Network
Marketing Legal Issues
by
Jeffrey A. Babener
MLM Legal Attorney
©1996
Although
not without its challenges today, as a general matter, legitimate network
marketing companies are well received throughout the U.S. With increasing
frequency, federal and state governments offer assistance and guidance to
the network marketing industry. The IRS releases special publications, videos
and has adopted specific regulations recognizing a very legitimate profession.
As in the franchising industry, several states have also adopted specific
legislation for multilevel distribution companies which set forth objective
standards for those companies to follow. Differentiating a legitimate network
marketing opportunity from a pyramid scheme should not be a difficult task
for the entrepreneur when some basic and objective indicators are observed.
Any industry that offers such dramatic rewards and carries with it a lower
dollar cost of entry obviously will tend to attract some of the best and some
of the worst entrepreneurs. The industry has not always thrived. Over the
years, it has come perilously close to extinction as a result of prosecution
by regulators who claimed the industry promoted pyramid schemes under the
guise of legitimate marketing. And, in many cases, the prosecutors were correctly
chasing and eradicating such scam and scheme pyramids.
Other programs which were in fact legitimate have survived, however. In a
classic legal decision in 1979, the Amway Corporation prevailed in such a
prosecution and in fact, effectively, received a stamp of approval of its
marketing program by the Federal Trade Commission. This particular decision
opened the door to many other legitimate multilevel marketing companies.
Because of the abuses of the "rotten apples" of the industry, multilevel
marketing has become a closely scrutinized and regulated industry. Regulations
regarding multilevel marketing companies in the United States are a constantly
changing patchwork of overlapping laws, which lack uniformity and vary from
state to state.
The basic thrust of these statutes is that marketing plans are prohibited
which require an investment or purchase by sales representatives for the right
to recruit others for economic gain. Under these statutes, multilevel marketing
companies must be bona fide retail organizations which market bona fide products
to the ultimate consumer. Inventory loading and "headhunting," or
remuneration for the mere act of recruiting others, are prohibited. Sales
kits should be sold at actual company cost to sales representatives.
In the leading legal decisions, a variety of abuses have been targeted as
potential elements of illegal marketing plans:
- Products which have "no real world" marketplace, i.e. the marketing
program is a facade for a scam.
- Products which are sold at inflated prices.
- Plans which result in inventory loading or "buy-in" qualification
by distributors.
- Substantial cash investment requirements.
- Mandatory purchases of peripheral or accessory products or services.
- Plans in which distributors are left with substantial unsold inventory
upon cancellation of participation.
- Plans in which fees are paid to distributors for headhunting and emphasis
is on recruitment rather than sale of product.
- Earnings misrepresentations or inflated earnings representations.
In determining whether or not a program is a legitimate multilevel marketing opportunity, the would-be participant or the entrepreneur, who is considering a multilevel marketing program, should consider several important points:
- Product or Service. The company should offer a high quality
product or service in which consumer satisfaction is guaranteed. It must
have a "real" demand in the marketplace. If the product is consumed
by distributors themselves, it must be one that distributors would want
to buy on its own merits, irrespective of participation in the marketing
plan.
- Price. The price of the product or service must be fair
and competitive in the marketplace. Distributors should be able to purchase
the company product at wholesale or at a substantial discount from prices
found in retail stores.
- Investment Requirement. There should be no investment
requirement at all, except a sales kit or demonstration material sold at
company cost.
- Purchase and Inventory Requirement. A legitimate marketing
program should have no minimum purchase requirement, nor any inventory requirement,
for one to become a distributor or sales representative. Once in the business,
however, ongoing activity or qualification requirements are typical of leading
network marketing companies - i.e. minimum monthly personal and group wholesale
purchase volume.
- Use of Product. Products should be used by consumers
and not end up in a garage or basement.
- Sales Commissions. Sales commissions should not be paid
for the mere act of sponsoring other distributors.
- Buy-back Policy. A legitimate multilevel marketing company
will agree for some reasonable period of time to buy back inventory and
sales kit materials in resalable condition from distributors who cancel
participation in the program.
- Retail Sales. The focus of the marketing program should
be to promote retail sales to nonparticipants. Many states and programs
recognize that purchases for personal or family use in reasonable amounts
by distributors are also retail sales.
- Distributor Activity. Many of the new statutes regarding
multilevel distribution companies require that distributors perform a bona
fide, supervisory, distributive selling or soliciting function in moving
the product to theconsumer, i.e. that they have meaningful contact and communication
with their downline sales organization.
- Earnings Representations. The basic rule is that a legitimate
marketing program should not make any earnings representations unless those
representations are based on a track record. Testimonials by individuals
of their own experiences are not uncommon, however.
- Training. A good network marketing program should offer solid training in sales and recruitment to its distributors.
The future of the network marketing industry will require cooperation by companies, distributors and those governmental agencies charged with regulating the industry to assure that legitimate practices prevail and pyramiding schemes are stamped out. Every network marketer should apply the above principles in evaluating a new program or working within their existing program.
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad. His firm has focus on startup and emerging MLM companies. He has been adviser to such companies as Avon, Nikken, Discover Toys, NuSkin, Excel, Fuller Brush, Cell Tech, Kaire, Sunrider, Melaleuca, etc. He is editor of the industry resource internet site www.mlmlegal.com. He is a frequent lecturer and has been interviewed on the industry, and published, in many publications. Babener & Associates, 121 SW Morrison, Suite 1020 Portland, OR 97204, www.mlmlegal.com
