Network marketing companies have special compliance challenge, expert says

Multilevel marketing, also known as network marketing (the term many of these companies themselves prefer) has become a major distribution channel for dietary supplements. One estimate in 2015 sized the sector at a $4.4 billion-sized slice of the $36 billion US dietary supplement market pie​.  And globally the sector is even bigger, with the biggest company that focuses solely on nutritional products, Herbalife, having reported $4.5 billion in revenue in 2015 (Herbalife operates in more than 90 countries). New MLMs crop up every year and others die, but recent estimates show that at least 60 companies are at present selling supplements in this mode in the US market.

Built-in compliance challenge​

So what happens within this sometimes opaque sphere matters. MLMs often cultivate a messianic fervor among their distributors, and urge supporters to pay attention to information that comes from the company, not from outside sources, some of whom, like friends and family, might question the amount of effort an individual distributor is putting into the business. 

Kevin Thompson, a Franklin, TN-based attorney, has a special insight into the sector. Thompson, a partner in the firm Thompson Burton, bills himself as the ‘MLM Attorney,’ specializing in helping multilevel marketing companies with their legal issues. Thompson spoke with NutraIngredients-USA on how the one-on-one enthusiasm inherent in the multi level marketing model creates a built-in compliance challenge for these companies.

“There is a higher level of risk when working with independent contractors. Not only does a company have to control its own messaging, it has an obligation to educate its contractors to color within the lines,”​ Thompson said.

The wide variety of MLMs in the supplement business means a wide variety of compliance efforts too, Thompson said. The sector ranges from the Amways, Herbalifes and Usanas of the world (Usana is closing in on $1 billion in annual revenue) that offer many different products down to recent MLM startups focusing on a limited product assortment or maybe just a single product aimed at a specific condition. 

“It’s not uncommon to see cash-strapped network marketing companies that are neglecting the compliance effort,”​ Thompson said.

The primary risk for noncompliant messaging arises from the zeal of individual distributors, Thompson said. Some of the most active of these have had what they consider to be good results with the products they are selling, and have a hard time understanding why it's inappropriate in some cases for them to share those experiences in a sales pitch. Many of these testimonials can trend over into illegal disease claims.

“They think, my arthritis was bad, and now it’s better. Why can’t I share that story?” ​Thompson said.

Pyramid scheme allegations​

The sector has come under the spotlight in recent years mostly from the efforts of a single activist investor, Bill Ackman.  In 2013 Ackman, through his investment firm Pershing Square, took a huge short position in Herbalife stock that has been valued at up to $1 billion and embarked on an unprecedented public information campaign that attacked Herbalife as being an illegal pyramid scheme, making illegal claims on products and preying upon what he characterized as vulnerable minority communities.

Ackman’s campaign energized a whole cadre of online investment commentators who started sharing doom and gloom stories about the legality of the practices of a number of MLMs, not just Herbalife. In 2014 FTC announced (perhaps not coincidentally) it was investigating Herbalife’s business practices.  A settlement of that case has been reported in the press, though neither Herbalife nor FTC has commented officially yet. Thompson said that while this was a painful episode for the MLM industry, there was a silver lining. 

“I think recent regulatory activities are starting to scare some companies straight,”​ Thompson said. 

FTC has never provided details of its Herbalife investigation, other than to confirm it was taking place, but it was widely believed that it focused on whether the company’s business model constituted an illegal pyramid scheme. The key point is to what degree an MLM company rewards participants for sales of products and services to people outside the network, as opposed to primarily incentivizing recruitment of new distributors. This is harder to parse out than one might think, and Thompson said this points to the need for a more definitive regulatory line in the sand on this issue.  The FTC ruling in 2014 in the BurnLounge case (an MLM that purported to sell music downloads) provides some guidance, but an actual rule or statute would be an improvement, he said. A new bill introduced in the US Congress by Tennessee GOP Rep. Marsha Blackburn aims to make this definition clearer, Thompson said.

“Since 2014 we have a better idea of what constitutes a pyramid scheme. The gray area has shrunk to some degree, but it still needs to be better defined. It is causing problems on both sides, for regulators and for companies that want to do things right,”​ he said.