Proposed Federal MLM Statute -
Personal Use: "OK"

By Jeffrey A. Babener
©  2003

Look, If you had one shot, one opportunity
To seize everything you ever wanted-One moment
Would you capture it or just let it slip?

Eminem – “Lose Yourself”

Seeking Relief from Cloud of Uncertainty

The Direct Sales Industry has patiently survived almost a decade of regulatory tension on an issue critical to the MLM business model — the legitimacy of “personal use” by distributors. Uncertainty on this point has resulted in unwanted FTC and state consent decrees and attacks on MLM companies that place a cloud over the direct selling industry. New proposed federal legislation, H.R. 1220, would formally recognize legitimacy of “personal use” along side of retail sales outside the network, and bring relief to network marketing.

The issue has arisen in the context of examination as to whether a network marketing company is a legitimate business opportunity or an illegitimate pyramid headhunting recruiting scheme. Analysis in MLM law cases has often looked to evidence of sales to and use by the ultimate consumer. Should personal use of a company’s product by distributors be viewed with the same weight as sales to those outside the sales network? Many of the leading direct selling companies offer consumable products and a substantial portion of product sold is in fact used by distributors. Is this legitimate?

Industry advocates, led by the DSA, say “yes,” personal use should receive the same weight as nonparticipant sales. The FTC says “no,” taking the position that more than fifty percent of product must be sold outside the network for the program to stay clear of pyramid accusations. The industry has been unsuccessful in convincing the FTC to change its position, although it has achieved such recognition in multiple states and the DSA has amended its Code of Ethics to recognize personal use. Although the FTC has focused scrutiny on companies “on the edge,” the rest of the industry has been left quite uncomfortable.

The FTC History

The FTC made its first full-scale assault on the MLM model, accusing Amway of being an illegal pyramid scheme, and thus, a "deceptive trade practice" under FTC federal legislation. From 1975 to 1979, the FTC and Amway were engaged in litigation, climaxing with a historic loss of the FTC in 1979. In a landmark administrative law decision, an FTC administrative law judge ruled that Amway was a legitimate business opportunity as opposed to an illegal pyramid scheme based on three primary consumer safeguards: (1) a reasonable buyback policy for terminating distributors; (2) the 70% rule, which prohibited purchases of new inventory before old inventory had been sold or used; and (3) the ten retail customer rule, which required sales to ten customers. (Interestingly today, the Amway 70% Rule defines a retail customer to include purchases for personal or family use, or sales to nonparticipants).

The FTC v. Amway case became known for its "Amway safeguards," the general rules honored by courts, legislators and enforcement agencies to uphold legitimacy of MLM type organizations. The FTC was quiet on this subject for the next 20 years.

In the aftermath of odd language in a civil case against an MLM company, Omnitrition, in 1994, the FTC began a new assault. In the Omnitrition case, the U.S. Court of Appeals for the Ninth Circuit in language known in legal circles as "dicta," i.e., language unnecessary to the ruling in the case, challenged the concept of personal use by MLM distributors as not fulfilling the mandates for retail sales in evaluating pyramid schemes versus legitimate direct selling. A new generation of FTC officials were emboldened to revisit the legitimacy of the MLM model.

From 1996 through and into the new millennium, in a series of FTC filings involving such companies as Fortuna Alliance, World Class Network, JewelWay, Futurenet, Equinox and 2Xtreme, in a step-by-step and case-by-case assault, the FTC challenged the MLM model and the Amway safeguards.

1. In the early cases, the FTC questioned whether or not the Amway safeguards of promoting legitimate sales were protected when a company demonstrated strong personal use by participants.
    
2. Next, the FTC argued that legality was determined by compliance with the Amway safeguards, plus sales greater than 50% of revenue to nonparticipant users.
    
3. In a 1999 filing against 2Xtreme, the FTC finally evolved to its position that the Amway safeguards were really irrelevant altogether. The key issue for the FTC was that sales to nonparticipants must exceed 50%, and constitute the majority of revenue for the MLM.
    
