MLM Expert Attorney, Jeff Babener offers ten FTC vs. Vemma litigation bullet points.

On August 17, 2015, the FTC filed a complaint in U.S. District Court in Arizona, seeking a permanent injunction against Tempe-based Vemma International Holdings, Inc., a long-time direct selling marketer of health-related products. The FTC was successful in obtaining a temporary restraining order, which shut the company and froze its assets. Further proceedings for a hearing on a preliminary and permanent injunction and other relief were set to the future.

Such a scenario has been a common approach for the FTC. The most recent actions resulted in permanent injunctions against BurnLounge and Fortune Hi-Tech Marketing. For a summary of the most significant federal actions during the past few decades, please see:

Herbalife: What Short Sellers Missed on the Way to the Press Conference…

Jeffrey Babener (2013)

The primary accusation against Vemma is that its program focused on recruitment rather than sale of product to the ultimate user, thus rendering the program a pyramid scheme and a deceptive practice under FTC legislation. In addition, the FTC has charged that Vemma is deceptive in its earnings representations.

FTC vs. Vemma Litigation Bullet Points:

1. (a) This case affirms the BurnLounge standard requiring emphasis on sales to ultimate users, which includes nonparticipant retail customers and personal use in reasonable amounts. Primary motivation for distributor purchases should be destination to ultimate users and not to qualify in the plan for compensation.

See: BurnLounge Appeal Decision: Guidance on Pyramid v Legitimate MLM and the Role of Personal Use in Pyramid Analysis

Jeffrey Babener (2014)

(b)       Contrary to some industry comment, autoship is not under attack, but rather the method of its promotion and implementation and amount, which suggests the primary motivation for purchasing is not for sales to retail customers/ultimate users or reasonable amounts for personal use, but rather to induce purchasing to qualify for commissions in the plan.

(c)        A similar analysis is applicable to up-front, fast-start packages.

2. The FTC alleges several accusations that Vemma is not complying with the BurnLounge standard, and, thus is a pyramid.

(a)       Emphasis not on use or retail but purchasing to qualify.

(b)       Distributors are told to give away product.

(c)        Little evidence of retailing or emphasis on retailing or teaching or training to retail.

(d)       Up-front emphasis on buying fast-start packs of $500-$600, plus sign up for $150 per month autoship to qualify for commissions, rather than servicing an actual need.

(e)       The FTC asserts that the Vemma program emphasis was about distributor purchasing and getting recruits to do the same, rather than sale of product in reasonable amounts for the needs of retail sales and personal use by distributors.

(f)        And the FTC no doubt had complaints from parents of college students, and parent lawyers, for targeting vulnerable college age students with promises of fast wealth from working “the system” of buying and recruiting. The FTC complaint focused heavily on accusing Vemma of abuse by targeting young individuals. Clearly, this is a sore point for the FTC, and it has been a concern of some industry observers even prior to the FTC case. The last time this criticism was made was when Equinox and Trek Alliance were shut by the FTC for the same reasons. In a way, this action is Equinox redux.

3. The FTC does not condemn, nor attack the MLM model (nor personal use), but rather goes out of its way to call out Vemma practices, which it contends makes Vemma an illegitimate pyramid. (See the FTC press release and complaint for FTC’s highly pejorative characterization of the facts.)

“…an alleged pyramid scheme, Vemma Nutrition Company, that lures college students and other young adults with the prospect of getting rich without having a traditional 9-to-5 job.”

‘Rather than focusing on selling products, Vemma uses false promises of high income potential to convince consumers to pay money to join their organization,’ said Jessica Rich, Director of the FTC’s Bureau of Consumer Protection.”

4. Vemma is accused by the FTC of deceptive earnings claims, potentials and hypotheticals as to how distributors could earn substantial income. Vemma published an earnings disclosure, but it was inadequate and deceptive to show the entire picture by limiting disclosure to earnings of active distributors rather than disclosing earnings of all individuals who signed up, of which the vast majority had no income.

