House bill could finally end pyramid scheme charges leveled at MLMs

By Hank Schultz

- Last updated on GMT

House bill could finally end pyramid scheme charges leveled at MLMs

Related tags Pyramid scheme Multi-level marketing

A bill now before the US House of Representatives that seeks to clarify the boundaries of Multi Level Marketing operations is imperfect but better than the status quo, said an attorney familiar with the sector.

Ever bigger chunk of the dietary supplement industry

Multi Level Marketing operations (MLMs), otherwise known as network marketing or direct selling, have become an ever more important way in which dietary supplements are sold. Some of the biggest companies in the dietary supplement industry, notably Amway, Herbalife, Usana and Advocare, sell their products in this way. According to the industry trade magazine Direct Selling News, Amway is far and away the global leader in MLMs, with 2017 revenue estimated at $8.8 billion. Amway sells a variety of consumer goods beyond supplements, but the other three are devoted almost exclusively to nutritional products, including dietary supplements, functional foods and to some degree personal care items. Herbalife was ranked No. 3 on DSN’s 2017 Global 100 list, with an estimated $4.5 billion in revenue. Usana was ranked No. 10 at $1 billion, and Advocare came in at No. 20 with $586 million.

The questions around the legality of MLMs sharpened with the unprecedented $200 million fine that Herbalife paid to the US Federal Trade Commission in 2016​ to settle claims that it was a pyramid scheme and not a true MLM.  The company also agreed to make changes in how it compensated its distributors and agreed to tighter accounting practices that would keep better track of the amount of its products actually ended up in the hands of and were consumed by end users, as opposed to the amount of product shipped to distributors. In the wake of that settlement, other MLMs such as Usana undertook their own accounting and compensation plan overhauls without waiting to be prodded by FTC.

A bill was introduced in July by Rep. Marsha Blackburn (R-TN) that aims to better outline the boundaries of what is a true MLM and what is a pyramid scheme ​and to settle this debate once and for all. A staffer in Blackburn’s office said Blackburn is still actively trying to line up backers for the bill. Blackburn’s bill, called the Anti-Pyramid Promotional Scheme Act of 2017, closely mirrors similar statutes that have already been passed in 21 states.

Who is the true end user?

The definition of what’s an MLM and what’s a pyramid scheme has to do with how participants are rewarded. Is the aim of the organization to allow independent distributors to set up their own sales operations to market products to consumers and are then compensated based on sales? Or are they primarily rewarded for signing up new distributors? Other complicating factors are the degree to which an MLM might require purchases by new distributors (which could run into hundreds of dollars) and whether unsold inventory can be returned.

Kevin Thompson, founder of the Nashville, TN-based law firm Thompson Burton​, has developed a practice advising MLMs. Thompson applauded Blackburn’s effort, even as he took issue with some of the bill’s specifics. Companies that seek to play at the blurred edge of what’s considered legitimate cast a shadow over the entire industry, he said.

“When pyramid schemes dance in the gray and masquerade as legitimate network marketing companies, it harms the entire profession. By shrinking the gray, scams would be less inclined to launch and the government could more easily pop the bubbles. While it sounds simple, the idea of ‘shrinking the gray forces us to define EXACTLY where the line needs to be drawn that separates good companies from bad,​ Thompson said.

Let’s start with definitions. Blackburn’s bill defines a pyramid scheme as a plan that rewards people for recruiting other individuals “[R]ather than primarily related to the sale of products or services to ultimate users.​ So far, so good. But who qualifies as an ‘ultimate user?’  Thompson’s bill lays it out this way: An ‘ultimate user’ is defined as someone who buys products “[F]or personal use, consumption, or resale so long as the plan or operation does not require inventory loading and the plan or operation implements a bona fide inventory repurchase agreement.

FTC has muddied the waters

Thompson said in his view Blackburn’s bill has been motivated in part by confusion generated by successive FTC decisions, and litigation that has arisen from those rulings. The agency has at certain times ruled that at least 50% of the sales of an MLM had to go to consumers who were not associated with the company as distributors. Critics, and some court rulings, have shot holes through that boundary as being one that cannot be found in any statute.

On the other hand, critics of Blackburn’s bill wrote a letter ​addressed to Reps. Paul Ryan and Rep. Nancy Pelosi. They said Blackburn’s bill removes any sort of requirement for any sales to end users who are not signed up as distributors.

Thompson, for his part, said a few compromises might move the bill foward. For example, he believes that a key modification might be in order. “I offer a suggestion that makes the bill more palatable for critics: Prohibit companies from having monthly personal volume requirements...the general practice of distributors subscribing to autoship as a way to qualify for commissions (ordering the bare minimum of inventory) leaves companies vulnerable,​ he said.

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