Following is a guest post from attorney Spencer Reese with an early analysis of the FTC settlement with Herbalife.
Network marketing is in the midst of a rapidly advancing Orwellian era. It’s been slow to develop, starting in 1996 when the Ninth Circuit Court of Appeals issued its decision in Webster v. Omnitrition, but it’s snowballed in the past two years. Today the snowball grew exponentially with the announcement that the Federal Trade Commission and Herbalife have reached a settlement agreement.
Watch for detailed updates and analysis on the settlement. We’ll break it down into many little pieces to determine how it will impact your business. But today we just have time for a broad sweep so I’m just going to address some critical topics.
The obvious first question is: “Does this settlement affect my business?” It’s certainly an important question. After all, the FTC was investigating Herbalife and analyzing Herbalife’s program, so why should it apply to any other company? The answer is two-fold. There’s the technically correct answer, and the real-world practical answer. The technically correct answer is that the FTC settlement with Herbalife has no binding impact on any other network marketing business. The real-world answer is quite different. The changes that Herbalife must implement offer a clear roadmap to the standards that the FTC expects all direct sellers to conform, and those are the standards that it will pursue in future cases against direct sellers.
There’s no law that requires direct selling companies to adhere to all of requirements in the Herbalife settlement. But those who stick their head in the sand and ignore the messages in the Herbalife settlement agreement do so at great peril. By now you’re certainly wondering what the settlement agreement requires. Here’s a high level summary of the most critical issues that will impact every network marketing program:
- The FTC has asserted a new basis upon which to attack MLMs under Section 5 of the FTC Act. They claim that Herbalife was “promoting participation in a multi-level marketing program with a compensation structure that causes or is likely to cause harm to participants.”
This is a groundbreaking position. Historically, the FTC has attacked MLM programs as pyramid schemes, but in the Herbalife settlement there’s no assertion that Herbalife is an illegal pyramid (that’s great news for Herbalife!). Rather, the settlement agreement asserts “the compensation structure is likely to cause harm.” This is a new angle of attack that requires a new analysis of compensation plans and programs. The legal standard of what constitutes a harmful compensation plan is not defined in any case law. The Herbalife settlement is the first glimpse we’ve had into what is a “harmful compensation structure.”
- Sales to non-participants in the business opportunity remain foremost in the FTC’s consideration of what constitutes a legitimate multilevel opportunity. The FTC acknowledges that some personal consumption of products by Herbalife distributors is appropriate. What’s critically important is that the settlement agreement specifies that no more than one-third of multilevel compensation may be paid from sales to distributors. Conversely, the FTC expects at least two-thirds of product sales to be to customers (i.e., those who are NOT distributors). Also of critical importance is that the settlement agreement very clearly delineates distributors from customers. The argument that distributors who don’t earn anything but who to buy products are “discount buyers” and not distributors will not hold water.
- To the extent that the program required distributors to meet minimum quotas to qualify for compensation, the minimum quotas MUST be met through sales to customers who are not distributors. This is a CRITICAL takeaway from the settlement because it stabs directly at the heart of the very common element of multilevel compensation plans that set minimum personal volume quotas necessary to be “active,” which is a prerequisite to being eligible for compensation.
- Distributors are PROHIBITED from participating in an auto-ship program. Yes, you read that correctly. Stop and take a deep breath. Now read it again. I don’t need to expound on that one.
There are A LOT of other elements to the settlement that are incredibly significant, and much further analysis needed on the points addressed in this blog. We’ll focus on the many facets of the settlement agreement in the very near future. But the above are such foundational concerns that every company using a multilevel compensation structure must be thinking about how to deal with this NOW. If these are the standards that the FTC will seek to impose on all multilevel marketers (and I fully expect that they are), it will impact EVERY direct seller and the structure of the overwhelming majority of direct selling businesses.
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