Franchise Legal Team

Multi-level marketing or "MLM" (also known as "direct selling" or "network marketing") can offer a wide range of benefits to business entrepreneurs seeking to leverage growth using the energy of a wide array of sale agents. However, anyone interested in implementing an MLM plan would be wise to consult with an attorney in order to avoid serious legal ramifications that can stem from these programs. Despite the potential for success, MLM distribution networks have held the attention of various regulatory bodies and legislatures for years, and the legal attempts at invalidating them have taken many forms. Often unwary and sometimes unscrupulous MLM sellers are found to have violated state laws prohibiting "chain letters," lotteries" or "pyramid marketing schemes." On the federal level, MLM operations may run afoul of the FTC Rule and various U.S. Postal regulations.

Hostility for multi-level marketing stems from the collapse of various businesses in the late 1960’s which essentially focused more on the recruitment of distributors than on sales of the actual product, allowing the market to become flooded with distributors. Eventually, the result was that some MLM schemes imploded leaving many of their participants empty handed.

Despite hostility among some legislators and regulatory bodies, not all forms of MLM programs have been or are likely to be made illegal. First, the FTC made clear in their landmark 1979 decision In re Amway that not all MLM plans are illegal pyramid schemes. Known as the Amway Rules, the FTC enumerated a list of various practices by Amway Corp. that shielded them from liability as an unfair or deceptive pyramid scheme. Those rules, however, are by no means an absolute "safe harbor" for any multilevel marketing company, and MLM programs remain under heavy scrutiny and regulation. These MLM programs can still be invalidated under a variety of state and federal statutes and can result in millions of dollars in fines, even incarceration.

When speaking of MLM, one generally means a compensation scheme where distributors receive remuneration from additional distributors when they are recruited who later sell additional products or services, or recruit other distributors. Thus a pyramid or network of down stream distributor’s sales and recruitment are attributed to and provide compensation to the distributors in the network above them. A hallmark of an illegal pyramid scheme is the incentive for its initial "front line" distributors to themselves primarily recruit other distributors into the company in order receive compensation from their sales and further recruitment, as opposed to being compensated on direct sales of the product to end consumers. This element is heavily regulated by both state and federal statutes.

Federal regulation of MLM programs fall broadly under the scope of 15 U.S.C. 45(a)(1), Unfair Methods of Competition. As described above, the Amway Rules have served as the foundation for evaluating MLMs, which consider: (1) the total ratio of annual sales of the product to distributors as compared to end customers; (2) if the MLM participants will spend an extraordinary amount of its revenues on training and product purchases, which are not resold; and (3) whether the money the participant makes is more dependant on its ability to recruit participants than on product or service sales. Amway’s plan was not illegal because it provided, in part, that 70% of the products must be sold to end customers and additionally, contained reasonable buyback provisions.

State regulation can be more particularized, although a majority of state statutes use broad definitions within their "pyramid" and "chain distributor" statutes. A small minority of states have a direct regulation approach, which allow for legitimate multilevel marketing operations through consumer safeguards. Similar to federal regulations, most state statutes include buyback requirements, which allow participants to cancel their contracts at-will, and require the seller to repurchase inventory at varying percentages of the retail cost.

The focus on recruitment of participants/distributors into the MLM program as compared to product sales to non-participants/distributors is of high importance, as this is the ground on which most MLMs are criticized. Traditional "pyramid schemes" were known to focus solely or primarily on recruitment of participants, with actual product sales being incidental to the operation. Today, legitimate MLMs will focus on product sales, and recruitment-based compensation will be incidental to compensation based on commissions from actual product sales to consumers. And that just makes good sense. The goal of a legitimate MLM operation should be to recruit loyal customers. Everyone should be a customer, but only highly-motivated participants who want to market your product should be distributors.

Under some state regulations, it can be illegal to make representations that distributors have made or will earn any stated dollar amount. Specific product claims can also be illegal. A product claim is essentially any type of advertisement, through any media forum, stating that a product can diagnose, heal, treat, cure, etc., any type of disease. These claims are illegal unless there is a scientific study backing up the claim, which can cost millions. The FDA regulates any type of product claim for virtually all products that go in or on the body. Violations of these rules can cost a company millions of dollars in fines. Additionally, the FTC recently released stricter guidelines for customer product testimonials, which now require a study and disclosure of "typical" results for the relative population if the testimonial is not a "typical" result. These studies are incredibly costly and must be carefully designed in order to comply with FTC rules.

And that’s not even an exhaustive list of ways MLMs can come under fire. Violations of regulatory rules, and state and federal statutes can be incredibly costly, and can even result in jail time for participants. Anyone considering participating in or structuring a multilevel marketing plan would be highly advised to seek guidance from an experienced attorney to avoid the severe ramifications that result from violations of these rules.

Companies considering entering the MLM marketplace, and those who are already in the marketplace who have yet to have their programs reviewed by counsel should have a legal review of their advertising activities and program compensation plan. This legal review will address the entire method in which the MLM program is advertised and implemented. While a legal review does not serve as "insurance" against prosecution, fines or enforcement actions, it does provide the company guidance and the comfort of knowing that it has taken reasonable steps to reduce the likelihood that its program violates applicable law. These efforts can save tremendous money, time and heartache for the company in the long run. In addition, as part of this legal review, the company may offer multiple ways in which it can improve its compensation plan and advertising to increase sales, increase the opportunity for participants to join its system, and ultimately grow its company. Thus, a legal review should not be considered an impediment to growth, but a key component in the company’s arsenal to achieve it. If your company is considering operating an MLM plan or is already doing so, consider contacting us to have our experienced counsel assist you with a legal review and, if necessary, modifications to your program.

If you wish to learn more about how to structure a legally compliant and effective MLM program, contact us at This e-mail address is being protected from spambots. You need JavaScript enabled to view it or call Scott at (813) 279-2100.

Check out this recent article.  It has interesting insights into franchisee success rates.

http://finance.yahoo.com/career-work/article/109355/10-most-popular-franchises

More from Scott Phillip Weber, PA blog is coming soon.  To see other blog posts by Scott Weber, see the Brandchise Blog at www.brandchise.com