The term “crowdfunding” has been thrown around a lot over the past several years. But what does “crowdfunding” really mean? And how does crowdfunding, particularly the recent enactment of rules from Title III of the JOBS Act, relate to network marketing?
At its most basic, crowdfunding is the pooling of financial contributions via the internet for a project or enterprise. The ubiquitous nature of the term has led to a great deal of confusion. However, “crowdfunding” is most easily understood as an umbrella term referring to three different models for raising capital: donation-based, rewards-based, and equity-based. Before discussing the challenges more commonly associated with equity-based donations, let’s cover the more commonly known types of crowdfunding.
DONATION AND REWARD-BASED CROWDFUNDING
Congressman Marsha Blackburn, House Representative of the 7th District of Tennessee, has proposed the Anti-Pyramid Bill Federal that aims to clarify the differences between pyramid schemes and legitimate network marketing companies. If you’re connected to the network marketing industry, whether as a distributor, executive, vendor or owner, the importance of this bill (or a modified version of this bill) is vitally important.
The Need for Clarity
As many of my readers know, I have aggressively advocated for almost a decade for the need to create cleaner guidelines in the industry. The “ocean of gray” that has separated legitimate direct selling from pyramid schemes has predictably led to some very serious challenges. As I accurately predicted in my first e-book titled “Saving the industry by defining the gray,” the fuzzy lines that distinguish legitimate and illegitimate network marketing has greatly contributed to today’s problems. In an environment with ample wiggle room, pyramid schemes can operate under the guise of legitimate network marketing. Zeek Rewards, notable ponzi scheme, did this better than all others. The veneer of legitimacy offered by legitimate network marketing allowed Zeek to amass tremendous influence and inflict significant harm. This, in turn, affects the entire profession.
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
Beyond just ringing in a new year, January 1, 2016, also signified the enactment of the Direct Selling Association’s (“DSA”) latest Code of Ethics. Before breaking down the differences that exist between the new and previous versions, my commentary on the subject remains the same: the DSA has a long way to go before providing a Code that offers serious protection for member companies from regulatory issues.
The Code’s prior shortcoming was epitomized by the FTC’s action this past year against Vemma, a longstanding member of the DSA that was touted for exemplifying ethical and appropriate business practices. Vemma went from being a recipient of the DSA’s Ethos Award in 2013 to getting targeted and sued by the FTC.
I’ve said it before and I’ll say it again — to really “tighten the screws,” the DSA needs to take the kind of proactive steps that’s bound to upset some people. This would mean implementing stricter requirements that will cause companies to really stretch, improve and adapt.