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BRIEF MLM DEFINITION A method of compensating independent representatives selling from other than fixed retail locations for both their own sales volume, and also for the sales volume of the additional representatives they introduce to the company.

BRIEFING ROOM

MLM LEGALITY TEST

There are many characteristics, or "red flags" that distinguish an illegal pyramid from a legitimate multi-level business opportunity, (often shortened to MLM.) They have been written about often in many publications and by necessity often contain legal terms and industry jargon. Also, danger signs of a few years ago may have been camouflaged or fixed by the newest drafters of plans so one needs to be on guard for new and different twists. Is there a simple, easy to apply, test one can give to a business opportunity, that addresses the pyramid law risk without all the pyramid law legal terminology? There is. What follows addresses that need. It is the single-level test for the multi-level business opportunity.

It goes like this: Can one make some money SINGLE-LEVEL, that is, without sponsoring another business opportunity seeker? Note the specific use of the word "can", not the word "would". It is usually a given that the business opportunity prospect is urged to sponsor, and that the business opportunity presenter will say or imply that the "real money" is in building a group. But that is O.K., SO LONG AS - those who choose not to sponsor at all, CAN STILL MAKE MONEY. Note also the use of the word "MAKE". It's "MAKE MONEY" not "SPEND MONEY", meaning paying income taxes if the gross income exceeds expenses associated with producing the income. Buying for personal use at distributor prices rather than customer prices, while a savings, does not generate INCOME upon which one is required to pay taxes. Buying for personal use by itself is not an income opportunity. If the proposed business opportunity consists ONLY of buying for personal use and sponsoring more representatives, with no provision for sales to customers, it is flawed.

This simple test needs to be applied to two aspects of a business opportunity. The first aspect is the design. What do the company documents say about how one makes money? How does the compensation plan work? Not all the fine details of every commission, bonus or reward need be understood, but simply, can one make SOME money without sponsoring. Remember, one does not MAKE money when one buys any product or service for personal use. The application of this test should in no way imply that there is anything wrong or illegal about personal consumption. It is just that it alone cannot be the sole basis for a business opportunity.

The second aspect of the application of the test is the plan implementation. Some plans are designed correctly but are flawed in the implementation. Can one make money, even without sponsoring, as the plan is being taught and implemented by the prospective sponsor and the distributors closely associated with him or her? If there is no acknowledgment or support for the non-sponsoring participant in the business opportunity, something is wrong, maybe not in the design, but surely in the implementation. Reputable and legally designed and implemented multi-level business opportunities provide a money making opportunity SINGLE LEVEL to those who choose not to sponsor. Of course, if one sponsors others, then ADDITIONAL money making opportunities exist when those sponsored generate sales.

Apply this test to multi-level business opportunities. Look at the plan design, and look at the way the plan is being implemented by the prospective sponsor and associates. If the ONLY WAY to make money is by sponsoring, STAY AWAY, the plan is fatally flawed.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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The ABC's of MLM 2000

What follows is from the legal perspective of an attorney who has had to defend MLM companies from regulatory scrutiny and attack. The creative genius of entrepreneurs is not discussed or highlighted in the following analysis. The marketing view is missing. The hype and the fluff and the attention-grabbing bells and whistles are left to be discussed by authors writing from a marketing perspective. When all extraneous twists and turns are scraped away, what is legally left needs to look something like this, or the MLM operation will not be allowed to continue long-term in the United States or Canada.

A.The company brings a product or service to the marketplace that:
 1.is retailable
 2.is being retailed, and
 3.does not include a right to bring more participants to the company. A service that contains the right to bring customers to the company, like a shopping mall, can qualify, but not if it also contains the right to bring more income opportunity seekers (legally, “participants”) to the company. Multilevel income opportunities CANNOT be sold in the United States or Canada.

B.The product or service reaches the end user through efforts of direct sales representatives (independent contractors), rather than through traditional retail establishments or other channel of distribution choices like mail order or telemarketing. This channel definition is driven, not by any e-commerce techniques, but rather by the payment of money to an independent contractor for producing a result. Another characteristic of this channel is a lack of employees (involved in selling) to whom W-2s are issued and the presence of independent contractors to whom 1099s are issued.

C.The company’s compensation plan
 1.is designed to reward representatives for the sales of the product or service they are involved in, and
 2.includes an incentive and reward for the representative to be the “new representative finder” (legally, another “participant”) in the form of payment to a representative who introduces an additionalrepresentative to the company, BASED ON the sales volume of the second representative.

It is the presence of the design plan feature described in C2 above that subjects a single-level direct selling company to multilevel laws and regulations, whether or not the company chooses to use the term “multilevel” in its literature. Not all companies or distributors agree with this definition. I respect differing views. At the time of this writing, I am unaware of any regulatory agency in the United States or Canada who defines an MLM company substantially differently fromwhat I have just stated. It is the compensation feature described in C2 above that brings the company under the microscope of regulatory scrutiny. A “participant” in the legal sense has the right to introduce another “participant.” If your rights stop at finding, introducing, locating, or selling to “customers,” you are not a “participant” in the legal sense, rather you are operating in the C1 portion of this analysis. Whether or not there are “participants” is very critical. The fact that you may receive a 1099 on the rewards of your efforts does not make you a “participant,” unless you also have the right to introduce others who also have the same 1099 potential. No amount of e-commerce manipulation or affiliate program wording can change this. Only legislatures can change laws, and they are notoriously slow to act.

Personal consumption by representatives is much discussed. A lot of it is good for the company’s bottom line, but too much of it is bad. How much is too much? One hundred percent personal consumption creates a presumption in the law and in the analysis of the business by regulators (in my view) that the only persons willing to buy the product/service are income opportunity seekers, and the amounts being paid are no more than disguised headhunting fees. Such payments are pyramidal and illegal.

“What percentage of sales to non-representatives do I need to be legal?” You do not want to ask the question, and you do not want it answered for you by government agencies. There are companies with very high percentages of “personal consumption” by their representatives that pose no risk of abuses, such as deceptive recruiting, inventory loading, or the “running out of people” pyramid risk. Also, an argument can be made that people who become representatives solely to buy products or services at wholesale, rather than retail, and who do not also buy for resale and do not sponsor, are customers, rather than income opportunity seekers. For the purpose of defending high amounts of personal consumption, an argument can be made that one does not become a “participant” in the legal sense until one introduces another participant, since only then can rewards flow based on the second participant’s sales volume. If all of the elements of the analysis above are present, the percentage of personal consumption by representatives should not matter. If the question is even raised, it usually means A1, A2, or C1 is missing or flawed. But I will not duck the question. My answer is this: Twenty percent of total sales to non-representatives should be sufficient to rebut any presumption. Of course, other pyramid tests would still apply. One reason I say this is because companies with very high personal consumption percentages have been going strong for ten years or more and pose no pyramid risk.

A1, A2, or C1 in the above analysis cannot be missing or flawed. C2 alone, without A1, A2, and C1, is deemed an endless chain and an illegal pyramid. If in the design or in the implementation of an MLM program all that is visible—all that the regulators see, all that is really happening—is income opportunity seekers who find more income opportunity seekers who find more income opportunity seekers, etc. (legally, “participants”), the regulatory end is near, sooner or later. The regulators, with or without specifically drafted laws, state their position simply—you run out of people.

