What Does The DSA Have To Say About The FTC Claiming VEMMA Is A Pyramid?

Direct Selling Association Preliminary Analysis - Federal Trade Commission Action against Vemma Nutrition Company

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John W. Webb, Associate Legal Counsel & Senior Director, Government Relations of the Direct Selling Association wrote the following preliminary analysis on the FTC .vs Vemma pyramid allegations. 

As some of you may have heard, earlier today, the Federal Trade Commission (FTC) announced action against Vemma Nutrition Company (Vemma). Direct Selling Association has included a brief preliminary analysis of the key documents from the case below. We will continue to monitor and evaluate the matter going forward.  There was initial concern that the practice of auto-shipping was being called into question and forming the basis for this cause of action. However, in our analysis of the action, the FTC does not appear to call these practices into question. In the action against Vemma, auto-shipping is only considered in the context of continuing payments to maintain eligibility for participation in the compensation plan. 

ftcThere is also a discussion by the FTC about the effectiveness of certain protections designed to prevent inventory loading and pyramid schemes. The action specifically mentions the 70% rule and product buyback policies. The FTC states that the 70% rule can limit the application of the buyback policy by excluding substantial amounts of product from being covered. The FTC criticizes the effectiveness of the buyback when substantial shipping costs are borne by the distributor.

Background

On August 24, the FTC served Vemma with a complaint and temporary restraining order with asset freeze and appointment of a receiver. The action was filed in the United States District Court for the District of Arizona, Case No. 2:15-cv-01578-JJT. The FTC charged Vemma with: 1) a pyramid scheme under Section 5(a) of the FTC Act, 15 USC § 45(a), 2) false and misleading income claims and, 3) failure to disclose, or disclose adequately income of distributors.

Legal Analysis

The FTC complaint focuses on Vemma’s compensation plan and inadequate income claims. To become an active Vemma Affiliate, a consumer must either purchase a $600 Affiliate Pack or personally enroll a Customer or Affiliate. The FTC urges that the “requirement that participants pay money for the right to sell products need not be in the form of mandatory join or renewal fees.  Instead, it can be met where participants are required to purchase inventory in order to receive the full benefits of the program.”  The FTC also alleges that in “practice Affiliates must purchase an Affiliate Pack to earn full rewards under the comp plan, and Affiliates are strongly encouraged to purchase Vemma products each month to maintain eligibility for bonuses.” 

Additionally, in order to remain qualified and be fully eligible for financial compensation, the Affiliate must either purchase a minimum of 120 points in personal volume a month (roughly $160-$171), or have customers that qualify the distributor with purchases of 240 points.  The FTC also alleged that Vemma affiliates were highly encouraged to sign up for a $160-$171 month auto-delivery to maintain eligibility for bonuses. Vemma gave higher rewards if those Affiliates recruited an individual who purchased an Affiliate Pack and signed up for a monthly-auto delivery order: “In practice Affiliates must purchase an Affiliate Pack to earn full rewards under the comp plan, and Affiliates are strongly encouraged to purchase Vemma products each month to maintain eligibility for bonuses.”

Pyramid Standard

For Vemma’s operations, the FTC applied the two-prong test in Koscot Interplanetary Inc, 86 F.T.C. 11106 (1975). Under this test, pyramid schemes are “characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product, and (2) the right to receive in return for recruiting other participants into the program rewards for which are unrelated to the sale of product to ultimate users.” The FTC indicates that the purchases of the Affiliates were not to ultimate users and that clearly, “the opportunity to earn cash rewards is the primary purpose of Affiliate purchases-the drinks contained in the product packs are merely incidental.”

The Right to Sell A Product

The FTC alleges that Vemma met the first prong because participants were “required to purchase an Affiliate Pack to earn full rewards under the compensation plan, and Affiliates are strongly encouraged to enroll in the monthly auto-ship program to maintain eligibility for bonuses.” These instructions came directly from the company. 

The Right to Receive in Return for Recruiting Other Participants

The FTC alleges that Vemma satisfied the second Koscot prong by claiming there was “clear emphasis on the program and the opportunity to achieve financial freedom through recruitment and enrollment of others.” Additionally, “when Affiliates earn compensation from Affiliate Pack purchases of their downlines, they are receiving compensation for recruitment by default.” The FTC asserts this provides little incentive to seek retail sales. 

