By Jeffrey Babener, © 2019
(First Published in World of Direct Selling)
The Answers are in the Shadows
In a legendary exchange about the genius of his music, Mozart noted that, if you are looking for the real music, you will find it in the silence between the notes.
On May 17, 2019, out of the blue, a 26 year old Texas-based MLM/direct selling company, AdvoCare, respected in the industry for its business and products, announced, after “confidential talks with the FTC,” its only “viable choice” was closure of the MLM aspect of its business, with its attendant negative impact on the livelihood of all those distributors who worked hard to build downline sales organizations.
The Internet lit up.
MLM distributors decried betrayal, and they also may have wondered if this was merely step one to go directly into retail stores or online as Slick50 and Metabolife did after their MLM sales force created a market and brand.
Other leading direct selling companies were stunned. And distributors of those companies wondered, “Are we next?”
What happened? We may never know. Should the $30 billion MLM/direct selling industry be worried? With the power and leverage of the FTC over the fate of any one company it is important to understand as “best as possible” what happened here.
We only know one thing after the AdvoCare MLM abandonment: that uncertainty has surfaced again in the direct selling industry about the MLM model. And because this issue is existential for MLM/direct selling, it should be a priority for leaders in the direct selling industry.
AdvoCare Announces MLM Closure
In its May 17, 2019 Press Release, 26 year old AdvoCare upended its business model and, at least momentarily, caused the industry to ask if there was something afoot that could upend the entire industry direct selling/MLM model. This follows a similar momentary concern after the 2016 FTC Herbalife settlement.
AdvoCare to Revise Business Model
New Compensation Plan to Focus on Direct-to-Consumer Sales
PLANO, Texas (May 17, 2019) – Today, AdvoCare International announces a revision of its business model from multi-level marketing to a direct-to-consumer and single-level marketing compensation plan. AdvoCare has been in confidential talks with the Federal Trade Commission about the AdvoCare business model and how AdvoCare compensates its Distributors. The planned change will impact Distributors who have participated in the multi-level aspect of the business. Those who currently sell only to customers will not be impacted and there will be no impact on Preferred Customers or retail customers’ ability to purchase products.
“Over the years, we have made many changes to the AdvoCare policies as the regulatory environment has shifted. Based on recent discussions, it became clear that this change is the only viable option,” says Patrick Wright, AdvoCare’s Chief Executive Officer… The company gave notice to its more than 100,000 Distributors on May 17 that, effective July 17, 2019, AdvoCare will revise the business model to a single-level distribution model, paying compensation based solely on sales to direct customers. The Retail and Preferred Customer programs will remain intact…
For the Industry: A Roller Coaster of Certainty and Uncertainty
Did the industry place too much reliance on its recent quiet period with the FTC? It is hard to say.
There has always been a cordial tension between the FTC and the direct selling industry. Each has had its view of an acceptable business model, and from time to time, they clash. The result has been a roller coaster of certainty and uncertainty for the direct selling industry.
In 1975, the FTC decided that the MLM model of Amway was a pyramid and pursued litigation against Amway for four years, ultimately resulting, in 1979, in the validation of the Amway model as a legitimate business opportunity rather than a pyramid. The favorable attributes of the Amway model, buyback policy, 70% rule and retail customer mandate, were then referenced for the next four decades by courts as the “Amway safeguards.”
After a nearly 20 year quiet period, the FTC and the industry were again at odds in the late 90’s and beyond regarding how they view the legitimacy of “personal use” by distributors as a legitimate sale to an end user per the universally recognized legal standard set forth in the seminal Koscot case. The uncertainty caused the industry to secure legislation in many states recognizing “personal use” as legitimate. To this date, the industry has failed to secure federal legislation on this point, although the U.S. Court of Appeals for the Ninth Circuit, in BurnLounge, rejected the FTC argument that personal use purchases should not count and gave a minor win to the industry.
The uncertainty continued, and, in 2016, the FTC successfully caused Herbalife to change its MLM model to give limited credit for personal use purchases. Other companies did not follow the Herbalife model and the tension continued. Riding high on the Herbalife settlement, the then FTC Commissioner Ramirez announced that there was a new “sheriff in town” and the tensions and uncertainty surfaced again as the industry felt that it was about to be upended.
(1) She renounced use of the famous Amway safeguards standard, adopted in the landmark FTC case, In re Amway, 1979 as being irrelevant, overrated and not really relied on by courts in pyramid cases. (An unfortunate misinterpretation of case law).