So, since retailing is so essential, let’s examine it in more detail. What does “retailable” mean? It simply means “Will people buy my product or service?” The question appears almost too simple, so we need to be more specific about “people.” The “people” need to be people in a “customer” sense, rather than in an “income opportunity seeker” sense. There are hundreds of reasons why people will not buy products or services: They already have one; the cost is too high; they have no need or desire to own one; what is being sold is of poor quality; etc. The test here does not need to find a specific reason. If no one but income opportunity seekers buys the product or service, the presumption is raised that the product or service is not retailable, and A1 in the analysis is flawed. Look at traditional companies by comparison. If no one buys what they offer for sale, they are out of business. If the MLM company continues in business anyway, regulators presume the company is selling the right to sponsor yet more people. Federal and state laws prohibit selling the right to sponsor.

Once the retailability of the product or service is questioned, the risk of the MLM element of the compensation plan (C2 above) being attacked as illegal greatly increases. An argument can be made that people who become representatives solely to buy products or services at wholesale, rather than retail, and who do not also buy for resale and do not sponsor or refer, are customers, rather than income opportunity seekers.

Examining A2 in more detail, it differs from A1 primarily in the focus placed on retailing by both the company and its distributors. If the product or service is not retailable, we do not even get this far. If the product or service is retailable, but little corporate or field focus is placed on retailing, A2 is flawed, possibly not in the design, but surely in the implementation. Some things to look for: Does information exist in paper or electronic form specifically designed to assist the retailing effort? Does training exist to assist the field in its retailing efforts? Is retailing discussed in opportunity meetings or on web pages if the company is primarily e-commerce driven? Once the lack of actual retailing activity is identified, the risk of C2 being deemed illegal greatly increases.

C1 and C2 are separated on purpose. It is a critical separation for legal positioning. The existence of a viable income opportunity, without the necessity of recruiting more income opportunity seekers, is absolutely essential. Simply stated, one test for the legality of a multilevel income opportunity is a single-level analysis. Can money be made by the income opportunity seeker without sponsoring? The form of the single-level income opportunity is not as important as the substance. Traditionally, the representative’s first way to make money is to keep the difference between what he/she pays for the product and what is received for the product when he/she resells it. This “two passages of title” method of distribution has been replaced to a great extent by the representative being a “customer finder” and the company performing direct fulfillment. The e-commerce revolution may totally obsolete the “two passages of title” method of distribution. Some companies add to the first profit opportunity an additional profit opportunity in the form of bonuses, rebates, or commissions. The key to the C1 analysis is that sponsoring of another “participant” must be optional. There must be a place in the compensation plan for the non-sponsoring income opportunity seeker. If the ONLY way an income opportunity seeker can make money is to bring to the company more income opportunity seekers, the plan is fatally flawed. It is an endless chain. The argument that it “really is not” an endless chain, when you carefully examine the design and read all the fine print, will not hold up if the field force presents it only as a sponsoring opportunity. The fine print does not save the day. How a plan is implemented carries much more weight than how a plan is designed.

Some specific points need to be made about C2. No reward can be paid to the first representative for the act of introducing the second representative to the company. Such payments or rewards are called “headhunting fees” and are barred by law. No charge or required product purchase can be imposed on the second representative by the company or the sponsor as an entry fee. (A required purchase of an at-cost, non-commissionable sales or starter kit is permitted.) Simply put, neither the company nor the sponsor can profit from the sole act of recruiting. Profit to the company and profit to the representatives must come from the sale of products and services to customers, and only from the sale of products and services to customers.

If, from the start, all of the points made above are addressed in the initial design and are monitored in the implementation, regulatory scrutiny is unlikely. When inadequate or no attention has been paid to A1, A2, and C1, the states with proactive consumer protection agencies are likely to start an investigation rather quickly. I advocate correct initial design and company-monitored, correct implementation. However, some companies getting off on the wrong foot can recover.

Fixing a flawed plan can be as easy as changing language in corporate literature, or as difficult as rolling out totally new and substantially restructured products, services, and methods of compensation, accompanied by massive nationwide retraining. Some companies have made these transitions, and others have died in the process. When the alternative is a cease and desist order in a key state, with more states to follow, hard choices must be made. The bottom line will be affected. Fickle representatives will jump ship. Some representatives seek out and work flawed plans for the quick monetary gain and are prepared to move on to the next one at a moment’s notice.

Patching up C1 and C2 is inadequate, without a corporate resolve to address A1 and A2. It starts with the company’s product or service. Long before MLM, around the turn of the century, someone said, “Build a better mousetrap, and the world will beat a path to your door.” The “making legitimate,” or “legalizing,” of an MLM plan under regulatory scrutiny can only be accomplished by going to the core. The core is the product or service being brought to the general public marketplace by the company, and, of course, how it is brought to the marketplace. The core is not the bells and whistles of the compensation plan.

If a flawed MLM plan is under attack, it must be taken most seriously. State and federal regulators are too savvy to accept wordsmithing patches without substantive changes to the way business is done. Often, distributor “leaders” want the simple formula of “get two who get two, et cetera, and cash those commission checks.” If, in the analysis above, A1, A2, and C1 are flawed, either in the design or the implementation, significant changes to the way business is done must be made. If few or no one will buy the company’s products or services, except to play the game, then the MLM plan will be attacked as an endless chain money game. The state or federal agencies will eventually hound the company out of business. What is often required to close or settle an investigation is a corporate marketing shift to a retailing focus, followed by field retraining. Corporate monitoring and verification that the changes are being implemented in the field are often required.

Since retailing is the legal answer to MLM longevity, finding the right products or services is critically important. But I am digressing from the legal perspective. To wrap up, I have looked for other paths through the jungle of laws and regulations regarding MLM. E-commerce increases the many variations of selling, but does not bring with it exemptions from anti-pyramid statutes. If another path exists that does not include or require these legal ABCs, I have not found it.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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Business Opportunity - What do the words mean?



The words sound exciting. The generally accepted meanings imply commerce and "making money", or as least having the realistic hope of making money. I purposely did not use the word "chance" in the last sentence, because "chance" implies luck, like buying a lottery ticket. Also, the two words, "business" and "opportunity," when used together, have a generally accepted meaning of the opposite of a JOB. Jobs have places to report to, set hours, a regular pay check, sick days, (sometimes) and other benefits (sometimes.) Business opportunities usually have none of these things.

People with jobs receive wages or salaries, with the employer withholding taxes as required by law. At the end of the year, what was paid to you and what was sent to taxing authorities on your behalf is reported on a W-2 Form. Business Opportunities are most often structured as independent contractor relationships. Payments to you, without taxes withheld, and sometimes sales to you (over certain amounts) are reported to you and to taxing authorities at the end of the year on Form 1099.

What is written above is generally true, whether the business opportunity does or does not have a multi-level element in the way compensation is paid. A critical factor, and the point of this article, is that Business Opportunities (Capital B, Capital O, on purpose) are strictly regulated in 22 states. But at the same time, virtually all of the traditional MLM income opportunities currently available, are NOT Business Opportunities in this sense.

