The Federal Trade Commission enforces a variety of laws and regulations relating to advertising, marketing, sales, billing, privacy, data security, franchises and business opportunities, among other topics, that apply or may apply to MLMs.
Agency staff as recently released business guidance to help multi-level marketers understand and comply with the law.
Direct selling is a “blanket term” that encompasses a variety of business forms premised on person-to-person selling in locations other than a retail establishment, such as social media platforms or the home of the salesperson or prospective customer. Multi-level marketing is one form of direct selling.
Generally, a multi-level marketer distributes products or services through a network of salespeople who are not employees of the company and do not receive a salary or wage. Instead, members of the company’s salesforce usually are treated as independent contractors, who may earn income depending on their own revenues and expenses. Typically, the company does not directly recruit its salesforce, but relies upon its existing salespeople to recruit additional salespeople, which creates multiple levels of “distributors” or “participants” organized in “downlines.” A participant’s “downline” is the network of his or her recruits, and recruits of those recruits, and so on.
Under Section 5 of the FTC Act, an unlawful MLM structure is generally characterized by the payment by participants of money to the company in return for which they receive: (i) the right to sell a product; and (ii) the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users.
According to the FTC, an MLM compensation structure that incentivizes participants to buy product, and to recruit additional participants to buy product, to advance in the marketing program rather than in response to consumer demand in the marketplace, poses particular risks of injury because a participant is unlikely to be able to earn money or recover his/her costs through selling product to the public. In such circumstances, the FTC states, participants will often attempt to recruit new participants who will buy product, and pressure existing recruits to buy product, with little concern for consumer demand.
“Where an MLM has a compensation structure in which participants’ purchases are driven by the aspiration to earn compensation based on other participants’ purchases rather than demand by ultimate users, a substantial percentage of participants will lose money.”
The FTC distinguishes between MLMs with lawful and unlawful compensation structures by focusing on how the structure as a whole operates in practice, and considers factors including marketing representations, participant experiences, the compensation plan and the incentives that the compensation structure creates.
The FTC also discussed how it treats personal consumption by participants in determining if an MLM’s compensation structure is unfair or deceptive, the concept of “inventory loading,” whether the FTC Act requires MLMs to retain sales receipts and whether MLMs are subject to the FTC’s Business Opportunity Rule.
In many areas, the FTC undertakes case-by-case law enforcement, which can offer significant benefits when compared with prescriptive rulemaking or legislative action. “Orders obtained through settlements of FTC law enforcement actions are not binding on the entire industry. Such orders, however, can be useful to MLMs that are not bound by them. Industry members may choose voluntarily to follow the provisions in these orders or to consider the provisions in developing their own practices and procedures. All industry members have an obligation to follow the law, and the provisions in FTC orders may provide guidance and insights to help them do so.”
An MLM’s representations and messaging concerning the business opportunity it offers must be truthful and non-misleading to avoid being deceptive under Section 5 of the FTC Act. An MLM’s representations about its business opportunity, including earnings claims, violate Section 5 of the FTC Act if they are materially false, misleading or unsubstantiated.
A company must have a reasonable basis for the claims it makes or disseminates to current or prospective participants about its business opportunity. A “reasonable basis” means objective evidence that supports the claim. If a company lacks such objective supporting evidence, the claims are likely deceptive.
An MLM’s compensation structure may give its participants incentives to make representations about the business opportunity to current or prospective participants. As a consequence, the FTC states that an MLM should: (i) direct its participants not to make false, misleading or unsubstantiated representations; and (ii) monitor its participants so they do not make false, misleading or unsubstantiated representations.
An MLM’s compliance program should “ensure that the MLM accurately represents the business opportunity it offers, both through its own marketing materials and messaging and through the representations its participants make to current or prospective participants.” In addition, an MLM’s compliance program should “ensure that compensation paid by the MLM is based on actual sales to real customers, rather than based on wholesale purchases or other payments by its participants.”
The FTC’s business guidance document can be seen, here. It focuses specifically on MLM practices that may violate the FTC Act. It does not address other types of unlawful structures that do not involve the right to sell a product or service, such as chain referral schemes and Ponzi schemes.
Contact an FTC defense lawyer if you are interested in discussing Twitter’s Country Withheld Content tool.
Richard B. Newman is an Internet marketing compliance and regulatory defense attorney at Hinch Newman LLP focusing on advertising and digital media matters. His practice includes conducting legal compliance reviews of advertising campaigns, representing clients in investigations and enforcement actions brought by the Federal Trade Commission and state Attorneys General, commercial litigation, advising clients on promotional marketing programs, and negotiating and drafting legal agreements.
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