How MLMs Finesse the FTC
By Brooke Fetterhoff
It’s well-documented that many multi-level marketing companies (MLMs) operate suspiciously like illegal pyramid schemes. In fact, a report from the Consumer Awareness Institute found that 99% of MLM participants actually lose money. The report analyzed over 500 MLMs and concluded that their compensation plans are based on recruiting large downlines, where only those at the very top of the structure with the most recruits make any money.
If that sounds familiar, it’s because that’s exactly how pyramid schemes operate. The Federal Trade Commission (FTC) even acknowledges that some multi-level marketing companies (MLMs) are illegal pyramid schemes. The question then is: if the business models of many MLMs so closely resemble an illegal design, why does the FTC allow some of these companies to operate?
In the early 1970s, it looked as though the FTC was going to crack down hard on the industry. An important precedent was set when the agency brought a case against Koscot Interplanetary, alleging the cosmetics company to be an illegal pyramid scheme. The ruling in this case established the principle that compensation of participants in MLMs must depend on actual sales, not recruiting other participants (like in a pyramid scheme).
Although Koscot lost that case, it wasn’t long before MLMs got their break. The 1979 ruling of In re Amway Corp. determined that Amway was not a pyramid scheme (as strictly defined by law), and established safeguards for MLMs that provided a path for them operate within specific legal boundaries. These included a requirement that MLM participants must sell 70% of previously purchased products to 10 customers before placing a new order, and that companies must provide a buyback policy for unsold inventory.
Amway was permitted to continue so long as it adhered to these retail rules. While one might hope that these guidelines would prevent MLMs from returning to their pyramid scheme ways, the rules were left to be enforced by Amway itself, which means they were never sufficiently implemented and do little to stop other MLMs from following Amway’s dishonest lead.
Still, Amway has faced multiple lawsuits over its questionable business practices in the decades since, including a class-action lawsuit that resulted in a $56 million dollar settlement. While the initial lawsuit alleged Amway was a pyramid scheme, the final settlement was amended so that the phrase “pyramid scheme” was practically eliminated.
With this legal roadmap established, the FTC would now go after particularly egregious MLMs on a case-by-case basis. In the past 42 years, the FTC has filed 32 cases against MLMs for allegedly operating as illegal pyramid schemes. Specifically, the FTC accused the MLMs in these cases of violating Section 5 of the FTC Act prohibiting “unfair or deceptive acts or practices in or affecting commerce.” The cases all alleged false earning claims, and most included several counts falling under Section 5, including having an illegal recruitment-based compensation model, and perpetuating false efficacy claims of their products. In most cases, a settlement was reached that included a fine and an agreement not to violate the FTC Act again.
The FTC claims that this case-by-case analysis allows for an assessment of bad actors without directly affecting the entire industry or having unintended consequences from “one-size-fits-all industry standards.” Yet, according to the University of Pennsylvania Journal of Law and Social Change, between 1997 and 2005, the FTC received over 18,000 complaints against MLMs but brought only 20 cases. It is abundantly clear that the FTC’s hesitance to go after the MLM industry as a whole is protecting the companies themselves — not the consumers that the FTC is meant to protect.
Part of this hesitance can be explained by the tremendous political power that the MLM industry has built up through decades of lobbying. Amway has been a prominent political donor since the 1980s, becoming one of the biggest financial backers of the Republican party. In fact, in 1994, Amway made what was — at the time — the largest single corporate contribution ever recorded to a political party. Three years later, Republican House Speaker Newt Gingrich returned the favor by gifting Amway a $283 million tax break through a last-minute addition to that year’s tax bill.
Though, the political influence of MLMs is not only limited to Amway or to the political right. Herbalife, for instance, makes donations to both Republicans and Democrats. Although the company was eventually subject to its own FTC investigation, the inquiry didn’t come easy. A FOIA request revealed the FTC had received at least 188 complaints related to Herbalife, but only acted when publicly pressured by a wealthy businessman. Yet, like Amway, Herbalife was simply told to restructure their compensation plan to fit the parameters set by Koscot and Amway, and let go with a $200 million fine. It appears that like Amway, Herbalife negotiated away the words “pyramid scheme” from the final settlement.