WHY NOT? All 22 states have a threshold dollar amount, BELOW WHICH their laws are not applicable. The threshold dollar amount varies between $200 and $500 and in its most common application, applies to the required purchases to participate in the opportunity. Now you know one of the reasons why the cost to get into an income opportunity is often zero, or a modest amount. The Direct Selling Association, through its own staff, and through the efforts of the Government Affairs staff of its member companies, monitors pending legislation in this and other areas affecting the industry. The "threshold exemption" in any proposed legislation is lobbied for, and the results benefit the entire industry. Direct selling companies at least one year old are urged to consider joining the DSA to support this and other worthy efforts benefiting the entire direct selling industry.

It has been my experience that 99% of the multi-level, direct selling industry positions their "income opportunity" offer to prospects below the thresholds of the "Business Opportunity" Statutes. If you are required to pay more than $200 to participate in the income opportunity, the Business Opportunity threshold has been exceeded in some states.

I have begun using the words "income opportunity" rather than "business opportunity" when describing a way to make money offered at a cost below the thresholds of the 22 states that have Business Opportunity Statutes. It is a small thing perhaps, but since so many states have defined what a Business Opportunity is to them, and I do not want to be caught by their definition, I will also avoid using their operative words where possible.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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PONZI OR PYRAMID



Ponzi schemes are pyramidal in nature, but are they the same thing as a pyramid scheme? No, they are not, and here is why.

Ponzi schemes are investment frauds that share some characteristics of pyramid schemes but also have some different dynamics. A requirement of a Ponzi scheme is the promotion of what starts out to be, or appears to be, a real investment opportunity. It often involves the development of a valuable resource such as oil, gas, minerals or real estate. And what is being promoted often actually exists. The promoter does own a mine, or does own investment property. Where the resource actually exists, the promoter has grossly overvalued its worth. Other times, the asset or resource which is the basis for the investment opportunity is totally a figment of the promoter's imagination. In either scenario, the promoter convinces investors that the asset can be further developed with more capital, and the promoter will share the profits with the investors.

Early on, substantial dividends are paid out to the investors. The representation is that these dividends are "profits" coming from the successful development of the investment assets. What is actually happening is that the promoter is merely returning a portion of the investors money to them. These early and substantial dividends produce two results. The early investors increase their share of the operation, and additional investors are attracted to the scheme. The process of paying dividends continues and more investors come forward until the fraud is uncovered or the promoter absconds with the investment proceeds.

Not all Ponzi schemes start out as frauds. Sometimes a promoter in good faith really believes the asset will prove profitable. Investment money comes in, but the returns are disappointing. To avoid loss of investor confidence lies are circulated and dividends paid. More money comes in and the possibility of millions of dollars of losses occurs but for the truth being told early.

The traditional method of dealing with Ponzi schemes in the U.S. is under the Securities Laws, including the Securities Acts of 1933, the Federal Securities Exchange Act of 1934, and state securities laws, (sometimes referred to as Blue Sky Laws). They are not pyramids however, and the pyramid laws we routinely associate with the regulation of multi-level marketing companies do not apply. There are several distinctions between Ponzi schemes and pyramid selling schemes.

The pyramid scheme involves a person making an investment for the right to receive compensation for finding and introducing other participants into the scheme. There is a clear understanding among the participants that the success of the opportunity is dependent upon attracting additional participants.. This is different from the expectations of the Ponzi scheme participant who believes the investment is dependent upon the successful development of a productive asset such as a mine or real estate complex. Pyramids must fail because, by their nature, they depend upon endless exponential growth to succeed. Ponzi schemes must fail because the underlying asset upon which the investment was based either never existed, or was grossly overvalued. Pyramid schemes require active participants who bring in more participants. Ponzi schemes can flourish even with passive investors without any responsibility to promote the opportunity. Pyramid scheme participants "go for the gold" by attracting others to the scheme. Ponzi scheme participants "go for the gold" by increasing their investment and hopefully their share of the profits from the successful development of the productive asset.

The author is indebted to John Brown, Senior Manager of Government Affairs at Amway, for developing these distinctions and articulating them clearly and often.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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Looking Past The Paper



In a recent article, I wrote, "I have had regulators from seven key states say to me personally or to an audience I was in, the equivalent of, "We look past the paper to what is really going on in our state."" I have also said on more than one occasion that the single most regulated act in MLM is the offer of the income opportunity to a prospect. Well, the Federal Trade Commission made both of those points for me recently in the Jewelway case. A legally designed program (the paper) only gets you half way home, if that far, as bad sponsoring conduct is not saved by the paper.

Federal investigators went to Jewelway opportunity meetings and did not like what they saw and heard. Note that I did not say that they did not like what was written in the Jewelway literature. They clearly were "looking past the paper." I will leave for another article an analysis of whether the Government response was appropriate for the circumstances. (It wasn't.) My purpose here is to make the point again that companies and distributors must PROPERLY IMPLEMENT a legally designed program.

There can be no required product purchase to become a representative of a company with an MLM compensation plan. The cost to get in must be "zero" or at most an at-cost, non-commissionable charge for a starter kit. The paper was O.K. The Jewelway representative had people believing they had to buy product to get in.

There must be retail sales to make money as a representative of a company with an MLM compensation plan. The paper was O.K. The Jewelway representative had people believing they could make money just through personal consumption.

There can be no earnings representations made to prospects by representatives of a company with an MLM compensation plan. The paper was O.K. The Jewelway representative made specific income representations.

What can companies and representatives do? The companies must monitor sponsoring conduct to ensure it is "by the book." Personal visits, required tapings, certification, refreshers and the are all possible ways to keep their finger on the pulse of what is happening in the field. Representatives must first and foremost realize the importance of studying the corporate literature and avail themselves to corporate training on how to sponsor. Entrepreneurs are by nature creative, but during an opportunity meeting is not the time. Presenting an income opportunity is high risk. The company must design the technique properly and the representative must implement the technique properly.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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Paper-less Sign Up



With so much business being done with faxes and electronic mail, the signed contract seems to be going the way of the 8 track player. What about the law that you need my signature to hold me liable? Well, not always.

First, let’s get the c.y.a. out of the way. I recommend that ALL contracts be dated, witnessed and signed by both (all) parties, preferably in blue ink so it is more obviously an original signature and not a copy.

Now we talk practicalities. Oral contracts are legal. The issue is not usually legality, but enforceability. Let’s examine the lack of a signed contract from two perspectives, that of the company and that of the distributor.

The company wants distributors who order their products and services and bring them more distributors. Nothing in the signed or unsigned distributor contract makes the distributor do those things. They are a volunteer army, who can do nothing if they choose (and often do.) The significant document is the product or service ORDER. Numerous orders create a course of dealings of the parties bringing payments or obligations to pay to the company. These documents, much more than the distributor contract, are important in the sense that they are convertible to cash that goes to the bottom line.

The distributor contract often even contains a clause making it cancelable at any time by the distributor by giving written notice to the company. If you were a bank lending officer, which would be more impressive, lots of orders, or lots of cancelable at any time distributor contracts?