4. In addition, in the 2Xtreme case, the FTC challenged autoship programs by consumable MLM companies as evidence of a pyramid scheme. Many leading direct selling companies have autoship programs for the convenience of their distributors.
    
5. The FTC also used the 2Xtreme case to challenge the standard of business utilized by virtually all direct selling companies, namely minimum monthly purchase or activity requirements - as evidence of inventory loading and pyramid schemes. Again, a devastating position for the direct selling industry.
    
6. Subsequent FTC actions have reaffirmed the FTC’s position on “personal use.”

The Purpose behind H.R. 1220

With help from the DSA sponsors of H.R. 1220, seek to bring relief to the direct selling industry. The proposed bill recognizes the importance of stamping out pyramid schemes while at the same time recognizing the problem created by the FTC’s interpretation of language in the federal case, Omnitrition, that started the debate:

SECTION 1. SHORT TITLE.

This Act may be cited as the `Anti-Pyramid Promotional Scheme Act of 2003'.

SEC. 2. FINDINGS.

The Congress finds the following:

(1) Pyramid promotional schemes, chain letters, and related schemes are enterprises--

(A) that finance returns to participants through sums taken from newly attracted participants;

(B) in which new participants are promised large returns for their investments; and

(C) involve unfair and deceptive sales tactics, and lead to the victimization of unwitting individuals.

(2) Pyramid promotional schemes, chain letters, and related schemes constitute a threat in interstate commerce and to the financial well-being of the citizens of the United States.

(3) The advent of the global Internet makes pyramid promotional schemes international threats.

(4) The Ninth Circuit Court of Appeals erred in defining a pyramid promotional scheme in Webster v. Omnitrition Int'l, Inc. (79 F.3d 776; 9th Cir. 1996).

Congress to FTC: Recognize Personal Use

The proposed federal legislation directs the FTC to adopt a new rule on pyramiding which both outlaws pyramid schemes, but recognizes personal use. The bill directs the FTC to adopt a model law similar to one adopted, at the request of the industry, in numerous states in recent years, including Texas, Louisiana, Oklahoma, Montana and Kentucky. In such state models, assuming that a network marketing company sells products to distributors in reasonable quantities, i.e. no inventory loading, and assuming that it adopts an industry standard 12-month, 90% inventory refund policy for terminating distributors, then personal use will be recognized as a legitimate destination for product in the same fashion as sales to nonparticipants.

SEC. 4. RULES TO PROHIBIT OPERATING PYRAMID PROMOTIONAL SCHEME.

(a) IN GENERAL- Not later than 1 year after the date of the enactment of this Act, the Federal Trade Commission shall promulgate a rule under section 18(a) of the Federal Trade Commission Act (15 U.S.C. 57a(a)) providing that it shall be an unfair or deceptive act or practice under section 5 of such Act (15 U.S.C. 45) for any person, by the use of any means or instrumentality of transportation or communication in interstate or foreign commerce, to promote, offer, sell, or attempt to sell a participation or the right to participate in a pyramid promotional scheme.

(b) LIMITATION- Nothing in this Act or in the rule to be promulgated pursuant to this section shall be construed to prohibit a plan or operation, or to define such plan or operation as a `pyramid promotional scheme', based upon the fact that participants in the plan or operation give consideration in return for the right to receive compensation based upon purchases of goods, services, or intangible property by participants for personal use, consumption, or resale, and the plan or operation does not promote inventory loading and implements an appropriate inventory repurchase program.

H.R. 1220 Deserves Industry Support

The dialog between the MLM industry and the FTC continues. It is unlikely the FTC on its own will change its position. Industry supports are hopeful that relief from uncertainty will come as a result of passage of H.R. 1220 or that introduction of H.R. 1220 will accelerate positive dialog with FTC toward adoption of new rules similar to progressive legislation that has been adopted in many states that protects the consumer on one hand from pyramid schemes, while, at the same time, recognizing the position of the direct selling industry that personal use by distributors should be counted as legitimate end destinations of company product sold by network marketing companies.

To view the actual proposed legislation, H.R. 1220, and for other important industry articles and issues, please visit www.mlmlegal.com.

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