FTC v. Equinox - Deja Vu

By Jeffrey A. Babener
  1999

It was no surprise to the direct selling industry that Equinox International Corporation and its founder Bill Gouldd were again embroiled in controversy. They earlier had been the subject of a highly critical report on ABCs 20/20.

"It's deja vu all over again."

Yogi Berra

In years past, Equinox had entered into a consent decree in Florida and its founder Gouldd had entered into a consent decree in California arising from pre-Equinox activity as an NSA distributor. Ex-Equinox distributors fleeing the company had been very critical of company practices, and one of its distributors had gone so far as to pen a book on the subject.

Thus, without even knowing the allegations, it was probably not a surprise to the industry that Equinox was subject to just one more regulatory action in August, 1999. What was surprising, however, was the depth and breadth of an action that could be lethal to Equinox. On August 3, 1999, the FTC, together with six states, Hawaii, Maryland, Nevada, North Carolina, Pennsylvania and South Carolina, filed suit in U.S. Federal Court in Nevada accusing Equinox and its founder of operating an illegal pyramid scheme. As has become a pattern in earlier FTC actions, upon request of the FTC and without notice, the federal court entered a restraining order and froze the assets of the company. Equinox has denied the allegations and posted resistance to the action, but historically, direct selling companies subject to this type of FTC action have not survived in the marketplace.

FTC SIGNALS ITS CONCERNS.

Apart from general pyramiding accusations, the direct selling industry can learn from the FTC's specific allegations of improper activity. Among the FTC accusations of inappropriate activity:

  1. Prospective recruits were lured by advertising for promises of job or employment interviews, which turned out to be opportunity pitches.

  2. New recruits were front-loaded with $5,000 inventory purchases by being encouraged to "buy-in" at the managerial level.

  3. New recruits were "sucked into" expensive auxiliary activities, including renting desks to engage in organized recruiting, as well as urged to attend expensive training meetings.

  4. The vast majority of recruits received little in return for their very large initial investment.

  5. The program appeared to be a headhunting scheme in which there was very little retail sales enforcement.

  6. The emphasis was on recruitment.

  7. New recruits were faced with inappropriate and unrealistic earnings claims.

As would be expected, the company denied the allegations, but other direct selling companies can learn from this laundry list and take stock in their own practices.

THE FTC "BAD ACTORS AND BAD ACTIONS" ENFORCEMENT POLICY.

If some of its specific accusations are proved correct, the FTC has legitimate concern. Whether that concern arises to a level of "driving" a well-established company out of business is another issue.

What, in fact, has enabled the FTC to take such sweeping actions and cripple MLM companies with restraining orders that become "death warrants" is a newly adopted FTC position, in the aftermath of the famous Omnitrition case, that has gone unrebutted by the direct selling industry. That position is that a direct selling company is a pyramid scheme if the majority of its sales revenue do not come from sales to nonparticipants. This position is asserted by the FTC in one case after another and never appears to be adjudicated, because companies either enter into crippling consent decrees or fold under restraining orders and asset freezes.

As a result, the FTC is free to pick and choose among its targets with the basic enforcement policy that it will chase after "bad actors and bad actions." This was the FTC's rationale in pursuing Fortuna Alliance, World Class Network, Futurenet and JewelWay. On the other hand, when the FTC has felt less strongly about the actors and the actions, it has entered into consent decrees, such as with NuSkin and New Vision, that allowed the companies to go forward and prosper.

A GOVERNMENT OF MEN, NOT A GOVERNMENT OF LAW.

A frequent comment when Americans do business abroad in third world countries and in the regulatory climates of Russia and China is the observation in those countries that "we are a government of men, not laws." The message in many such countries is that regulatory activity is arbitrary and capricious and at the whim of officials. As a result, regulatory activity is selective and unpredictable.

Although the FTC may be correct in its accusations against Equinox, and only time will tell, its basic approach is dangerous for a major industry in the United States, the direct selling industry. Its position on personal use, demanding a majority of revenue to come from sales to nonparticipants, allows for a sweeping, arbitrary and selective action against members of the direct selling industry where personal use by distributors has been a major component for the business model through its existence. Its procedural approach by which a lawsuit is filed under seal, a restraining order is achieved and the assets of the company and its owners are frozen without notice, is an unfair tactic against a well-established company that virtually seals its death before a dialog has ever taken place between the FTC and the company.