When everything is fine, the lack of a signature means little. It’s when discipline up to and possibly including termination is needed that companies check the files to find the signed distributor application. It is evidence that these rules were in effect (right here on the document you signed) and you broke that one. Companies who do paper-less sign up have many choices after the fact (and before any trouble arises) to obtain a signed document for the files. They should check with their marketing and/or legal consultants to see what works best in their system.

The distributor has different issues that may be tied to signatures. Most distributor applications have a place for the distributor to sign, but not a place for the company to sign. If the distributor contract is viewed as an offer it needs to be accepted. Most often, something other than the return of a signed contract is the acceptance. Sending a welcoming letter or package, issuing an identification card, or merely starting to accept orders closes the loop. Again, when all is going well, flaws in the formal process mean little. It’s when an expected bonus check does not arrive, or a disciplinary action is taken by the company, that the distributor starts reading the fine print, (or tries to find the fine print.) If a distributor seeks to hold the company to a particular clause (such as arbitration, or written notice of changes in the compensation plan) it is always better if completed paperwork is available. Keeping in a file all correspondence and documents from the company is a very good idea. Of particular importance is paperwork used in the annual renewal of the distributorship. Distributors are urged to save their canceled checks used to pay the renewal fee. Also, if the company communicates with the distributor by e-mail, send it to the printer before deleting it and save it in your paper file for a rainy day.

Bottom-line, paper-less sign ups work. Getting signed copies into the files latter is recommended for the protection of all parties.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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ARE TWO-TIER AFFILIATE PROGRAMS MULTI-LEVEL MARKETING?

The title begs two questions we must address first. What is a two-tier affiliate program? And - How does it differ from a one-tier program? And, of course, what is MLM? Let us start the definition process.

Affiliate programs are a product of e-commerce. An on-line seller offers a commission to another for referring a customer to an on-line site. An offer to a person to compensate them in some fashion for bringing in business, WITHOUT any additional incentive to locate (find, recommend, recruit, sponsor) more business finders, is a one-tier program, (at least for the purposes of this article.) I have personally had two, two-tier programs explained to me in excruciating detail. What I write next is based on that experience, and not on any universal examination of all the programs that are titled "two-tier." When a program contains TWO sources of income, namely compensation for bringing in business, AND compensation when you locate (find, recommend, recruit, sponsor) more business finders, WHO THEN BRING IN BUSINESS, it is a "two-tier" program.

The "program" involves selling something, and paying commissions for sales. Look at the money flow, and the REASON for the money flow:

Someone buys something. Money flows from the buyer TO the program. This is a customer sale.

The program pays a commission to the "customer finder." Money flows AWAY from the program TO an income opportunity seeker, to reward the person for bringing business volume to the program. This money flow evidences the existence of a single-level income opportunity. (To use affiliate program words, "one-tier") Note that there exists NO incentive for the income opportunity seeker to find more "income opportunity seekers," only to find customers.

If, in addition to the above, the program pays a commission to an income opportunity seeker, BASED UPON the business volume of another income opportunity seeker introduced by the first income opportunity seeker, a two fold incentive exists. The income opportunity seeker has a financial incentive to get customers for the program, AND a financial incentive to find more income opportunity seekers. In this second case, the second type of money flows AWAY from the program TO an income opportunity seeker, BUT to reward the person for business volume not directly generated, but generated by the income opportunity seeker "found" by the first one. This second type of money flow evidences the existence of a "two-tier" program.

There are two other characteristics to the money flow away from the program (both one-tier and two-tier) that should be noted. It is gross income, taxable to the recipient, to the extent income exceeds allowable business deductions, and it is reportable by the payer under the 1099 rules to the extent it exceeds $600 in a year to an individual recipient.

"Is a two-tier affiliate program MLM?" - takes us to an attempt to define MLM. The Direct Selling Association defines MLM (my paraphrasing) as a form of compensation that creates the incentive and reward for income opportunity seekers to "sell" to consumers, AND find more "sellers." Clearly two-tier programs fit the definition. This is not LAW, and not even all DSA member companies accept this definition. There is MUCH law affecting direct sellers, but LITTLE law specifically defining MLM. Only five states and Puerto Rico attempt a definition. It follows:

"Any person, firm, corporation, or other business entity which sells, distributes, or supplies for valuable consideration, goods, or services through independent agents, contractors, or distributors, at different levels wherein participants in the marketing program may recruit other participants, and wherein commissions, cross-commissions, bonuses, refunds, discounts, dividends, or other considerations in the program are or may be paid as a result of the sale of such goods and services or the recruitment, actions, or performances of additional participants."

Although there is an argument that the first part of the definition excludes from MLM direct fulfillment (not different level) distribution systems, the rest of the definition talks to recruiting and compensation that would include two-tier affiliate programs. The way out of the dilemma is judicial interpretation. Unfortunately there is none. The real practical answer is - it does not matter. All the laws affecting direct sellers apply to everyone, whether or not this or any definition is met. The summarized laws of Prohibited Activity in the first four states in an alphabetical list will show what we are up against:

ALABAMA - Prohibited Activity
… any plan … wherein a person for consideration … acquires the opportunity to receive a pecuniary benefit, which is based primarily upon the inducement of additional persons … to participate in the same plan … and is not primarily contingent on the volume … of goods, services or other property sold or distributed. "Consideration" Exclusion …sales demonstration equipment and materials furnished on a nonprofit basis … less than $100

ALASKA - Prohibited Activity
… a sales devise whereby a person, upon condition that he make an investment, is granted a … right to … recruit … additional persons "Investment" Exclusion … sales demonstration equipment and materials furnished at cost

ARIZONA - Prohibited Activity
… any plan … by which a participant gives consideration for the opportunity to receive compensation … derived primarily from any person's introduction of other persons into participation in the plan … rather than from the sales of goods … by the participant … introduced into the plan …
"Consideration" Exclusion … goods or services furnished at cost …

ARKANSAS - Prohibited Activity
… any scheme whereby a participant pays valuable consideration for the chance to receive compensation primarily from introducing one or more additional persons into participation in the scheme …
"Consideration" Exclusion … payments based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

No one can charge for, or require a product purchase for, entry into an income opportunity that includes the right to recruit other income opportunity seekers. This statement is based on LAWS of a vast majority of states (samples above) and is NOT dependent on any MLM definition. What does it all mean? Well, if you offer, or participate in, a one-tier affiliate program, think vacuum cleaner or encyclopedia company representatives of years ago. The laws applying to those types of arrangements will apply to your arrangement. Pyramiding and endless chain concerns are generally not present. A quality general practice law firm should have the answers to virtually all questions that may come up. But if you offer, or participate in a two-tier affiliate program, a line has been crossed. The unique skills of an MLM Legal Specialist, either in-house, or from one of the approximately ten such specialty firms in the United States, are highly recommended. Two-tier affiliate programs, while not structured in a traditional MLM way, must be as carefully structured as a full featured stair-step breakaway or uni-level to which they are closely related (in a legal sense.)

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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PROHIBITED ACTIVITY



Have you ever spoken words to the effect (or heard others say) that direct selling (in many instances called network marketing or multi-level marketing) is primarily about recruiting? Speaking or even thinking that way sends shudders through the very being of lawyers who provide legal services to direct selling companies. Let me explain why. The word "primarily" is not very precise. My definition, for the purposes of this article, is "more than half."