(2) She redefined the famous Koscot standard to require compensation to upline to be based on sales to nonparticipant retail customers rather than based upon Koscot’s language which specified that commissions must be based on sales to “ultimate users,” effectively reclassifying distributor users as “second class ultimate users.”
(3) She pivoted away from a legal analysis in the most recent BurnLounge case, which demanded, in pyramid cases, a factual analysis of the “primary motivation” test in which a court asks “what is the primary motivation for distributors when they make purchases…” instead migrating to a punch list of inflexible operating restrictions imposed on Herbalife in its recent settlement.
(4) She essentially attempted to create a new legal standard, the “percentages test,” an arbitrary new rule in which upline distributors would be limited to receive commission credit for only one-third of sales volume attributed to personal use by downline distributors, whether or not such purchases were reasonable in quantity and for actual use by the distributor “ultimate user.”
(5) She announced that a long-time practice of almost all leading direct selling companies, autoship to distributors, should, effectively, be prohibited.
(6) She pivoted away from a well-established component of leading direct selling programs, stating that monthly activity volume requirements may not include any purchases by distributors.
(7) She asserted that the long-time practice of established direct selling companies, tracking of performance activity, connected to wholesale purchasing, should be banned.
Following the 2016 Presidential Election, a new anti-regulatory climate set in and the tension and uncertainty subsided with the subsequent Acting Chairperson asking the industry to come to the table with the FTC as stakeholders, again accepting a “going forward” FTC policy based on long established case authority and principles of government/industry collaboration rather than top down directives.
And then, out of the blue, comes the May 17, 2019 Press Release of AdvoCare abandoning its multilevel program, based on confidential discussions with the FTC and deciding that abandonment was its only “viable choice.”
And it is here that the roller coaster is again on the on again/off again track of uncertainty.
An Enigma Wrapped in a Mystery Wrapped in a Riddle
Why did AdvoCare capitulate and abandon its core business and its MLM distributors?
Doing the Right Things
Actually, it seemed like one of the least likely candidates. In fact, it seemed to be a poster child for adopting major consumer safeguards found in case authority and the DSA Code of Ethics.
- It adopted the classic legal safeguards called out in case after case, all patterned after the famous Amway “safe harbor” rules, first noted in Amway’s successful litigation with the FTC in 1979 and heralded over and over in case authority.***
- A complete inventory refund for terminating distributors for product purchased within 12 months of termination.
- A prohibition on inventory loading and the adopting of the classic Amway 70% rule, prohibiting new purchases in the absence of use or sale of 70% of previously purchased product.
- A five retail customer rule which conditioned payout of downline commissions unless distributors made at least five non-participant retail customer sales per pay period.
- It followed FTC and DSA initiatives that encouraged and incentivized retail selling by adopting a preferred retail non-participant customer program that was subscribed to by thousands and thousands of preferred customers.
- It published average earnings disclosures that exceeded most state and FTC standards.
***Of course, the assumption here is that AdvoCare lived up to those consumer safeguards. If the FTC had cogent information that the above promised consumer safeguards were not enforced or implemented, it would be a new game, and a new strong explanation for any pressure felt by AdvoCare management to make a statement like “we had no other viable choice”. On this point, since the discussions were “confidential”, the answer is unknown unless either the FTC or AdvoCare elaborates further.
- Even one of the MLM industry’s harshest watchdog critics, BehindMLM.com, seemed favorably impressed in its 2015 AdvoCare review, a rare happening:
AdvoCare has one of the strongest retail focuses I’ve seen in MLM yet.
Affiliates are required to submit retail customer details to the company, with fixed numbers of retail orders required on an ongoing basis…. (“made at least five (5) retail sales to at least five (5) different customers (other than yourself) in each pay period”)
From time to time, AdvoCare may contact the customers listed on your Retail Sales Compliance form to verify that the sale took place as reported.
If you provide false or inaccurate information, your Distributorship may be suspended or terminated, at the sole discretion of AdvoCare.
Do note that I couldn’t find any information on how frequently or widespread AdvoCare verify submitted retail customer information.
Theoretically an affiliate could rig the retail requirement, but the hassle of setting up five bogus customers just to qualify for commissions seems hardly worth it.
You’d be far better off actually retailing AdvoCare’s products, failing which you probably should instead find a company whose products interest you.
AdvoCare’s product lineup is in the health and wellness niche and is quite robust. Price wise you’re going to have to compare with what’s available locally.
Given the retail commission requirements and years AdvoCare has been around, there’s a good chance you’ll find them to be competitive.
