New Wave of Class-Action Pyramid Cases Swamps Direct Selling Industry

New Wave of Class-Action Pyramid Cases Swamps Direct Selling Industry

“The Plaintiff’s Bar is Smelling Blood.” 

by Jonathan Gilliam, Momentum Factor


In March of this year, a federal judge in Nevada accepted a $7.7 million dollar settlement offer from Xocai as the result of a class action lawsuit. Last November, the U.S. Fifth Circuit certified a class-action suit against Stream, reversing a successful dismissal issued by a three-judge panel in October 2015. The Court’s apparent newfound willingness to consider racketeering charges against legitimate DS operations could open the door to significantly higher damages. This ruling came on the heels of two class action lawsuits filed in Arizona against Jeunesse, seeking to void their arbitration clause as “unconscionable.” Yet another lawsuit was filed in Utah against LifeVantage in October 2016.

There’s no doubt that high-profile media exposure continues to drive a particularly costly spate of class action lawsuits, says Buchalter Nemer’s Larry Steinberg. “With recent public attention to network marketing, a segment of the plaintiff’s bar seems to be smelling blood, sparking a cottage industry in suing MLM’s as a class action for engaging in an illegal pyramid scheme, false and misleading income claims, false advertising and other unfair business practices.”

For now, these lawsuits can exhibit an unfortunate tendency to feed on themselves, as “the FTC’s recent enforcement activity and position statements provide a readily available roadmap for class action attorneys,” said Brent Kugler of Scheef & Stone.

Our experts don’t dismiss the potential danger of this new blueprint for class action litigation in the industry. “I am frankly surprised,” Mr. Kugler said, “to see established DS companies become ensnared in class action litigation due to questions about the enforceability of the arbitration provisions in their independent contractor (“IC”) agreements.”

When it comes to regulatory compliance, the details matter. Even one failure to maintain the recommended slate of mitigation strategies can have massive consequences for a company. The costs of legal challenges that aren’t dismissed or channeled to arbitration can be massive, even for businesses that ultimately prevail, Kugler warned, “One or more of the DS companies under attack will likely be forced to spend a not so small fortune in defense costs, even if the company ultimately prevails. If the case is certified as a class action, the cost to defend the lawsuit can easily be several million dollars.” If litigants are successful, of course, the costs are even more daunting, amounting to “tens of millions of dollars in damages and millions more in attorney’s fees for the plaintiffs’ attorneys.”

The broader reputational damage inflicted by a major legal defeat can have far-reaching negative effects, even leading to the death of the company: negative PR not only hurt sales but can drive a mass exodus of members of the company’s sales force.

The fact that legal challenges can have devastating consequences for DS firms does not come as news to veterans of the industry. Fortunately, our experts interpret recent legal challenges as reminders of the necessity of rigorous, up-to-date compliance and practices and policies, not as omens of a regulatory sea change. Class action litigation will force companies to continue to examine their business practices to ensure that they are in compliance with current FTC directives.

Proactive Compliance Remains a Sound Defense

Our experts agree on this point: while recent legal actions highlight the cost of compliance failures, recent events don’t change the fact that an up-to-date contractual framework provides an excellent first line of defense.

Well-crafted IC agreements are so vital because they can keep class actions out of court altogether, avoiding costly legal fees. Mr. Kugler emphasized that “The FIRST and BEST defense to any class action lawsuit is an enforceable arbitration provision and class action waiver.” There’s no reason to believe that the effectiveness of these provisions has been diminished: “It is highly unlikely that companies with valid, enforceable arbitration provisions will be class action targets.” The recent rash of lawsuits don’t indicate a flaw in this strategy, but suggest that it’s more imperative than ever, illustrating “what can happen when companies do not have these protections in place.”

Recent rulings on the enforceability of these provisions require DS enterprises to act proactively to update IC language. Compliance teams must ensure that IC agreements not only contain all the relevant provisions but are up to date and fully enforceable. Companies need to be very careful when updating these agreements—unlawful changes to the agreement can themselves invalidate underlying provisions and expose the firm to legal risk. For instance, “companies that reserve the right to make unilateral changes to their IC agreements should give reasonable notice of the change or amendment prior to the effective date of the amendment,” wrote Kugler. Attempts to retroactively apply any amendments can also invalidate the agreement.

While DS businesses must be rigorous with their IC agreements, our experts remain confident about the industry’s overall legal strategy. Kevin Thompson from Thompson Burton is particularly bullish. “The recent class action lawsuits should be of no concern.  The arguments are the same, worn-out and thoroughly debunked pyramid arguments that we’ve seen in similar lawsuits over the past decade.  Class action litigation is always a risk in this industry until the DSA gets serious about passing a Federal anti-pyramid statute that clarifies the distinctions between good and illegal companies.  Over the past 10 years, I have never seen a class action lawsuit go the distance.  There’s usually a monetary settlement at some point.”

The bottom line has not changed when it comes compliance in the DS industry, it seems. There will always be risk, but there are still powerful mitigation strategies that will keep good companies in the clear.

To learn more, click here to contact Jonathan and the Momentum Factor team today.

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