"Primarily" is not a word one would expect to find in legislation, for the very reason that it lacks precision. Laws in this country are, for the most part, very precise, for the benefit of the persons and corporations affected by them, and for the benefit of judges who enforce the laws. This is not the case with a group of laws affecting direct sellers. Sixteen states use the word "primarily" in laws prohibiting certain conduct of direct sellers who have a multi-level form of compensation. Here is the (abstracted) language from those statutes:

Alabama
Prohibited Activity: …any plan…wherein a person for consideration…acquires the opportunity to receive a pecuniary benefit, which is based primarily upon the inducement of additional persons…to participate in the same plan…and is not primarily contingent on the volume … of goods, services or other property sold or distributed. "Consideration" Exclusion: …sales demonstration equipment and materials furnished on a nonprofit basis…less than $100

Arkansas
Prohibited Activity: …any scheme whereby a participant pays valuable consideration for the chance to receive compensation primarily from introducing one or more additional persons into participation in the scheme… "Compensation,"…does not mean or include payments based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.
"Consideration" Exclusion: …payments based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

Florida
Prohibited Activity: …any sales or marketing plan…whereby a person pays…in excess of $100 and acquires the opportunity to receive a benefit…not primarily contingent on…goods (or) services sold in bona fide sales to consumers, and which is related to the inducement of additional persons…to participate in the same sales or marketing plan…
"Consideration" Exclusion: …goods or services furnished at cost for use in making sales…

Idaho
Prohibited Activity: …any plan…whereby a person gives consideration for the opportunity to receive consideration to be derived primarily from any person's introduction of other persons into…the plan…rather than from the sale of goods, services, or other intangible property by the person or other ersons introduced into the plan…
"Consideration" Exclusion: …not for profit sale of sales demonstration equipment and materials

Illinois
Prohibited Activity: …any plan…whereby a person, in exchange for money…acquires the opportunity to receive a benefit…which is primarily based upon the inducement of additional persons…to participate in the same plan…and is not primarily contingent on the volume or quantity of goods, services or other property sold or distributed.
"Consideration" Exclusion: …sales demonstration equipment and materials furnished on a nonprofit basis…

Louisiana
Prohibited Activity: …any plan…by which a participant gives consideration for the opportunity to receive compensation which is derived primarily from the person's introduction of other persons into a plan…rather than from the sale of goods, services, or intangible property by the participant or other persons introduced into the plan…
"Compensation" Exclusion: Payment to participants based upon sales of products purchased for actual use or consumption, including products used or consumed by participants in the plan.
"Consideration" Exclusions: …products furnished at cost to be used in making sales…Purchase of products where the seller offers to repurchase the participant's products under reasonable commercial terms.

Maryland

Prohibited Activity: …any plan…by which a participant gives consideration for the opportunity to receive compensation to be derived primarily from any person's introduction of other persons into participation in the plan or operation rather than from the sale of goods, services, or other intangible property by the participant or other persons introduced into the plan or operation.
"Consideration" Exclusion: …goods or services furnished at cost for use in making sales to persons who are not participants in the scheme…

Massachusetts
Prohibited Activity: …any multi-level marketing program wherein the financial gains to the participants are primarily dependent upon continued, successive recruitment of other participants and where retail sales are not required as a condition precedent to realization of such gains…

Missouri
Prohibited Activity: …any plan…whereby a person for a consideration acquires the opportunity to receive a pecuniary benefit, which is not primarily contingent on the volume or quantity of goods, services or other property sold…for purposes of resale to consumers, and is based upon the inducement of additional persons…to participate in the same plan…

New Mexico
Prohibited Activity: …any…plan…by which a participant gives consideration for the opportunity to receive compensation which is derived primarily from any person's introduction of other persons into participation in the plan or operation rather than from the sale of goods, services or intangible property by the participant or other persons introduced into the plan or operation.
"Consideration" Exclusion: …goods or services furnished at cost to be used in making sales…

North Dakota
Prohibited Activity: …any plan…by which a participant gives consideration for the opportunity to receive compensation which is derived primarily from any person's introduction of other persons into participation in the plan …rather than from the sale of goods, services or intangible property by the participant introduced into the plan…
"Consideration" Exclusion: …goods or services furnished at cost for use in making sales…

Oklahoma
Prohibited Activity: …any plan…by which a participant gives consideration for the opportunity to receive compensation which is derived primarily from the person's introduction of other persons into the plan…rather than from the sale of goods, services or intangible property by the participant…introduced into the plan…
"Consideration" Exclusion: …products furnished at cost to be used in making sales…

Puerto Rico
Prohibited Activity: …any marketing program in which the benefits of the participants depend primarily on the continuous and successive enlistment of other participants and where the distribution and/or sale of properties or services is not required as a prerequisite to obtain said services.

Tennessee
Prohibited Activity: …any…plan…wherein a person for a consideration acquires the opportunity to receive a pecuniary benefit, which is not primarily contingent on…goods, services or other property sold…to consumers, and is based on the inducement of additional persons…to participate in the same plan…

Texas
Prohibited Activity: …a plan…by which a person gives consideration for the opportunity to receive compensation that is derived primarily from a person's introduction of other persons to participate in the plan…rather than from the sale of a product by a person introduced into the plan…
"Compensation" Exclusion: …sale of a product to a person…for actual use…
"Consideration" Exclusion: …product furnished at cost to be used in making a sale…

Utah
Prohibited Activity: … any … plan … under which a person gives consideration in exchange for compensation … which is derived primarily from the introduction of other persons into … the plan rather than from the sale of goods, services or other property
"Consideration" Exclusion: …sales demonstration equipment and materials furnished at cost…

I ask the question again, "What is Direct Selling PRIMARILY about?" It must be PRIMARILY about products and services moving to consumers. The starting point, or root cause, of the majority of Attorney General actions with which I have been involved has been a thought process put into action in some form by the company or by distributors that the venture is about recruiting. Bottom line - change the thinking, change the actions, be about getting products/services to consumers, and significantly reduce legal risk.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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CONFIDENTIALITY OF NAMES AND ADDRESSES



What degree of confidentiality can be placed on a name, an address, or a phone number? Companies must remember that they have a direct relationship with every distributor. The uplines and downlines are not connected contractually, but only in the company's computer. One level of connection in the field is definitely personal, but usually it stops there. People are recruited into an income opportunity PERSONALLY. They have a sponsor who introduces the opportunity to them, and the sponsor, in return for the bonuses that are based on the sponsored person's volume, helps the new person get their business going. Most often a relationship of some kind existed between the two people before the sponsored person joined the income opportunity, just as some form of relationship would continue if the person chose not to join, but remained in the prospective sponsor's "little black book."

As we go beyond the personal relationship, and as a direct result of being a representative, names and addresses, other than of one's immediate upline and frontlines, become known to representatives through company documents. One can say that "But for being a representative, this information would not be known to me." This information BELONGS TO THE COMPANY, and the company may require that this information be given confidential treatment.