Inadequate Anti-Pyramid Safeguards

The FTC claims that Vemma pays “lip service” to two anti-pyramid scheme rules as delineated In re Amway Corp, 93 FTC 618, 716, which deemed the following anti-pyramiding policies effective:

  • A requirement that distributors sell or consume at least 70% of the products bought in a given month before reordering products.
  • A requirement that the company buy back from any distributor any unused, marketable products if they decide to leave the business (buyback rule);

As made clear in Webster v. Omnitrition, Inc. 79 F.3d. 776 “these safeguards are not one size fits all, but were found to be effective in Amway as a matter of fact, not of law.” Additionally, “there must be evidence that these safeguards are enforced and actually serve to deter inventory loading and encourage retail sales.” The FTC claims Vemma inadequately attempted to employ two of these safeguards.

Inadequate 70% Rule

The FTC alleges “Vemma’s 70% safeguard is insufficient to deter inventory loading or to encourage retail sales.” Saying the policy is inadequate because Vemma simply states in its Affiliate agreement that placement of a new order is the Affiliate’s certification that 70% of products previously purchased were sold to end consumers. The FTC alleged this policy is inadequate because it is dependent on “self-verification and there are no explicit sanctions for violation.”

Ineffective Buy-Back rule

Vemma’s return policies state that consumers may return unused products within 30 days, but must pay shipping costs incurred on both the order and return. The policy also states that affiliates may return marketable product within one year of purchase, less all shipping costs in both receiving and returning.

However, the FTC indicates that the “high costs of shipping are typically significant because of the weight of the products.” Additionally, “if Affiliates incur months of auto-delivery orders, they may not even attempt a return for previous orders given Vemma’s 70% rule, which states that Vemma will not issue refunds for products certified as consumed by end consumers. The FTC alleged that by crafting the policy this way Vemma appears to only reserve the right to refund 30%.”

Inadequate Income Disclosures

The FTC also alleges that Vemma made inadequate disclosures when making income claims, resulting in an action for deceptive and misleading practices. In recorded presentations making disclosures that “results may vary” was typically in small white print, or did not appear at all. Additionally, if Affiliates made the income disclaimer during an oral presentation, “they quickly followed with a statement that diluted it” such as encouraging people to become Affiliates through pressure tactics. The FTC asserts these claims are deceptive and misleading because consumers may reasonably believe that the statements of earnings potential represent typical or average earnings.

Misleading Income Disclosure Statements

Lastly, the FTC alleges that Vemma “did not adequately disclose that Vemma’s structure ensures that most consumers who become Vemma affiliates will not earn substantial income is a material omission similar to the failure to disclose the true nature or service of a product.” The FTC asserts that by failing to adequately contextualize information contained in the disclosure statements, Vemma’s activity and omissions constitute a violation of Section 5.

Income disclosure statements released by Vemma only included Affiliates “who met certain minimum purchase thresholds. Omitting Affiliates who fared worse, for example, those who purchased an Affiliate Pack but were unsuccessful in recruiting others.”

Conclusion

After a preliminary review of this complaint and supporting documents, DSA believes the FTC has not changed or altered their pyramid review analysis.  Additionally, legal precedent prosecuting pyramid schemes and identifying unfair and deceptive practices appears to have remained unchanged. Although a part of the FTC’s analysis is tied to Vemma’s auto-ship program, it should not be viewed in a vacuum. At this point in time, there is no indication that auto-ship is problematic in and of itself, but merely can be problematic if it is tied to continuing purchases to maintain eligibility for full participation in the compensation plan. DSA will continue to analyze the complaint in this regard.

Joseph N. Mariano, DSA President also addressed the Federal Trade Commissions actions against Vemma twice this week.

First was on August 24th, the day the FTC hit the Vemma offices, stating:

“Earlier today, the Federal Trade Commission (FTC) announced action against Vemma Nutrition Company alleging violations of federal law, which, if true, would also constitute violations of DSA’s Code of Ethics.

Every member of our Association, including Vemma, is required to abide by our Code as a condition of membership. All companies which use the direct selling model must uphold the highest ethical business standards, including polices that protect consumers and members of the salesforce against unrealistic earnings, lifestyle and product claims.

The Code’s independent administrator will be alerted to the action and will review the FTC’s allegations against Vemma. If they are proven to have merit, the administrator may pursue punitive measures to ensure that appropriate standards of consumer protection are enforced.

The allegations against Vemma have yet to be proven, and the company is entitled to due process of law. Any consumers or salespeople who have concerns regarding any DSA member, including Vemma, should contact the Code Administrator.”

joe.web_-300x225After Mr. Webb’s Alaysis, Mr. Mariano followed up with the following:

You may have heard that on August 24, the Federal Trade Commission (FTC) served Vemma Nutrition Company (Vemma) with a complaint and a temporary restraining order with asset freeze and appointment of a receiver. The action was filed in the United States District Court for the District of Arizona, Case No. 2:15-cv-01578-JJT. The FTC charged Vemma with: 1) a pyramid scheme under Section 5(a) of the FTC Act, 15 USC § 45(a), 2) false and misleading income claims and, 3) failure to disclose, or disclose adequately income of distributors. Vemma is a member of the Direct Selling Association.