As if the industry did not already have significant problems with the FTC's fifty percent plus rule, the FTC went even further in the Equinox case. In the landmark FTC v. Amway decision, Amway was exonerated because of its 70 percent rule, retail customer rule and buyback policy. Equinox had similarly adopted a 70 percent rule, six retail customer rule and buyback policy. In other words, its rules came close to the famous FTC administrative decision which legitimized Amway.

Of course, the FTC questioned in this suit whether Equinox enforced these policies. That is not what is significant about this case, however. The FTC went on to state in its complaint that, even if the 70 percent rule and the six customer rule where enforced, it would be insufficient to satisfy the FTC because its fifty percent plus rule should be the guiding factor and that the six retail customer rule did not guarantee that the majority of sales revenue would come from nonparticipant customers.

This FTC position goes way beyond the FTC v. Amway case and hangs "like a sword of Damocles" over all direct selling companies. Established companies, such as Amway, Shaklee, Rexall and Herbalife, must ask themselves if they can meet this new arbitrary standard promoted by the FTC, namely the fifty percent plus nonparticipant sales revenue rule. And, all companies in the direct selling industry, given the FTC's position on personal use and its procedural approach of "trial by ambush" must ask "who is next?"

In addition, another worrisome precedent has been launched in the Equinox case. In the Equinox case, unlike earlier FTC cases, the FTC has invited involvement by state agencies as well. In other words, the FTC positions are spilling over to state actions and positions by state agencies. In addition, many of the actions by the state agencies are based on allegations of securities violations as well as consumer law violations. Again, although the FTC may be right in its accusations against Equinox, nevertheless a contagious element of prosecution can be demonstrated from Omnitrition to the FTC actions to state enforcement actions. This makes predictability for the direct selling industry very difficult.

A CALL TO ACTION FOR THE DSA.

The DSA, the Direct Selling Association, is the principal spokesperson and lobbyist for established companies in the direct selling industry. It has in the past had an enviable track record including recent success in convincing states such as Texas, Louisiana, Montana and Wyoming to recognize personal use by distributors as part of the business model of legitimate direct selling companies. It has, however, sorely missed the opportunity since the FTC first started espousing the fifty percent rule in the Fortuna Alliance case to work with the FTC to reach an acceptable position on what is a "legitimate business model" for the direct selling industry. As a result, the FTC has become more emboldened in each case, to the point where it now may be proceeding with an enforcement policy that is arbitrary, capricious and inconsistent with a decision imposed upon it in the 1979 FTC v. Amway case. Every day that goes by without substantive dialog and resolution between the industry and the FTC will produce more arbitrary regulatory action and less predictability in this form of enterprise both from federal authorities as well as an expanding array of state authorities.

As has been suggested by industry commentators for several years, and perhaps not taken seriously enough by the Direct Selling Association, the DSA should adopt as its number one priority a dialog with the FTC to:

  1. Implore the FTC to discontinue its "trial by ambush" approach to regulation of direct selling companies, and

  2. Back off from the fifty percent plus model that is unfair to an established industry that does $20 billion a year in sales.

For its part, the DSA and the industry should have no problem in lending support to the FTC in stamping out invidious practices that are truly connected to pyramiding activity such as: front-loading of inventory, inappropriate earnings claims, encouragement of large investments, "buy-ins" to positions in programs, headhunting recruiting schemes, and other deceptive-type behavior. These are legitimate challenges that the industry should assist the FTC to eradicate.

WINDOW OF OPPORTUNITY.

The Equinox case may provide a window of opportunity for both the FTC and the industry. By focusing on specific practices that are objectionable, companies in the industry may learn and control their behavior and that of their distributors. At the same time, the industry (and in particular, the DSA) should take the case as a wake-up call that its future will be even less secure if it does not seriously dialog with the FTC on the two issues of "trial by ambush" and "personal use" by distributors as a part of the direct selling business model. With each new case, the industry situation is more tenuous. Will Equinox be vindicated? Will Equinox survive? These are questions that will only be answered in time. The company will have to answer for itself. Its practices are not the role model for the industry, some of the broader issues in the Equinox prosecution face imperative questions for the ongoing future of the direct selling industry.


Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
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.

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