Such names, addresses, and phones numbers of distributors are CONFIDENTIAL AND PROPRIETARY TO THE COMPANY, and the use by a representative may be limited to business purposes in furtherance of the company's income opportunity and sales objectives. Distribution should be restricted. Genealogies, mailing lists, and names and addresses of distributors should only go to and from authorized recipients, and only to further the income opportunity and sales objectives. This information should only pass from one distributor to another, if the recipient has a need to know, and again for the specific business purpose of furthering the interests of the company.

Companies are recommended, through their counsel, to have terms and conditions spelling out the confidential nature of the information. Also, companies should consider a confidential legend on the genealogies or lists, putting everyone on additional notice of the company's proprietary rights in the information.

Courts need an education, and it often is a steep learning curve, when the issue is as complex as "cross group sponsoring." They do not know what it is, and even when carefully explained, may still view it as a restraint of trade, not sufficiently "reasonable," in their view, to pass muster. A much easier case can be made for theft of, or conversion of, or misuse of confidential information, because these principles come up often in general business litigation, and are known to the courts. A company's customer list is generally deemed by the courts as an important asset, which can be legally protected. In almost all MLM structures, the distributors are the company's primary customers, purchasing for personal use, and for resale. By taking steps to treat their names and addresses as proprietary and confidential, a company is laying the groundwork for a strong legal argument, if such becomes necessary. Note that the emotional argument of a dismissed distributor that "I have a right to make a living" is significantly diffused by the counter- argument that "Yes, you do, but not with MY confidential and proprietary information, in your possession SOLELY for the furtherance of MY business purpose."

The recommendations are simple to implement, and either the company's General Counsel, or the company's MLM Specialist Counsel can advise on language and technique. Also, they are not so controversial as to be resisted by the field.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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DO THE PRODUCTS HAVE "INTRINSIC VALUE"?



Direct selling companies and their independent (non-employee) sales representatives operate in a minefield of laws, codes, and regulations, and interpretations of those laws, codes, and regulations. Companies whose products (unless clearly indicated otherwise, "products" includes services) are sold to its representatives exclusively, with no true customers, pose a pyramid law challenge most everywhere. For the purposes of this analysis, assume some sales are being made to customers who are not also sales representatives. I suggest you can test any company against the ideas presented here. Some ideas are brand new and untested in the legal arena.

Regulatory agencies in the United States and in other countries have interpreted laws and regulations to mean that some percentage of sales of a direct selling company (that also has a multilevel form of compensation) must be to persons outside of the program. The two most common actual numbers are "more than 50 percent" or "70 percent." The 70 percent number coincides with the 70 percent rule from the Federal Trade Commission versus Amway case decided in 1979 in the United States, although the linkage and reference is incorrect. A careful reading of the Amway case will reveal that "70 percent," wherever it appeared, appeared in the context of a prohibition against inventory loading, rather than as a retail sales requirement "outside the program."

Why is this issue so important? Well, pyramids and endless chains are illegal in the United States and in most of the rest of the world. You cannot "pay to play." Very simply, that is why no company (following the United States model) which offers an income opportunity with multilevel compensation can charge anything to join, or can require a product purchase to join. The only exception carved out of this very clear prohibition is that a requirement to purchase an at-cost, non-commissionable sales or starter kit is permitted. Some statutes contain a specific exclusion for sales kits. Where there is no specific exclusion, the same conclusion is reached by interpretation. Another way to say this is that one cannot be charged for the right to recruit others. Such a "charge" is prohibited as an illegal "headhunting fee."

In my view, the only legal basis a legislator or regulator can have to prohibit or challenge commissions on independent representative consumption is to characterize product purchases as "headhunting" or "paying to play." Another version of the same problem is the specific requirement in many laws that the company's plan be "primarily" about moving products to consumers, rather than about recruiting more "participants." But that issue brings us back to the same place - if the product purchases are linked to recruiting, rather than to traditional marketplace supply and demand, then the product purchases will be deemed disguised "headhunting" fees.

Nothing I have written above is new. The traditional methods of dealing with these concerns are various forms of company-imposed requirements for sales to consumers, and differing levels of record keeping and retention or submission of those records to the company. These protections and techniques all have their good points, yet some regulators view them as inadequate or subject to manipulation, going so far as requiring company verification of independent representative submissions. The following is a new (and, I believe, complementary) idea, and applicable to companies whose structures allow them to identify what product purchases are for "intrinsic value," which means the purchaser wants the item and is willing to buy the item without the added incentive of an income opportunity. The idea is this: If the surrounding facts support the position that the product is being purchased for its intrinsic value, then the purchase is not being made "to play the game." The facts must counter the regulatory accusation or the statutory prohibition that but for the income opportunity no one would buy the products. I also propose (remember, I said these are new ideas) that the status of the purchaser (specifically, an outside, non-participant consumer, rather than some form of independent representative) should make no difference. I will expand on this by looking at various types of purchasers:

1 . The traditional retail customer.
A person totally unconnected to the direct selling company and usually unknown to the company, because the purchase was from the independent representative. There should be no question that sales to such persons are for intrinsic value.

2. The customer "direct fulfilled" by the company.
The company knows this person because the company has a distribution system that provides direct shipping to end-users. The independent representative tells the company to ship, or the customer calls the company, identifies the independent representative who told them about the company for sales credit purposes, and places an order. The company deals with each order as it occurs and maintains no separate file of customers. It treats the order as if placed directly by the independent representative, but with a different "ship to" address. There should be no question that sales to such persons are for intrinsic value.

3. The preferred customer.
Many companies encourage their independent representatives to connect preferred customers directly to the company. Sometimes application forms are used and identification numbers are issued. Customers order directly. These persons, however, do not sign an independent representative application and do not have an income opportunity. There should be no question that sales to such persons are for intrinsic value.

4. The independent representative without a right to sponsor.
Some companies offer a separately delineated, single-level income opportunity. None of the purchases of these people can possibly be deemed "to play the game of an endless recruiting chain," because these persons do not have the right to recruit other independent representatives. These sales are for their intrinsic value or for resale to customers, and no argument can be made that the sales are a disguised headhunting fee, since the person cannot recruit other income opportunity seekers.

5. The independent representative who "signs up" to buy wholesale.
This is very new thinking and not yet tested with regulators. I am willing to argue that the right to sponsor others in the independent representative agreement is an "offer" of a multilevel income opportunity, which is accepted when - and only when - the act of sponsoring occurs. A person signing up to purchase at the independent representative price, and choosing not to sponsor, cannot be purchasing "to play the game," since, again, no recruiting of income opportunity seekers has occurred.

6. The non-sponsoring independent representative.
This is also very new thinking and not yet tested with regulators. I am willing to argue, and if unable to convince a regulator, to the appropriate judge (with good facts), that purchases by a non-sponsoring independent representative cannot possibly be a disguised headhunting fee or a "payment to play." The reason is based on simple logic - the independent representative has (for the moment, at least) declined the company's offer to "participate" (a word with legal significance) in the multilevel portion of the income opportunity. No argument can be made that the purchase is to qualify for downline bonuses or for the right to recruit, since no recruiting of additional participants has occurred.

