramid scheme. Rather, the Commission’s position on what constitutes a pyramid is at best a fuzzy and ever-changing. The industry itself has not done a good enough job at: (a) shaping a federal law or regulatory rule that clearly establishes the parameters of what constitutes a legal multilevel marketing program as opposed to what constitutes an illegal pyramid scheme; and (b) educating the FTC on how the industry actually operates.

Unless the industry can resolve this issue with the government, we will continue to be forced to deal with the FTC’s playbook and the denial of Constitutional Due Process and watch as one company after the next is buried. In coming months we will be addressing these topics, so stay tuned. In the meantime, we will report back on the outcome and the import of the Vemma decision as soon as it is published.

FTC Amends Door-to-Door Sales Rule (Not Really)

What Is The FTC Door-To-Door Rule?

The FTC recently announced that it has finalized the amendments to the Federal Cooling-Off Rule, (aka Door-to-Door Sales Rule).  The amended Rule will go into effect on March 13. When the proposed amendment was published, there was some anticipation on the part of the direct selling industry that sellers would be granted some relief from the Rule.

For those not familiar, the Rule requires that customers (including new distributors or consultants) be given two copies of the 3-day Notice of Right to Cancel whenever a purchase transaction for consumer goods or services takes place at a location other than the seller’s place of business.  While there are some possible exemptions, for the most part the rule covered many transactions between distributors and their customers and between distributors and their newly recruited distributors.

The major exemption that has been in place since the Rule was originally enacted (in 1972) was a $25 threshold requirement.  If the purchase amount was less than $25, the Rule did not apply and there was no requirement to provide the customer with two copies of the Notice of Right to Cancel.

When the FTC initially proposed the amendment, the threshold was raised to $130, which would have accounted for inflation since 1972.  This change would have been a relief to many direct sellers with lower cost items and kit prices.

Ultimately, the FTC left the $25 threshold in place for transactions that occur at the buyer’s residence.  For transactions that take place at other locations but are otherwise subject to the Rule, the threshold was raised to $130.

For many direct sellers, nothing has changed.  A company cannot print separate contracts, order forms or sales receipts for different sales locations.  Because a company will not always know the actual location of a sales transaction, the better course will be to include the Notice of Right to Cancel on all order forms, receipts, and purchase agreements.  For additional information, please feel free to contact our office.

Breaking News: MLM Attorney Kevin Grimes, Joins Network Marketing Attorney Kevin Thompson Over At Thompson Burton

As we’ve been building out Thompson Burton over the past few years with my longtime friend and business partner, Walt Burton, there’s one simple concept coined by Jim Collins that’s never failed us: Get the right people on the bus.

Kevin Grimes is the right person. I’m excited beyond measure to be announcing the addition of Kevin to our team!

Kevin and I have a history that goes back close to seven years. Back in the day when I was an in-house lawyer for Orrin Woodward, one of MonaVie’s distributors, I worked closely with Kevin. He was serving as their outside legal counsel on MLM and FDA compliance issues. During those interactions, I came to really respect and appreciate his level of expertise.

Click Here To Read Full Press Release!