In a blunt message to the MLM industry, as well as those companies that offer business opportunities over the internet, in May, 1996, the FTC swooped down upon a relatively unknown newcomer Fortuna Alliance, whose product on its face was a consumer benefit service. A closer look caused the Federal Trade Commission to believe that the company was an illegal pyramid and its lawsuit froze the company's assets, enjoined the company from offering its opportunity, and, through order of the federal court, required the return of cash in foreign bank accounts.
This matter was serious business for the U.S. government. With the assistance of the U.S. Department of Justice, Office of Foreign Litigation, the U.S. government obtained a court order in Antigua freezing company funds that had been transferred to an Antigua offshore bank. In February, 1997, the case was resolved, allowing the company to continue under restrictions, and requiring refunds from both U.S. and foreign accounts. Was this a frontal assault on an MLM-styled company? Yes. Upon the industry? No. Can we learn from this case? Most certainly.
The FTC and the MLM.
The Federal Trade Commission, located in Washington, D.C., is the U.S. government's primary consumer protection agency. It is charged with routing out deceptive trade practices. Over the years, it has a history of going after some "real scams." Sometimes, however, it has worn the cloak of "big brother" intermeddling in the private sector and trying to micro-manage the business affairs of small business and the American consumer. Sometimes, it delivers the message, and sometimes the FTC itself needs to "get the message."
In the 1970s, the FTC defined the playing field for differentiating an MLM from an illegal pyramid scheme. In its earlier cases, the FTC chased after Glen Turner and the Dare to be Great and Koscot programs. Dare to be Great sold high-priced motivational programs and Koscot sold cosmetics. Those cases differentiated MLMs from pyramids by identifying inappropriate conduct, such as inventory loading, buy-ins, high investments, nonrefundable purchases, earnings hype, etc. Of key importance was evidence of the sale of products and services to the "ultimate user." Also significant, was whether or not the product was merely incidental to the selling of an opportunity. Operating under the successes of the Turner case, the FTC was emboldened to chase Amway, a direct assault on the MLM industry. On the table was the question as to whether or not the method of operation of Amway was an illegal pyramid scheme or a legitimate multilevel marketing direct selling company. After years of litigation, an administrative law judge found Amway to be a legitimate multilevel marketing company and not an illegitimate pyramid scheme. Among the factors pointed out were its buyback policy, 70 percent rule and retail customer policies.
There was a resounding message to the FTC that the multilevel marketing method of direct selling can be a very viable and legitimate method of distribution. As a result of Amway's success in that case, every MLM company in existence today has an opportunity in the marketplace.
The Amway case represented the end of the Federal Trade Commission's attack on the structure of MLM programs. No longer did the FTC maintain that the structure of such programs caused them to be pyramid schemes if certain consumer safeguards were met. Instead, the FTC moved on in later years to focus, not on the pyramid structure issue, but on deceptive claims of companies. In most recent years, the most significant action by the FTC was a consent decree entered into with NuSkin regarding the extent of claims that could be made by the company regarding both its products and earnings opportunities. Although no MLM company likes to be in litigation with the Federal Trade Commission, arguing about earnings claims and product claims is a welcome alternative to arguing about structure, i.e. pyramid versus legitimate direct selling.
The FTC Revisits Pyramiding in Fortuna Alliance.
In the Fortuna Alliance case, the FTC reawakened to challenge the basic structure of what appeared to be an MLM program selling consumer benefits services. Unfortunately, when the FTC examined the program more closely, and in particular its early materials that were broadcast on the internet, it was concluded that the company was really involved in selling positions in an opportunity, rather than goods or services. Upon settlement of the case in February, 1997, this is how the FTC's formal press release described the FTC action:
Troubling Indicators for the FTC.
With some frequency, the FTC and state regulators have taken to sweeping the internet for examination of business opportunities offered. Having seen the earliest marketing materials offered by Fortuna Alliance on the internet, it is understandable that the FTC could not turn its back on this MLM. Documentation of early marketing materials filed in court by the FTC indicate the troubling indicators that might cause the FTC to attack the basic structure of the Fortuna Alliance program.
On its face, Fortuna Alliance was selling consumer benefit services. This type of product is not unusual and has been in the MLM industry and actually has been very popular. A number of issues were of concern to the FTC, however, expressed as follows in their court filed documents:
3.Very little if anything was said about retailing the product to the ultimate nonparticipant consumer. Instead, the emphasis was upon the benefits that would accrue through the purchase of a membership. Members were told that, after getting into the program, automatic placement by the company would result in large income to the member with little activity required by the member.
The FTC argued that individuals were encouraged to purchase multiple income centers, spending up to $1750 each to maximize their investment. With respect to each business center, individuals were required to pay $250. An additional $250 per month was to be paid for the membership, although the subsequent payments were to come from earnings commissions of the member. Assuming that the consumer benefits membership was the product of the company, it is difficult to ascertain (1) why an individual would buy more than one consumer benefits membership, (2) why such consumer benefits services could be worth $250 per month, and (3) the FTC was very troubled by transfers of over $3 million to a bank in the West Indies with a reputation for hiding assets under assumed names. In addition, the company promoted programs to educate its members on establishment of offshore bank accounts.
Lessons to be Learned.
Although the facts of Fortuna Alliance stand on their own, the message is that the FTC will still examine the structure of MLM programs as to whether or not they are a pyramid versus legitimate direct selling. It does appear that the FTC is done with the basic attack on the structure of MLM organizations, and is instead looking for deceptive practices and claims that can turn MLM organizations into pyramids, however. After Fortuna Alliance, what should MLM companies keep in mind:
An Ambiguity of Concern.
In its final settlement, which does allow Fortuna Alliance to proceed forward after payment of refunds, some ambiguous wording may create problems for other consumer benefits programs in the MLM industry. In the final settlement, Fortuna Alliance is permitted to pay commissions on the sale of goods and services, but it is strictly prohibited from paying commissions on membership fees or dues. On its face, this would appear to be a prohibition to MLM companies selling consumer benefits programs to pay commissions on their membership fees or dues. Does this mean that a company such as Amway, which may sell a travel club, may not pay commissions on the travel club membership fees or dues? This does not appear to make sense from a business standpoint. Membership fees and dues of a consumer benefit service are in fact the payment that consumers pay for those services. It would appear that the FTC was speaking more in the context of the Fortuna Alliance situation in which a "membership" represented the purchase of a business center, which entitled individuals to receive both services and the right to earn money in the compensation plan. This interpretation would be very acceptable to the direct selling industry. Nevertheless, some ambiguity remains because of the language prohibiting "payment of commissions on membership dues or fees" that may create a cloud of uncertainty for MLM companies selling discount buying packages, consumer benefits packages and travel club packages in which the commissions are paid on "consumer membership fees." Hopefully, this uncertainty or ambiguity will not become an ongoing problem for the industry.
The Fortuna Alliance case is the most sweeping FTC action in years regarding the operation of an MLM company. Both MLM companies and their distributors should pay attention to the case, and learn from it.
|Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
|Jeffrey A. Babener, the principal attorney in the
Portland, Oregon law firm of Babener & Associates, represents many of the leading
direct selling companies in the United States and abroad.
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