In a striking development, the Federal Trade Commission (FTC) issued a revised Notice of Proposed Rulemaking on March 18, 2008, recommending significant revisions to the proposed Business Opportunity Rule that the FTC announced nearly two years ago. The revised proposed Rule largely adopts the recommendations of the Direct Selling Association (DSA) and clearly indicates that the FTC intends to exempt direct sellers from coverage of the Revised Proposed Business Opportunity Rule.  The FTC concluded major revisions to the initial Rule were necessary to “avoid broadly sweeping in sellers of multilevel marketing opportunities” and “that the proposed Rule is too blunt an instrument to cure fraud in the MLM industry.”  Rather, the FTC determined that it will continue to use the flexibility it has in existing law to enforce and address individual cases of fraud on a case-by-case basis.

By way of background, in April of 2006, the FTC issued proposed changes to its 1970’s era “business opportunity rule” by issuing a new proposed Business Opportunity Rule which would have broadened the rule’s scope to include direct sellers and other businesses that had previously not been covered.  In response, The Direct Selling Association (DSA) and its members carried out an advocacy strategy to educate the FTC about the direct selling industry and how the proposed rule would have adversely affected direct selling companies, salespeople, and their customers.  Among the proposed requirements, the original Rule would have imposed a seven-day waiting period on any person interested in signing up as a direct seller, and required a number of information disclosures related to earnings, legal actions, and salespeople.  In DSA’s view, these burdensome disclosure and reporting requirements were not only unnecessary but would have stifled the dynamic growth of the direct selling industry.

The FTC agreed with DSA’s views that the initially proposed Rule “would have unintentionally swept in numerous commercial arrangements where there is little or no evidence that fraud is occurring” and that the changes would have “imposed greater burdens on the MLM industry than other types of business opportunity sellers without sufficient countervailing benefits to consumers.”  Accordingly, the FTC proposed changes to its initial proposed Rule to unequivocally remove direct sellers from coverage of the proposed revised Rule.

The FTC has requested comments to the proposed revised Rule by May 27, 2008.  DSA in coordination with its member companies, intends to provide comments to the FTC on the revised proposed Rule.  Following the end of the comment period, the FTC might hold hearings or workshops on the proposed revised Rule prior to the promulgation of a final Rule.

FTC ANALYSIS AND COMMENTS

In its comments and analysis announcing the revisions to the proposed rule, the FTC makes extensive observations that may have as much significance as the revisions themselves.   DSA’s comments to the FTC on the adverse impact that the initial proposed rule would have on the direct selling industry, as well as those of a number of DSA members, are cited often by the Commission.  Additionally, the FTC noted the almost 17,000 comments which had come from individual members of the “MLM industry.” ¹  Specifically, the FTC comments and analysis address:

• The inapplicability of the Proposed Rule, as amended, to direct sellers;
• The difference between legitimate multilevel companies and pyramid schemes (p.43);
• The lack of a need for a specific anti-pyramid rule (p.49);
• The lack of evidence of  prevalent deceptive practices in the “MLM [direct selling] industry” (p.42);
• The preference for a fact specific inquiry into the legitimacy of any one entity on a case-by-case basis rather than a broad rule (p.44); and
• The difficulties and undesirability of imposing a uniform earnings disclosure requirement across the direct selling industry (p.46).

Inapplicability of the Rule to Direct Sellers

The FTC comments repeatedly reiterate the agency’s intention not to cover direct sellers (“multilevel marketing”) under the proposed Rule.  Specific references are cited below:

“The [original proposal] would have unintentionally swept in numerous commercial arrangements where there is little evidence that fraud is occurring . . . [and] imposed greater burdens on the MLM industry . . . without sufficient countervailing benefits to consumers” (p.17);

“The revised proposal does not attempt to cover MLMs (p.16);

“The Commission does not believe it practicable or sufficiently beneficial to consumers to apply the proposals…against multi-level marketing companies…” (p.23);

“The Commission does not dispute the proposition that MLM companies can operate legitimately (p.38);

“The Commission is not persuaded that any of the proposals would likely to lead to a rule that would not unfairly burden legitimate companies (p.45);