5. Autoship: Rumors of its demise are exaggerated. In the future, autoship will continue as a form of orderly ordering… the legal key will be “tracking” how that product is consumed or sold to ultimate users. After the Vemma case, all other cases will demand “tracking” evidence to determine what will clearly become cases that are “fact driven.”

6. As the FTC v. Vemma action unfolds, the outcome will be “fact driven” on the issue of “primary motivation” for distributor purchasing. The FTC has made it clear that it believes that the facts show that Vemma operated a “recruitment” machine that targets college age students with promises of wealth for merely using the system to “buy and recruit” rather than “sell and use,” i.e., per BurnLounge, the product was incidental to the opportunity. The FTC’s complaint does its best to present a factual picture that the Vemma program implementation and distributor purchasing patterns are dominated by “recruitment and qualify” motivation rather than sales to be used by “ultimate users,” whether they be outside retail customers or distributors for personal use.

7. Of course, Vemma will argue a completely different characterization of the facts. Vemma will be obliged to prove the opposite. The “facts” will determine the outcome.

If the FTC allegations on incomplete earnings disclosure are correct, the FTC has a point that merits correction… But certainly not a shut down.

If the FTC is factually supported that distributor purchases are “dead ended” to garages and basements or given away, then there is a real pyramid problem. 

However, if Vemma can demonstrate that distributor purchases actually make their way to “ultimate users,” whether retail customers or personal use in reasonable amounts, then the wholesale ordering mechanisms of fast start packages and autoship subscriptions are not really a challenge for pyramid analysis.
The entire direct selling industry has been offering fast start packages and autoship ordering for a half century. If product is making its way to a destination to be used by ultimate users, then a program is a legitimate direct selling/MLM program, and not a pyramid.

8. How will the facts play out? Without extensive discovery, it cannot be determined at this stage. (Presumably, in its sealed filing, the FTC provided significant fact scenarios to support its position). However, if extensive discovery is needed at this point, a temporary restraining order and preliminary injunction seem inappropriate on the pyramid issue, particularly for a company, Vemma, whose roots, including its predecessor company from which Vemma was “spun out,” New Vision, go back almost 25 years. Nevertheless, this is a reality of this matter. Historically, the FTC has done a good job on the “fact gathering” even though it has been wrong on or misstated the state of pyramid law. (It was roundly rebuked by the U.S. Court of Appeals for the Ninth Circuit for its stated legal position that distributor “personal use” should not be considered in pyramid analysis.)

9. How long will this litigation process take? Had the FTC merely asked for injunctive relief and a preliminary injunction, Vemma would be in a stronger position to see through the litigation. However, the fact that the court ordered an asset freeze and appointed a receiver does not bode well for Vemma. And although a preliminary injunction hearing was set for a very short period of time after the temporary restraining order, case history suggests that most companies, including Vemma, are not prepared to present factual testimony at a preliminary injunction hearing on short notice. The net result is that companies often stipulate to continue the temporary restraining order for months while they gather evidence. And the remainder of the litigation may go on for months or years all the while that a company is shut down and not in control of its assets. Similar scheduling scenarios for companies such as BurnLounge, Fortune High Tech Marketing, Equinox, Trek Alliance, spelled a death knell to the future of those companies, all of whom became “dead man walking.”

In the last two decades, MLM companies, which have been subject to a receiver and asset freeze at the commencement of FTC litigation, have not emerged “alive.” If Vemma survives the process, it may be viewed by some as an outlier. Unless Vemma can immediately compile a mountain of evidence to refute the FTC fact allegations on “product movement,” it is more than an uphill battle.

10. Lessons learned for the future for MLM companies… and for which they should start “yesterday:”

(a) Track product to its final destination. Bottom line, is that companies should be able to document that product makes its way on to and is used by ultimate users.

(b) Marketing emphasis should always be on product first, and opportunity second.

(c) Employ procedures to avoid inventory loading.

(d) Employ procedures to mandate and guarantee retailing.

(e) 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.”