Indeed, Herbalife had plenty of cash to go around. The company’s lobbying expenditures increased dramatically in the years preceding the investigation, from under $600,000 in 2012 to nearly $2 million by 2014 — the year the FTC formally announced its investigation. With a whopping $3.98 billion gross profit in 2014, the fine was a slap on the wrist for a company as wealthy as Herbalife. The FTC allowed Herbalife to go on its merry way without fundamentally restructuring its business model. It is possible that the company may stray from the clearly defined 1979 guardrails and face another multi-million dollar fine a few years down the road, but its army of lawyers will undoubtably do everything in their power to keep the company technically compliant. The Journal of Law and Social Change points out that high-powered MLM lawyers have become particularly adept at protecting their companies “on the basis that they disclosed their actions through hidden or generic disclaimers.”
Of course, not every MLM company can afford to hire an army of lobbyists and lawyers like Herbalife and Amway. Luckily for those lesser-resourced MLMs, the industry has the Direct Selling Association (DSA) as its lobbying arm. The DSA has made it a priority to protect the deceptive practices of MLMs from widespread scrutiny.
Perhaps the most profound impact of the DSA’s lobbying occurred with the successful weakening of the FTC’s Business Opportunity Rule. According to the aforementioned Consumer Awareness Institute report, the FTC proposed a Business Opportunity Rule in 2006 that would “require sellers of business opportunities to disclose average incomes, references, and other information crucial to a decision on whether or not to participate.” The DSA both lobbied Congress and encouraged MLM participants to appeal against the rule, resulting in 17,000 comments (largely following MLM company form letters) in opposition to the FTC’s planned action. In 2008, the agency yielded to DSA’s lobbying and introduced a Revised Rule that essentially exempted MLMs from such financial disclosure.
In 2011, the rule was officially adopted. While the FTC states that this rule does not entirely exempt MLMs — with investigations still being conducted on a case-by-case basis — the final rule hampered the FTC’s ability to investigate MLM companies for deceptive practices; the agency can only investigate after claims of false or deceptive practices are brought against a company. While the Business Opportunity Rule was originally crafted to allow consumers to assess the risks of business ventures, the FTC’s concession to the MLM industry legitimizes a business structure known for making false claims and made accountability possible only after participants have been financially harmed.
Since then, the DSA has only grown in political power — now even boasting its own congressional caucus. In 2017, some of its members pushed the controversial H.R. 3409: Anti-Pyramid Promotional Scheme Act. By its name, one might expect the bill to be pro-consumer protection in nature, but critics argued that it would actually let MLMs operate even more like pyramid schemes, allowing for purchases by participants to count as retail sales to consumers — with the participant being their own “consumer”. Thus, if the main legal distinction of MLMs from pyramid schemes relies on actual sales to retail consumers, forgoing this requirement and allowing participants to buy their own products is simply creating a compensation plan based on recruitment.
The bill was sponsored by 50 members of Congress — 18 of which were then part of the DSA’s caucus. Seven of the ten organizations registered to lobby on the bill were MLM companies — six of which are members of the DSA. The bill eventually died, but that certainly didn’t stop the DSA from continuing to fight for looser MLM regulations, broadly.
There are, however, some encouraging signs — with the FTC taking more action against MLMs in recent years. The COVID-19 pandemic saw an increase in MLM activity, and this flare-up has caught the agency’s attention. An attorney for the FTC explained that social media makes it difficult for the agency to determine whether distributors are making false claims, as most communication is done via private message on private accounts. In 2020, The FTC sent warnings to at least 16 MLMs regarding deceptive income and health claims related to the efficacy of their products against coronavirus. William Keep, a researcher who has studied multi-level marketing companies, describes the shift of FTC enforcement: “’20 years ago, the overwhelming emphasis was, ‘Is this a pyramid scheme?’ Now regulators are saying, ‘Whether this is a pyramid scheme or not, you can’t go out and say misleading things.’”
Yet, it still seems as though the entire MLM industry relies on deception. If an MLM tried to recruit under the basis that 99% of participants would lose money, nobody would fall victim to MLMs. The FTC has set precedents to control the industry, but does little to ensure these regulations are being met. In fact, rather than assert more control over the controversial industry, the FTC bowed to the power of its lobby in the case of the Business Opportunity Rule. In 2021, the FTC began reviewing this rule, with potential changes coming this year. Altering its exception for MLMs would aid in protecting consumers and allow the FTC to evaluate the claims of MLMs prior to infringement.
Further action is profoundly needed to control the powerful MLM industry. The FTC reportedly plans to ramp up its actions against MLMs. Whether or not such action comes to pass, it’s clear that the “safeguards” established in the Amway decision do little to protect consumers against MLM harm, and something stronger must be codified into law.