The Most Important Lessons in MLM Legal History: Avoiding the Accidental Pyramid Classification

How to prevent your company’s downfall by learning from the past

“Those who neglect history are doomed to repeat it”
George Santayana.

Despite our familiarity with these wise words, I’ve come to find we don’t take them to heart when it comes to MLM legal history. In fact, we continue to face similar legal battles year after year.

The average MLM executive and field leader are not aware of the game-changing cases or the impact on their companies. As a leader in your MLM company, you’re so focused on the day-to-day operations of your fast growth. Yet, if you miss out on the lessons of MLM history, you’ll fall into a similar legal quagmire.

Ultimately, your understanding and compliance determine whether you remain a true, legal MLM company or inadvertently fit the definition of a pyramid. The FTC and federal courts consider two key areas to differentiate: compensation and operation.

MLM Legal Compensation

The FTC defines compensation clearly: any company must generate more than 50% of their revenues and more than 50% of distributor compensation from sales to customers. Failing to do so will put the company at risk for attack by regulators.

Beginning in 1996 with Webster v Omnitrition, the federal courts and the FTC made their point about the pre-eminence of customer sales loud and clear:

“The key to any anti-pyramiding rule in a program like Omnitrition’s, where the basic structure serves to reward recruitment more than retailing, is that the [compensation plan eligibility requirements] must serve to tie recruitment bonuses to actual retail sales in some way.”

The US District Court then repeated the same statement in 2015 in FTC v Vemma. It stated Vemma would be “preliminarily restrained and enjoined from…[paying] any compensation related to the purchase or sale of goods or services unless the majority of such compensation is derived from sales to or purchases by persons who are not members of the marketing program.

Had Vemma learned from the Omnitrition case, it might have been able to avoid both litigation and ultimately closing its doors.

And yet, even after those two cases, companies still failed to heed the lessons. Consequently history repeated itself with FTC v. Herbalife in 2016.

Herbalife not only had to insure at least two-thirds of a distributor’s compensable volume came from sales to customers, but it had to pay $200 million for equitable monetary relief. The Herbalife company also agreed to sweeping changes in its compensation plan, and was forced to implement an FTC mandated compliance training program for all of its distributors.

What can we learn from these cases?

  • An MLM legal compensation program must derive the majority of revenues from sales to customers. The only true definition of business is creating a customer. Regulators and courts define a customer as a purchaser who is not a participant in your compensation program. Make sure: (1) your business model contemplates the two discrete categories of customers and distributors; and (2) you are compensating your distributors so they are rewarded in material and significant ways for selling to customers, not simply building their team.
  • If your company does not derive the majority of sales revenues and distributor compensation from customer sales, it is at risk for a regulatory challenge. Too often, the change to the compensation plan is too late and the company is forced out of business.

Read more about creating the Best MLM Compensation Plan here.

MLM Legal Operations

While the compensation plan is important, it isn’t the only element that is scrutinized by regulators and courts. This is a lesson learned from FTC v BurnLounge in 2014.

In addition to paying rewards for recruitment as opposed to customer sales, BurnLounge’s entire operational structure proved problematic in a variety of areas.

  • The value of the company’s products.
  • The operational realities.
  • Who is buying what and how much?
  • The products and services cannot be a sham or smoke screen for a “pay-to-play” scheme.
  • Some sales to non-distributors (customers) are not enough.
  • Required purchases for distributors.
  • Compensation plan rules to promote retail sales.
  • Meaningful opportunities for retail sales.

And if these issues weren’t enough, the FTC also made a point to highlight two additional problems which have proven to be the perennial low-hanging fruit for MLM investigations:

  • Deceptive income claims
  • Lack of adequate substantiation for product claims

By the time the courts were finished with BurnLounge, it ceased to exist.

In addition to the BurnLounge metrics, some additional “operational realities” about which the FTC has complained or a court has found problematic include:

  • Overemphasized distributor auto-ship participation.
  • Awarded a lower amount of PV/BV on customer purchases vs. distributor purchases.
  • Required a high personal volume and failed to track sales to end consumers.
  • Failed to enforce anti-inventory loading safeguards such as the 70% rule and 10 Customer Rule.
  • Lacked adequate refund and buy-back policies.
  • Lacked regulatory compliance training for distributors.

What can we learn from this case?

  • How an MLM operates serves as the ultimate determiner of its legality. The first Burn Lounge factor, value of the company’s products or services, drive many of the other operational realities. And of course, value is the only reason customers will purchase your products or services. No value = No customers = You are living on borrowed time. Nevertheless, you should diligently focus on each of the bullet points above. You must be proactive in your compliance efforts. Make every effort to ensure your sales language and distributor training is legally sound. We recommend using compliance software to find and reconcile potential pitfalls.

  • MLMs must take a holistic approach to evaluating their operations. Closely examine elements such as income claims, auto-ship orders, product claims, product packs and fast start bonuses. If the majority of your sales are not made to customers, you probably need to adjust your pricing and your compensation plan.

Be the Company That Gets it Right

For your company to thrive, you need to do more than know your MLM history—you need to be willing to adjust your paradigms and practices accordingly.

If you remain compliant, when a problem arises, you’ll be protected. But, if you keep pushing for growth and hope for the best, you can find yourself facing legal battles.

You have your hands full scaling your company. If staying up until the wee hours of the night trying to make sense of 20+ years of legal briefs sounds less enjoyable than being chased by a shark, let us help you.

At Thompson Burton, we’ve spent the past 27 years representing more than 1,000 MLM companies. We know what’s happening in the courtrooms.

We’ll help you take a comprehensive look at your compliance in a variety of areas, including:

  • Corporate resources
  • Website
  • Videos
  • Promotional materials
  • Distributor compliance (including training, monitoring, and correcting)

Let us help you learn from companies who have refused to learn from past mistakes. Visit our website to see how we can help you stay selling on solid legal ground.