Most Multilevel Marketing companies claim that their list of distributors is a proprietary asset of the company. When a departing distributor uses the list to solicit other distributors to follow him or her to a new company, the MLM company cries foul ball. Indeed, many MLM companies include in their Policies & Procedures provisions acknowledging the proprietary nature of the company’s distributor list (i.e. genealogy) and providing restrictions allowing use only in conjunction with the company’s business.
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Wellman & Warren, LLP has, once again, successfully defended a Federal Trade Commission (FTC) investigation of a Multi-Level Marketing company. Due to the private and confidential nature of the investigation, Wellman & Warren is not able to disclose the names of parties involved in the investigation. The FTC’s investigation centered around the methods in which the company paid commissions to their distributors as well as various income claims made by the company and their distributors.
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Out of all of the topics covered in MLM law, there is not a single topic more obfuscated and misinterpreted than the 70% Rule. This rule has been purposefully screwed up by MLM critics in an effort to craft a narrative that suits their agenda. Candidly, I’m shocked that neither myself nor my peers have addressed this sooner. The rule is incredibly easy to understand ONCE YOU UNDERSTAND THE HISTORY.
The Origins of the Seventy Percent Rule
The Seventy Percent Rule was one of the “Amway Safeguards” that the court highlighted in 1979 when it found that Amway was NOT a pyramid scheme. The summary of the rule: In order to qualify for downline bonuses, Distributors had to move 70% of their existing inventories to customers OR distributors. The spirit of the rule is designed to ensure that Distributors were not “garage qualifying” and sitting on inventory. The inventory had to MOVE to other people.
When Paul O’Neil delivered his first speech as CEO at Alcoa (the aluminum manufacturing giant), he shocked the audience of shareholders when he disclosed his top priority for his tenure as CEO. Instead of doing the usual dance where the CEO talks about increasing sales, increasing margins and driving down costs, he talked about something that seemed completely unrelated to revenue. His top priority: worker safety.
Worker safety!? The shareholders were appalled. After all, what does safety have to do with share value on the New York Stock Exchange? Countless shareholders immediately dumped their shares, thinking that Alcoa hired an out-of-touch powder puff CEO…someone who lacked the guts to make tough decisions and focus on the bottom line.
The result? During O’Neill’s tenure as CEO at Alcoa, shares more than tripled in value. O’Neill explained his logic when he said, “I knew I had to transform Alcoa. But you can’t order people to change. So I decided I was going to start by focusing on one thing. If I could start disrupting the habits around one thing, it would spread throughout the entire company.”
I recently fielded a phone call from a business owner who asked me the following question: Does my business model qualify as a multi-level marketing company? It’s a good question whose answer invokes a variety of possible legal implications.
THE MLM LEXICON
With no single authority providing some sort of precedential definition of “MLM,” the best way of boiling the concept down to its essential elements is through the lens of different authorities and sources.
When I sense a gap in the industry’s understanding on an issue, I see it as an opportunity to learn more and write content that sets the record straight. I’ve been fielding a lot of questions lately on the subject of whether a company can require monthly product purchases as a condition for pay plan qualification. When I give the answer, I’m sometimes met with surprise. They’ll often say, “They’re doing it over here and over there…..are you telling me they’re a pyramid schemes!?” Here’s the truth: multilevel marketing companies cannot require their participants to buy inventory as a condition to participation. This is black letter law, meaning it’s a rule not subject to any dispute. Whether this principle comes as a surprise or makes no difference, an understanding of why it exists and where it comes from is crucial to the avoidance of regulatory trouble.
The best definition for what constitutes a pyramid scheme arises out of the 1975 FTC case, In re Koscot Interplanetary, Inc. What separates a legitimate MLM from an illegal scheme boils down to two basic elements:
(1) a participant’s payment of money in return for the right to sell a product/service; and
By: Scott Warren, David Van Sambeek, Scott Wellman*
There has been a recent surge of enforcement actions by governmental agencies claiming that that certain network marketing companies are illegal pyramid schemes. The most notorious of these recent actions is the action filed by the U.S. Federal Trade Commission (FTC) against Vemma. But this is just one of the actions and investigations brought by both the FTC and the U.S. Securities and Exchange Commission in recent time. In order for your MLM company to avoid the same fate and regulatory scrutiny, it is essential that you (1) gain an understanding of the crucial role retail sales play in the determination of what is a legitimate MLM company versus what will be considered to be an illegal pyramid scheme, and (2) implement any needed changes immediately.
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