7. The sponsoring independent representative.
In many companies that have low monthly business volume requirements to qualify for bonuses on the business volume of downlines, the following occurs: The independent representative consistently orders in excess of the minimum needed to qualify for all available downline bonuses. First, the amount above the minimum needed to qualify is not "to play the game," since only the minimum is needed. A second, optional, argument can even be made that all of the order is for intrinsic value, since one ordering solely to "participate" would just order the minimum. This may be more aggressive than necessary, but is worth noting.

Conclusion
Many companies are structured to have available, at the corporation, records supporting the above types of purchases for intrinsic value. I believe sales defined in this manner (which is one approach, and not the only approach) directly address conduct that the anti-pyramid and endless chain laws everywhere seek to regulate. Note that I have avoided the use of the term "retail sale" or "retailing" throughout this article, and on purpose, because the concept I propose is more precise. The assumption (and legal argument in the proper forum, with good facts) is that the regulated and prohibited conduct is the sale of products that no one would buy for their intrinsic value, but instead would buy in order to participate in and further an illegal endless chain. Without "intrinsic value," such sales become disguised headhunting fees, specifically prohibited by the laws of most countries.

Would you buy the company's products absent the income opportunity? Would anyone? The answer needs to be "yes." If a company's sales are "primarily for intrinsic value," the company can withstand legal scrutiny. In closing, please note that in this area what is good for the legal health of the company is also required for the economic health of the company. That is a whole new subject and article. I will just conclude by saying "sales for intrinsic value" are an absolute necessity for both legal and economic survival of direct selling companies around the world.

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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RAMBLINGS OF A TIRED LAWYER, or WHERE HAVE ALL THE PRODUCTS GONE?



Tired of the wrong idea for starting a company - and I do not mean "To make money." That will always be at the core of a new company launch. But how will the company make money? By selling something. Great. That is also proper planning. Something people want and are willing to pay for. We are still on the right track. But now the train is about to get derailed.

What do people want the most? A way to make lots of money with little effort. So we will sell them a way to do that! WRONG - TILT - STOP! Start over. Income opportunities CANNOT be sold. A company that is in business to provide income opportunities CANNOT survive. Distributors who believe their mission is to provide income opportunities to everyone they come in contact with, and who will sign the always ready application, CANNOT, long term, survive. Products or services that no one will buy, unless an income opportunity is attached, DO NOT a company make. Let me explain.

The great song of the sixties has a line, "Where have all the flowers gone?" Well, I ask, "Where have all the products gone?" (and services). The first and paramount mission of every direct selling company and its independent contractor sales force MUST BE to place as many of its "better mousetraps" in the hands of as many end user consumers as possible. An end user consumer is a customer who is buying the "better mousetrap" for its intrinsic value or worth, and NOT to participate in an income opportunity. The argument that purchases are for intrinsic value is seriously weakened if the purchases are:

  • Required to be made to be allowed to sign up as a distributor.
  • Required to be made by a distributor to "open a product center."
  • Required to be made by a distributor to qualify for a compensation plan payment.
  • Required to be made by a distributor to advance in the compensation plan.
  • Required to be made by a distributor to "re-enter" the same or a different "phase" or "cycle" of the compensation plan.
  • Required to be made by a distributor to "buy in" to a higher compensation plan title or pay level.

The above list includes an assumption that the products stay with the distributor and are not consumed or do not move on to an end user consumer. Of course, distributors can "certify" that they consumed themselves or sold to customers X percent, and/or they have on file or have sent to the company the names of Y numbers of their retail customers. (My personal view is that personal consumption in reasonable quantities and not for qualification is a retail sale and fully commissionable. Al Sheldon, California Deputy Attorney General, said as much at the last MLMIA conference, and referenced the AuQuest Settlement with specific language on personal consumption. Not all state Attorney General Offices agree.) Note that this list DOES NOT exclude ALL purchases by distributors. In some programs the company itself has proof of "purchases for intrinsic value" by the nature of the ordering system and compensation plan. For example, all companies who direct ship to customers who are linked up to the company by their representatives can easily verify that they are shipping products to a non-representative name and address. A strong presumption is raised that these are purchases for intrinsic value.

Another example would be the second and subsequent purchases by representatives who have not sponsored anyone. I concede the first purchase by a distributor is most often made with the intent of "making money" or "working the program." But if they make a second purchase, and have not sponsored anyone, they cannot be making the purchase to qualify for any portion of the multi-level aspects of the pay plan, since, by not sponsoring, they have chosen to not participate in the multi-level aspects of the program.

Yet another example would be a company with a pay plan where say $45 of personal volume is all that is ever required to be classified as "active" and eligible to receive commissions on downline volume. If the average order size is $81, a strong presumption is raised that all purchases, or at least the amounts over $45, are purchases for intrinsic value.

But I am rambling. Back to my point. I want to leave for another day and another article the issue of WHAT PERCENT of the company's sales or an individual distributor's sales should be "for intrinsic value." What I am really tired about is when the percent is ZERO. First, the most obvious: the "bad design" programs. Another name I give to such programs is "Representative only" programs. The company is really trying to enter the income opportunity business. The products or services are an afterthought, and purchased by the representatives to "play the game." There are NO true customers. Regulatory actions in numerous states in the last year have sent the strongest message possible: "Such programs will not be tolerated."

The less obvious, but also "in jeopardy," programs are those that have a "good design," but bad implementation. Company executives and their marketing and legal advisors can only go so far in setting up the program. It then comes down to what the field forces, especially the leaders, do with the program. If they take a properly designed program and implement it as a "Representative only" money game, it is doomed. I have had regulators from seven key states say to me personally or to an audience I was in, the equivalent of, "We look past the paper to what is really going on in our state."

In closing, "How much retailing?" and "What is a retail sale?" is a serious issue for all legitimate MLM companies, and is probably the number one legal issue for MLM direct sellers. I am not addressing that issue here. BUT - The existence of ZERO retailing MLM companies just gives the regulators sitting ducks, AND the opportunity to paint all companies with the same brush. The plea from this tired lawyer to company entrepreneurs is, "Do not start yet another such venture." The plea from this tired lawyer to distributors is, "Do not work such a program expecting it to be long term, as it cannot survive, and do not distort the properly designed program you are working into a 'Representative only' program."

Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.