It is important to note that while these allegations are serious, they are not proven, and the company is entitled to due process under the law, and indeed under the DSA Code of Ethics.

Some observers on social and other media have speculated about certain aspects of the action and its possible implications for other companies. DSA has begun a thorough review of the action against the company and will report to our General Counsel Committee about the potential implications of the case, if any, for other direct selling companies. I anticipate there will be continuing discussion about the facts of the case, as well as the legal theories for the action, as the matter progresses.

DSA’s preliminary review of the complaint filed by the FTC does not support most of that speculation mentioned above, and suggests rather that the FTC has not changed or altered its general pyramid review analysis. While an aspect of the FTC complaint describes potential alleged abuse of the company’s auto-ship program, there is no indication that auto-ship is problematic in and of itself. The complaint suggests that the company’s auto-ship program was instead tied to continuing purchases to maintain eligibility for full participation in the compensation plan, and alleged that compensation was tied only to recruitment and not actual product sales. Accordingly, the FTC alleges that auto-ship was abused in this case. DSA will continue to analyze the complaint in this regard. Additionally, the complaint focuses on the purported ineffectiveness of certain company anti-pyramid protections, including alleged limitations on the inventory repurchase policy as enforced by the company.

DSA, through its General Counsel Committee, Lawyers Council, and outside counsel will continue to analyze the implications of the allegations and conclusions in this case. We will continue to monitor procedural developments and report as appropriate. As always, DSA will work to protect the direct selling business model through our regulatory, legislative, judicial and public education and advocacy efforts, and through rigorous enforcement of our Code of Ethics.

What concerns me with Mr. Mariano’s memo above is the fact nowhere does he address the fact the DSA may be partially responsible for the FTC’s action against VEMMA!

Now you may wonder why I come to a conclusion that the DSA must take partial responsibility, and it’s due to the fact that Mr. Mariano never states “we talked to Vemma executives, or BK Boreyko personally about any of the FTC’s allegations prior to the August 24th TRO.

If, as the DSA Legal Analysis states, the “FTC has not changed or altered its general pyramid review analysis” then one could come to the conclusion that the Direct Selling Association, did not review a member company, nor enforce the DSA Code of Ethics against the member company.

What good is a Code of Ethics, if the governing body which created the COE, doesn’t enforce it?

As a matter of fact, exactly what good is a governing body of members, if the purported actions of one member open all the other members up for regulatory scrutiny?

I suggest the following, for ANY regulatory body… DSA, ANMP, MLMIA, or whoever the next so-called association to launch calls themselves.

Either enforce the current Code Of Ethics or meet with the FTC, SEC, FDA and State AGs and create a set of ethics, that these regulatory bodies approve and ENFORCE THEM! What good is pretending to care, if we allow members to go down?

Collecting membership fees just to hold events, travel on “lobbying” trips, and feel like a secret club, isn’t going to work much longer. When the members are all gone, then as Donald Trump would say… You’re Fired!

Get with the Direct Selling attorneys who are actually practicing MLM law in the trenches, as well as working with the regulators to create a Federal Bill, as well as distributor minded legal eagles to be presented to Congress, that will take the mystery out of “What’s a legit direct selling company!” 

If we want to create legislation that will benefit everyone from the consumer to the government, then we need everyone to participate and collaborate together. We have to stop pussyfooting around trying to keep from creating loopholes and legal language which leaves way too large of a gap for legal interpretation.

Accept the reality that the backbone of the Direct Sales/Network Marketing/MLM channel is recruiting customers to buy product, and/or recruiting salespeople to recruit more customers and more salespeople, who then do the same. Design the above regulations around this fact and get Congress to pass the Bill into Law! 

I am all for self-regulation, but it is very clear to me, that from the current associations to the company owners and independent field forces, most do not want to hold each other accountable!

I am not propagating recruiting just to funnel a compensation structure. I am talking about recruiting to grow a company through the growth and management of a large sales and distribution funnel we call Direct Sales/Network Marketing/MLM.

Troy Dooly is recognized internationally as an influencer in the areas of personal branding, leadership development, marketing campaigns, organizational expansion, and corporate launch strategies. Dooly is a speaker, results coach, and radio host. He is a founding member, show host (Beachside CEO) and News Director of the Home Business Radio Network. He is a founding member, and currently serves on the Board of the Association of Network Marketing Professionals