AdvoCare’s compensation plan as a whole seems pretty well balanced, offering upfront retail commissions, a three-level unilevel and expansion based on a rank generation and 0.75% infinitely at the Platinum, Double and Triple Diamond ranks.
Note that recruitment is required to advance in AdvoCare’s ranks from Gold 3 Star, however chain-recruitment is not an issue due to no mandatory purchase of product and/or incentives for recruiting affiliates who purchase product.
Any recruited affiliate orders do count volume wise, but at the end of the day an affiliate’s own PV requirements must be satisfied in order to qualify for commissions.
$500 PV to qualify as an advisor is far easier achieved through retail sales over the ongoing self-purchase of product.
Furthermore, AdvoCare employ a 70% rule on top of the retail customer requirements already in place:
Overrides, Leadership Bonuses and the 70% Rule AdvoCare pays Overrides and Leadership Bonuses, and other bonuses and incentives based on your representation that you have sold or consumed 70 percent of all products purchased by you.
If AdvoCare later discovers that you did not sell or consume 70 percent of such products, AdvoCare may deduct the amount of the Override, Leadership Bonus or other bonus or incentive previously paid from compensation due to you in subsequent pay periods, or AdvoCare may deny payment of any Override, Leadership Bonus or other bonus or incentive in addition to any disciplinary action that may be taken, including suspension or termination.
How strictly the above rule is adhered to is unclear, but at least on paper AdvoCare work to prevent inventory loading.
I’ll point out again that an affiliate purchasing $500 of product each pay period is hardly going to be viable for most affiliates. Ditto having a recruited affiliate purchase the same.
Nonetheless, I would encourage a prospective affiliate to ask their potential upline for a copy of their last few Retail Sales Compliance forms.
Check the details don’t look suss (I’d advise against calling any of the customers due to privacy reasons), and ask the upline what the customers ordered, how long they’ve been customers and perhaps how they became customers in the first place.
That should eliminate any suspicion of shenanigans with regards to the details on the form being fudged.
All in all with AdvoCare you’re looking at a stable company that’s been around for twenty-two years, a large product lineup to market and a retail-orientated compensation plan that pays deeply at the upper tiers.
If you’re interested in the products, have checked out their viability against what’s available locally and think you can carve out a customer-base to market to, AdvoCare might be the MLM opportunity for you.
- It is true that it faced criticism by watchdog organization, TINA, a perennial industry critic, and in a Texas class action, that, like most MLM companies, a very small percentage of active distributors made significant income. However, the FTC standard for deceptive or unfair practices is disclosure, as opposed to the amounts of earnings by distributors. And, in the case of AdvoCare, the company annually published one of the most robust and transparent earnings disclosure charts. (And it should be noted that, if the negative litmus test for a direct selling company is the fact that few distributors earn substantial income, then virtually every major direct selling company for 60 years has been illegal. The fact is that this industry, like others, offers an opportunity as opposed to a guarantee.)
- It was praised in the U.S. and abroad for its fine line of products and its branding of sporting events and personages was outstanding.
So What Happened? Who’s to Blame? Who Knows?
Victory has a thousand fathers, but defeat is an orphan.
John F. Kennedy
The answers are completely speculative, but to the extent that they may be based on non-legal factors, then, the entire industry should be worried.
And the primary answer lies in becoming a target of the FTC and its position of leverage.
- AdvoCare was carrying on, under pressure on two fronts: the FTC and class action litigation. Since 2017, AdvoCare has attempted to fend off a class action in Texas which accused it of a myriad of offenses, from pyramid to fraudulent behavior. This sort of litigation is extraordinarily expensive, terrible public relations and always speculative as to outcome.
Might the litigation have been averted? Perhaps. If the company’s arbitration clause in its distributor agreement had been ruled enforceable, the class action might have been averted. However, the request to enforce arbitration was denied and the matter thrust back into federal court.
One industry legal advisor with knowledge of AdvoCare offers this opinion:
AdvoCare did not help itself by not updating its distributor agreement to prevent the class action lawsuit that has contributed to its current state of affairs.
The arbitration provision in AdvoCare’s lawsuit was unenforceable because it let AdvoCare amend at any time with no prior notice and was not limited to prospective conduct. This allowed the plaintiff to successfully argue that the arbitration provision is illusory.