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The Amway Case from the Price fixing Perspective



Ask ten people who have been around MLM for a few years what the Amway case says and nine of them would know at least some of the pyramid danger signs, and that Amway was held to NOT be a pyramid, etc., etc. The case, indeed, lays out a very detailed picture of what an illegal pyramid might look like, and does conclude that Amway was and is NOT a pyramid. The purpose of this article is not to rewrite an analysis from the pyramid perspective. The case is ALSO about PRICE FIXING, and we can learn much by examining those issues. The citation of the Amway case is 93 F.T.C. 618. A citation is a way of identifying, and finding, a case in a set books reporting legal decisions. The Amway Case is in the 93rd volume of Federal Trade Commission Decisions, and the decision begins at page 618. The official name of the case is IN THE MATTER OF AMWAY CORPORATION, INC., ET AL. The case has a sub-title which reads: FINAL ORDER, OPINION, ETC., IN REGARD TO ALLEGED VIOLATION OF THE FEDERAL TRADE COMMISSION ACT. The 120 pages of information is arranged in the following manner:



Page NumbersContents
618-629 Caption, Appearances and Government Complaint
629-631 Initial Decision - Preliminary Statement
632-678 Initial Decision - Findings of Facts
678-706 Initial Decision - Discussion
706-707 Initial Decision - Conclusions
707-709 Initial Decision - Order
709-714 Opinion of the Commission - Introduction
714-733 Opinion of the Commission - The Alleged Violations
733-735 Opinion of the Commission - Procedural Issues
735-735 Opinion of the Commission - Conclusions
735-738 Opinion of the Commission - FINAL ORDER

Someone reading the Orders in this case might miss the incredible significance to MLM and Pyramid law because of the significant focus on price fixing. The Order in the Initial Decision has half of its space devoted to price fixing. The FINAL ORDER of the commission has fully two-thirds of its space devoted to price fixing. The Judge concluded that Amway fixed prices. "Respondents (Amway, De Vos, Van Andel, and the Amway Distributor's Association) have agreed, combined and conspired with each other and Amway distributors to fix resale prices for Amway products, on sales between Amway distributors and to consumers, in violation of Section 5 of the Federal Trade Commission Act, 14 U.S.C. 45." The Commission, in reviewing the decision of the Judge, reached the same conclusion. "We conclude that respondents have agreed and combined with each other and/or Amway distributors to fix the resale prices of Amway products, at both the wholesale and retail levels, in violation of Section 5 of the Federal Trade Commission Act."

While no company relishes the thought of being declared a price fixer, the totality of the circumstances of this decision softened considerably the sting of such a result. First, the critical issue of an illegal pyramid was decided in Amway's favor. Second, the price fixing issue was "old news" in that much of the evidence was of practices long since discontinued and derived from manuals and literature long since amended or totally rewritten.

One view is that both the Judge and the Commission were particularly harsh on Amway on the price fixing issue to give to the Government some semblance of a victory, since the pyramid issues in the case were without merit. In the Final Order, which has no expiration date, the Commission dictated the ACTUAL WORDS of the disclaimer Amway must put on any wholesale or retail price list, order form, promotional material, or any other document which lists resale prices for products:

"The prices stated here are suggested prices only. Distributors are not obligated to charge these prices. Each Distributor is entitled to determine independently the prices at which products may be sold to other distributors or to consumers."

Section 5(a)(1) of the Federal Trade Commission Act is incredibly broad: It says "Unfair methods of competition in commerce, and unlawful or deceptive acts or practices in commerce, are declared unlawful." Combining and conspiring to fix resale prices is a prohibited act, says this Judge, says this Commission, and says hundreds of cases before and after the Amway case. The price fixing lesson from this case can be looked at from three viewpoints, the MLM or Direct Selling Company, the Distributor, in his or her relationship to the Company whose products or services the distributorship sells, and the Distributor in his or her relationship to other distributors.

A company has an absolute right to SET prices. SETTING prices is not FIXING prices. Combinations or conspiracies are needed to FIX prices and one cannot combine or conspire with one self. No matter how many employees of ABC Company sit around the conference table deciding what to charge for the new widget, it is not a conspiracy. However, no independent contractor distributor of the company should ever be at such a meeting. All of the company's employees are part of one legal entity, the corporation, for purposes of deciding whether "two or more persons" conspired to do anything. Have a distributor, or a competitor, or a supplier, or a visitor on a plant tour for that matter attend, and the requirement of "two or more persons" has been met. This, of course, is not automatically an illegal conspiracy, by why even take the chance. The classic example is two or more COMPETITORS agreeing to fix prices, usually to damage a third competitor or just to line their pockets at the expense of the consuming public. The variation on the classic theme, also prohibited by law, is retail price maintenance. It usually involves one manufacturer, with or without the knowing cooperation of one or more of its distributors. It can also involve just two or more distributors.

A company can unilaterally publish SUGGESTED retail prices. A company CANNOT do anything to require that its independent sales force sell at the prices suggested by the company. Amway's practices in the early Sixties were deemed to be illegal acts intended to maintain the retail price of its products.

It is on the issue of retail price maintenance that the Amway case becomes very specific. The Judge writes: "The Rules of Conduct of the Amway Sales Plan published in 1963 required that distributors sell Amway products to consumers at the specified resale price. It also provided that no unauthorized discount be given on sales to other distributors, and fixed the resale charge for freight. The record does not show when Amway stopped using this sales manual or whether distributors were ever clearly notified that it does not express Amway's policy. Such resale price maintenance is per se unlawful."

Amway argued that the quoted manual and the actual practice had been discontinued since at least 1972. Remember, the trial took place in 1978. The Judge listened but was not persuaded. He said "While much of the evidence of price fixing agreements is relatively old, it raises a presumption of continuity which respondents (Amway) have not rebutted." The Judge's view that there exists an affirmative duty to tell distributors they may set their own prices was further emphasized is this footnote, "The record does not show that Amway has ever clearly told its distributors that they are free to set their own prices on sales to other distributors or to consumers."

Clearly today's companies must have the right words in their literature. But beyond that, regulators and prosecutors, as they did with Amway, will examine the company's overall attitude toward the issue. Fertile ground are transcripts of company officer's speeches. Amway's Co-Founder, Rich De Vos, in 1971 in Dallas Texas, was recorded speaking to Amway Direct Distributors: "If you have a distributor who is selling Amway products at wholesale to a customer, our action has got to be first of all to get a complaint on it and find out who the distributor is that's doing it. Our next move has got to be to work on his removal, but that isn't an easy problem, because if this person wishes to sell to anybody on the street at whatever price he wants to, you're getting into some touchy areas on price fixing. Now the only thing you can point out is that sooner or later the distributor is going to go broke - because you can't go on selling the product at what you paid for it and survive in the business." In the same speech, De Vos said that price fixing is a serious matter that the federal people and the FTC watch like a hawk. Still he persisted in his advice to pressure the price cutting distributor into compliance. "You do a sales job on the guy and pointing out that if he's going to continue that he's going to destroy his own business, he's gonna work at a no-profit situation, he'll ultimately not be able to recruit distributors, because they can't make any money and what he's doing is destroying himself, and therefore in most cases where you have it happen it disappears quite rapidly."

The laws in the area of retail price maintenance are as strict today as they were in 1979 when the Final Order was issued in the Amway case. Enforcement is not limited to the FTC or the Federal arena. The States have become much more active, and Judges need little more than inappropriate quotes to support their rulings.

The lesson from the Amway case should be clear to any company selling through independent distributors: Do not directly or indirectly attempt to control or maintain the retail prices of your products. For added legal protection, remind your distributors in your literature that they have the final say in determining retail prices.

The lesson for the distributor is to resist any attempt by the company to control retail prices, and take affirmative action to get the practice stopped, both for your own protection, and the continued viability of the company. Asking the company's officers and/or counsel to read the Amway case would be a good first step.

An added lesson for the distributor is to avoid any temptation to combine or conspire with other distributors to maintain or control retail prices. A leader cannot tell his or her downline, "We sell at full retail in our line", for all the same reasons the company is prohibited from maintaining retail prices.


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Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.

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