The FTC And MLMs
According to the FTC, any direct selling company, that relies on distributors to recruit other distributors, is an MLM. While there are several variations of the MLM business model, the basics remain similar. It’s that business opportunity where you can make money if you just ‘share the opportunity with a few friends’.
There was an FTC ruling in January 2018 which was a Business Guidance For MLMs. This document sets out the core consumer protection principles, which apply to all MLMs. Regardless of what product or services they promote or which compensation model they use.
According to the FTC, an MLM is engaging in unlawful activity if it offers “the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users.” In other words it’s illegal to get paid purely for recruiting.
This is why MLMs try to make it as clear as possible that they don’t pay commission for recruiting. That being said, if you sign up to any MLM opportunity, you will be strongly encouraged to spend money on whatever it is that they promote. The person who recruited you will get commission from your starter pack.
Despite what they tell you, simply selling a product or service does not make an MLM legal. The FTC states ‘An MLM compensation structure that incentivizes participants to buy product, and to recruit additional participants to buy product, to advance in the marketing program rather than in response to consumer demand in the marketplace, poses particular risks of injury’
In other words, even if there is a product attached, MLMs will lose money unless there are retail customers. The importance of retail customers is something we happen to agree with. After all, the system can’t be a good business opportunity, if all the money is coming from participants! The FTC deems these compensation plans are deceptive and unlawful.
The FTC notes that without external consumers, it is unlikely that the participants of an MLM opportunity will recover any of their costs. Rather than making sales to the public, participants pressure their recruits to buy more product and to try and recruit even more people. The FTC warns that under such a system the majority of MLM participants will lose money.
The FTC law requires that ‘an MLM pay compensation that is based on actual sales to real customers, rather than based on mere wholesale purchases or other payments by its participants’. So even if it does sell a product or service, an MLM can still be an illegal product-based pyramid scheme.
When Is An MLM Breaking the Law
The FTC warns that consumption needs to be to satisfy real demand. In other words product that is purchased needs to be for personal use or sold to real customers. The FTC found that some participants may buy product, and pressures others in their downline to recruit and buy product purely for the chance to advance in the MLM.
There was a letter in 2004 FTC letter, which advised that it is unlawful to pay compensation on wholesale purchases which are not linked to real demand. There was a case against an MLM called ‘Burnlounge’, in which they tried to claim that the demand was for internal consumption. When the compensation plan was removed, demand for their packages fell by over 98%, thus proving that the purchases were based on the desire to advance in thecompensation plan and not real demand.
Having said that, this rule is difficult to enforce because it’s not always clear if product is being used or if MLM participants are stockpiling product. The question then becomes whether or not MLM compensation plans encourage stockpiling. If the complicated commission structure was removed, it’s quite likely that sales for most MLM products would fall substantially.
How Can MLMs Promote their Opportunities
Along with rules regarding how compensation is paid, there are also rules as to how MLMs are allowed to promote themselves. The 2018 Business Guidance addresses these too.
An MLM’s representations and messaging concerning the business opportunity it offers must be truthful and non-misleading to avoid being deceptive under Section 5 of the FTC Act. An MLM’s representations about its business opportunity, including earnings claims, violate Section 5 of the FTC Act if they are false, misleading, or unsubstantiated and material to consumers.
The FTC explains that MLM distributors can be deceptive in how they promote their business opportunities. To avoid being unlawful, MLM participants should abide by the following:
Reasonable Basis - Companies must have objective evidence to support any claims they make. Without evidence, the claims could be considered deceptive
Roads to Success - Many MLMs through words or images may present their business opportunities as a way to gain financial freedom. In reality very few participants will achieve financial success, and therefore these claims are false or misleading to prospective entrants.
Be Your Own Boss - MLMs have been found through words or images to suggest that their business opportunity will replace a full time career. If these results are not achieved by most participants, then such claims are considered false and misleading.
Earnings - Any claims about potential earnings need to be substantiated or the may be considered false and misleading. This includes testimonials from top earners. Even if their earnings are true, it is deceptive to give new entrants the impression that such earnings are achievable by anyone.
‘An MLM’s compensation structure may give its participants incentives to make representations about the business opportunity to current or prospective participants. As a consequence, an MLM should (i) direct its participants not to make false, misleading, or unsubstantiated representations and (ii) monitor its participants so they don’t make false, misleading, or unsubstantiated representations’.
In other words, it is the responsibility of the MLM to ensure that participants act within the FTC legal Guidelines. While these are just guidelines, and not necessarily laws, MLMs should to their best to adhere to them.