This analysis appears to reference the landmark Texas decision by the U.S. Court of Appeals for the Fifth Circuit, which struck down the “mandatory arbitration” clause for direct seller, Stream Energy, as unenforceable and illusory:
Under Texas law, a stand-alone arbitration agreement requires binding promises on both sides as consideration for the contract. “But when an arbitration clause is part of an underlying contract, the rest of the parties’ agreement provides the consideration.” Still, an arbitration agreement may be illusory if a party can unilaterally avoid the agreement to arbitrate. Here, Torres and Robison assert that the arbitration clause is illusory because Ignite could amend the clause “in its sole discretion” ….
It does appear that AdvoCare did ultimately update its arbitration clause, but post class action filing.
This prompted the same industry legal observer to opine:
It is a travesty what’s happened with AdvoCare. Almost all of its wounds appear to be self-inflicted.
Score one arrow in the quiver for FTC leverage.
- Second non-legal arrow in the FTC quiver. One cannot underestimate the pressure on individual managers or owners when the FTC has the ability to threaten naming the individuals as well the company. Although entirely speculative, the above industry legal advisor offered a speculative opinion:
If you take AdvoCare’s public statement at face value then it is saying that any MLM comp plan is not a viable option. I think this was a fear-based decision in an attempt to ensure to the maximum extent possible that AdvoCare’s owners are immune from any potential fine from FTC as part of any potential settlement.
Again, at best, this is speculative opinion. However, such a scenario is plausible in difficult legal circumstances.
- Third FTC arrow in its quiver. The direct selling industry has long been critical of the FTC’s use of a temporary restraining order as its first litigation volley. It has sometimes been referred to as “trial by ambush.” In this scenario, the FTC walks into federal court ex parte (without the presence of other counsel) with a brief and motion that have been months in the preparation, requesting the court to temporarily shut the company down and to freeze the assets of both the company and its owner/managers. At once, the company finds itself out of business and also lacks access to its own funds to defend itself. Under such pressure, many MLM/direct selling companies have capitulated and entered into stipulated injunctions. This unique potential and historically employed leverage hangs like a “sword of Damocles” over every direct selling company, including AdvoCare. This makes negotiation very difficult.
- Fourth FTC arrow in its negotiating quiver. The impact of an FTC suit on the branding, sales, marketing or public reputation of any company cannot be overstated. The recent FTC Herbalife settlement illustrates the pressure to achieve resolution by target companies. And, although AdvoCare is not at the same risk of exposure as that which may impact the stock price of a publicly traded company, the adverse publicity may easily be destructive of its brand and sales in the marketplace, i.e., need to move on.
- We don’t know what we don’t know.
A Fifth speculative arrow for the FTC quiver:
This is new territory. Nothing like this has ever happened before to a 26 year old well established direct selling company. As they say in international intelligence circles, “We don’t know what “kompromat” (compromising materials)” the FTC has on AdvoCare. But when a company announces that scrapping its core marketing system is “the only viable choice,” eyebrows raise. What does that mean?
In the Absence of Clear Legislation, The Only Certainty is Uncertainty. What Next?
The AdvoCare announcement of MLM abandonment has shocked the industry. Its public explanation of “after confidential discussion with the FTC, there was no other viable choice” raises a million speculative questions to which we may never know the answer.
We’re just dancing in the dark….Bruce Springsteen
We can only know what we know and act on it. And this we know:
- Nothing about the announcement changes the existing legal standards for pyramid vs. legitimate direct selling. Those standards weave their way from the Koscot case through Amway through Burnlounge. And the acid test is: Are distributor payments and commissions driven by recruitment and qualification in the plan, on the one hand, or sales to ultimate users.
- Now is the time to support DSA dialogue with the FTC and also to support DSA sponsored federal legislation to provide clear explanation of the ground rules for legitimate direct selling, including recognition of the legitimacy of personal use by distributors as an end destination for product sales.
And if you are looking for life in a post FTC/Herbalife world, and in the absence of either capping credit for personal use (Herbalife) or abandoning your MLM altogether (AdvoCare), here are some common sense guidelines to create the strongest defense to your MLM program by clearly promoting anti-pyramid practices:
- Bulletproof yourself on earnings claims. Don’t be the nail that sticks up and gets hammered down.
Avoid earnings hype in advertising, testimonials and lifestyle presentations. Scuttle the Maserati and the Tuscan villa images. Be realistic… this is the anomaly and not the norm. Take the bullseye off your forehead. In almost every FTC case, the first invitation to regulators is unrealistic earnings claims. The hype “opens” the door or lifts the canopy of the tent. And, as they say, “Once the camel has his nose in the tent, you can be assured that his ‘body’ will soon follow.”