“The Commission is not persuaded at this time that the proposed remedies would significantly redress consumer harm…(p.52);

“The Commission believes that the proposed rule is too blunt of an instrument to cure fraud in the MLM industry (p.52);

“The Commission takes MLM companies out of the ambit of the Rule (p.61);

“The [Rule] has been pared back to exclude MLMs (p.74);

“… these provisions would no longer apply to MLM companies, inasmuch as these companies, and their representatives, are excluded from the ambit of the [Rule] (p. 75); and

“MLM companies’ peculiar concerns are no longer relevant inasmuch as they are excluded from the scope of the [Rule] ” (p.78).

DSA believes that the  FTC’s statements exempting  “multilevel marketing companies” refer to an exemption for all DSA members and those companies that would qualify for DSA membership, inasmuch as the narrowing of the rule  was undertaken in response to DSA’s concerns.

Defining Pyramid Schemes

In its comments, the FTC affirmed the differences between legitimate multilevel companies and pyramid schemes, reflecting the same standard the agency has used for many years.  The FTC concluded:

“The main difference between a pyramid scheme and a legitimate MLM is that the legitimate company actually derives its income primarily [emphasis added] from the retail sale of products to end users [emphasis added], while the pyramid scheme supplies income to participants at the top of the pyramid primarily [emphasis added] through fees that new participants pay for the right to participate in the venture.”² 

Notably, the comments do not describe who might constitute an “end-user” and avoids any discussion of compensation based on internal consumption.  The comments do not explore the topic of whether an end user might also be a plan salesperson. In fact, the Commission rejects the option of adopting a separate rule defining and prohibiting pyramid schemes, but rather relies on its existing authority and flexibility under Section 5 of the FTC Act ( which generally prohibits unfair or deceptive trade practices) to take actions against such frauds.  The FTC concluded:

“[T]here is no bright-line, universal test for the particular quantity of retail sales that in every case would suffice to fund the payment of commissions for every MLM company. While economic analysis can reveal if an individual company clearly is operating legitimately or if it clearly is a pyramid scheme, it is difficult to draw an appropriate line in the gray area.  Second, any definition of “pyramid scheme” would provide bad actors with a road map for restructuring their businesses to skirt the definition, at least facially, and thereby providing them with a safe harbor that could undercut law enforcement efforts.”…AT this time, and on the basis of evidence in the record, the Commission declines to define “pyramid scheme” through rulemaking but will continue to use Section 5 to attack such schemes.”³

In the FTC’s (and DSA’s) view, adequate precedent exists for accurately defining pyramid schemes under Section 5 of the FTC Act without threat to legitimate direct selling companies.  Importantly, the Commission rejects any absolute standard regarding retail sales, despite the promulgation of such a standard by FTC economists in other publications.⁴

Economic analysis of the MLM business model suggests a continuum with clearly legitimate MLMs at one end and clearly fraudulent pyramid schemes at the other. … in the middle is a substantial gray area where differentiating between the two is much more difficult…Indeed, the question of whether a purportedly legitimate MLM is, in reality, only a pyramid scheme in masquerade is a highly fact-intensive inquiry (p.44).

In previous discussions with the FTC, DSA has urged that such fact based inquiries be used when taking action against pyramid schemes, in order to avoid artificial tests that might call into question long accepted practices of legitimate companies.

Earnings Disclosures

The FTC rejected the application of the business opportunity rule’s earnings disclosure requirements to direct sellers as “fraught with problems and complexities” (p.46).  Moreover, the FTC concluded: 

Given the complexities of each MLM’s compensation schedule, developing a standard, useful, understandable, and straightforward earnings disclosure that would serve industry-wide is elusive. Further complicating the problem are the practical considerations of whether MLMs could, using an industry-wide format, gather reliable information on retail earnings.”⁵  Accordingly, the FTC is not inclined to apply a hard and fast rule on earnings disclosures.