In other words, don’t be the low-lying fruit. Don’t effectively, and unintentionally, “bait” the FTC to initiate an enforcement action by over-aggressive hype and promises.
Absolutely do not make claims of wealth, fast wealth, easy money or sure-fire systems, nor effectively invite the FTC to inquire into a program based on earnings hype and systems based on distributor “purchasing” rather than distributor “selling” and “using.”
And whether legal or not, now is the time to “ditch” the pictures and videos of distributor mansions and luxury cars. Since such MLM driven lifestyles are clearly the exception to the rule, why wear a red flag in front of a “bull.”
- Post a transparent earnings disclosure.
As a general matter, the FTC is all about disclosure so that consumers can make informed decisions. Once you have a track record, post a simple and transparent average earnings disclosure. At a minimum, you should disclose:
(a) What percentage of distributors who have signed up are active, i.e., earning any income?
(b) Of those that are active, what is the average earnings?
(c) If any example, testimonial or illustration of a particular income, bonus or lifestyle award is presented, what percentage of active distributors earn at least that amount or above?
Irrespective of the depth of the earnings disclosure, do not ever play fast and loose with earnings disclosures, nor “parse” to exaggerate the opportunity.
- Adopt, follow and enforce the Amway safeguards.
The Amway safeguards have been the gold standard and been honored in case after case going on 40 years. Although the FTC may wish to pivot away from the Amway safeguards, the courts have not done so.
(a) 70% rule to avoid inventory loading … no ordering unless 70% of previous orders have been sold or used for personal/family use. Place lids on initial orders and allow a ramp up of size of order over time. Never mandate monthly autoship to qualify for commissions. And avoid front-loading. In the famous Omnitrition case, the court noted that the Amway safeguards are rendered ineffectual as a defense to pyramiding if a company encourages or allows front-loading of product because it becomes clear that commissions are not related to sales to ultimate users when distributors are incentivized to buy huge amounts of inventory that are out of proportion to needs for resale or the needs of personal and family use.
(b) Adopt and enforce an actual nonparticipant retail sales mandate to qualify to receive commissions. Over the years, that number has been expressed in numbers from five to ten or in sales volume … often with an allowable ramp up over time.
(c) Honor a buyback policy on inventory and sales support materials for terminating distributors…no less than 90% for 12 months.
- Promote non-participant retail sales and a preferred customer program.
It is in everyone’s interest, the company, distributors, the industry and regulators, to place an emphasis on retail sales to non-participant customers. After all, the business is called “direct selling,” and not “direct consumption.” The promotion of retailing should find a thread through every piece of company literature and advertising.
In addition, the gold standard of retailing is the presence of non-participant preferred customers, i.e., those retail customers that are provided incentives and discounts to commit to monthly or orderly product purchases. From a legal standpoint, a robust preferred customer program makes the statement that there is a real market for the product and purchasers are purchasing because they want the product as opposed to being motivated by qualifying in the business opportunity.
- Track. Track. Track… flow of product to and use by the ultimate user.
After FTC v. Herbalife, few priorities are as important as tracking and verifying the flow of product to and use by the ultimate user, whether it be a nonparticipant retail customer or distributor for personal/family use. Although the FTC may wish to assert that the legal standard requires tracking to the nonparticipant retail customer, that assertion does not accurately state the case law in Koscot or BurnLounge, which speak in terms of compensation related to the sale of product to the ultimate user. The short answer: Track the flow and use of product to both nonparticipant retail customers and distributor personal/family use. If the FTC is desirous of a new legal standard, it will not achieve it by merely stating its position, but rather through case law, federal legislation or federal rule adoption. It is also worthy to note that more than a dozen states have adopted legislation recognizing personal use.
Either way, the time to start tracking is “yesterday.”
Jeffrey A. Babener, of Portland, Oregon, is the principal attorney in the law firm of Babener & Associates. For more than 30 years, he has advised leading U.S. and foreign companies in the direct selling industry, including many members of the Direct Selling Association. He has served as legal advisor to various major direct selling companies, including Avon, Amway, Herbalife, USANA, and NuSkin. He has lectured and published extensively on direct selling and many of his writings will be found at mlmlegal.com, of which he is Editor. He is a graduate of the University of Southern California Law School, where he was an editor of the USC Law Review. Post USC Law, he served a one-year term appointment as a law clerk to Hon. David W. Williams, U.S. District Court, Central District of California. He is an active member of the State Bars of California and Oregon.