Specifically, the Commission cites treatment of inactive salespeople, abuse of the earnings disclosure by true pyramids, treatment of wholesale purchasers, and the deduction of expenses as practical difficulties in adopting an industry-wide rule. By recognizing these issues as raised by DSA and its members, it appears that the FTC has effectively precluded the adoption of any specific earnings requirement, even one outside of the business opportunity rule, to direct sellers.  Instead, the Commission will continue to undertake enforcement actions against deceptive earnings claims using its authority under Section 5 of the FTC Act.  Precedent under that section gives guidance to direct sellers and other businesses regarding earnings claims and is consistent with the obligations of  the DSA Code of Ethics provisions regarding unsubstantiated earnings claims. ⁶

PROPOSED REVISIONS TO THE BUSINESS OPPORTUNITY RULE

The FTC has set forth specific language redefining a “business opportunity, and relies upon three aspects of the definition to effectively remove direct sellers from coverage.⁷

• First, the FTC limits coverage to those business relationships in which the prospective purchasers makes a required payment, but excludes from the definition those relationships in which the only required payment is for inventory at bona fide wholesale prices.
• Second, the application of the Rule would no longer be triggered by virtue of an earnings claim being made, i.e. the mere representation by a company that an individual might make money will not trigger the rule.
• Third, in order to be considered a “business opportunity” the company would have to offer “business assistance” to a prospect.  “Business Assistance” is defined as providing locations, outlets, accounts, or customers, or promising to buy back goods or services that an individual makes. ⁸

Taken in their totality, these provisions significantly narrow the scope of the initially proposed rule and reflect the FTC’s intent to remove direct sellers from coverage.

Nonetheless, DSA will use the renewed comment period to make clear that direct sellers will not covered by the Rule  by virtue of  certain payments for saleskits or application fees, Internet sales or customer referrals to individual sellers.

CONCLUSION

While the FTC Business Opportunity rulemaking is not complete, it is clear that the concerted efforts of DSA and its members have had a significant impact on the thinking of the agency.  Equally clear is the intention of the FTC to remove direct sellers from the coverage of the revised Rule.  Further refinement of the revised Rule is anticipated over the next several months, and DSA’s Business Opportunity Task Force and Government Relations Committee will continue to develop an industry-wide response.  Concerted, coordinated and thoughtful response by the industry, through its association and individual members, has proven to be a potent tool in our efforts thus far, and we expect, and we urge continued involvement and vigilance by the entire DSA membership on this important issue.

DSA also wishes to thank Government Relations Committee Chair Josephine Mills of Avon and FTC Business Opportunity Task Force Chair Michael Lunceford from Mary Kay for their leadership in coordinating an industry strategy that has led to such a positive result.

NOTES:

1. The FTC comments describe “multi-level” marketing as “one form of direct selling.”  We take the FTC’s meaning in this instance to exempt all direct selling from the coverage under the Proposed Rule, but will seek clarification of the agency’s intent nonetheless.
2. RPBOR at p. 43.
3. RPBOR at pp. 49-50.
4. See VanderNat and Keep, Marketing Fraud: An Approach to 155
   Differentiating Multilevel Marketing from Pyramid Schemes, 21 J. of Pub. Pol’y & Marketing.
5. RPBOR at p. 46.
6. Direct Selling Association’s Code of Ethics, “Section 8. Earnings Representations,” July 2007.
7. RPBOR at p. 108.
8. In the RPBOR, the FTC defined a “business opportunity” as:

(c) Business opportunity means:
    (1) A commercial arrangement in which the seller solicits a prospective
purchaser to enter into a new business; and
(2) The prospective purchaser makes a required payment; and
    (3) The seller, expressly or by implication, orally or in writing, represents that
       the seller or one or more designated persons will:
(i) Provide locations for the use or operation of equipment, displays,
       vending machines, or similar devices, on premises neither owned nor
       leased by the purchaser; or
       (ii) Provide outlets, accounts, or customers, including, but not limited to,
       Internet outlets, accounts, or customers, for the purchaser’s goods or
       services [emphasis added] or
       (iii) Buy back any or all of the goods or services that the purchaser makes,
produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example,
       stuffing envelopes from the purchaser’s home