(f) Do not boldly target demographic markets that the FTC might view as vulnerable to hype and abuse. Such groups may be young people or poor populations.

(g) Do not play fast and loose with earnings disclosures. To be transparent, always indicate the percentage of new sign ups who have no earnings, i.e., what percentage of new distributors actually make money.

In FTC vs. Vemma, who owns the facts?

BurnLounge set the standard for years to come. The decision in case after case, including FTC vs. Vemma, will be “fact driven“… is distributor behavior driven by product sales to the ultimate user or is it driven by recruitment?

In the end, he, who owns the facts, will prevail.

Stay Tuned.

For detailed analysis of the Vemma case and an actual copy of the FTC vs. Vemma lawsuit, please visit www.mlmlegal.com 

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 NYSE direct selling companies, including Avon, Herbalife, USANA, NuSkin, etc. He has lectured and published extensively on direct selling and many of his writings will be found at www.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 the Hon. David W. Williams, U.S. District Court, Central District of California. Mr. Babener is an active member of the State Bars of California and Oregon. He has served as trial counsel in numerous direct selling cases in federal and state courts for 30 years.

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The FTC and the Direct Selling industry are clearly of the same opinion of the basic goal that the direct selling industry should prosper through effective and ethical practices. However, FTC Chairwoman Edith Ramirez emphasized new legal standards that would abandon a 40-year old gold standard, the Amway Safeguards Rule, and that would also upend and call into question decades of industry accepted business practices.

Briefly, the Chairwoman argued for:

1. Abandonment of reliance on the Amway Safeguards Rule as a key test for legitimacy.
2. Effectively creating a new legal standard patterned after those requested by the FTC in the FTC/Herbalife settlement that, in reality, may upend decades of industry accepted practices and rewrite 40 years of court legal standards.
3. The existing Court standard derives from:

(1)  Koscot … Compensation to upline should be based on sales to the ultimate user.

(2)  Amway … A program that enforces the Amway Safeguards of a retailing mandate to qualify for MLM commissions, a 70% rule that prohibits ordering unless product is sold or used and a reasonable buyback policy for inventory for terminating distributors, if effectively enforced and in conjunction with avoidance of inventory loading, is indicative of legitimacy. (Also, Amway did not challenge recognition of distributor personal use purchases as legitimate sales to the “ultimate user”.)

(3)  BurnLounge … The primary motivation for distributor purchases should be the purchase of product in reasonable amounts for resale or use as opposed to mere qualification in the program for rewards. A pyramid analysis will be “fact driven.”

1. On the FTC wish list for a new paradigm for legitimacy is:

(1)  Abandonment of the reliance on the Amway standard.

(2)  Redefining Koscot to require compensation to upline to be based on sales to the nonparticipant retail customer rather than the ultimate user.

(3)  Adopting the FTC/Herbalife settlement “punch list” of mandates in lieu of the factual analysis of “primary motivation,” called for in BurnLounge, including:

(a)    Only one-third of MLM compensation to upline should come from personal use by downline distributors, whether or not such purchases are reasonable in quantity for use by the distributor “ultimate user.”

(b)    Autoship to distributors should be prohibited.

(c)    Monthly activity volume requirements may not include any purchases by distributors.

(d)    Tracking of performance activity connected to wholesale purchasing should be banned.

Leading MLM industry expert Jeff Babener takes a closer look at what this means for the direct selling and multilevel marketing industry. Read the full article: Fact Checking the FTC’s New Legal Guidance

Visit us at www.mlmlegal.com to learn more.

The Tennessee language is similar to language adopted in more than a dozen state statutes, which recognizes personal use, so long as it is coupled with consumer safeguards to avoid inventory loading and to provide for a reasonable inventory repurchase policy. In 2014, the state of Tennessee adopted such a pyramid test:

(8) “Pyramid promotional scheme”:

(A) Means any plan or operation by which a participant gives consideration for the opportunity to receive compensation that is derived primarily from the introduction of other persons into the plan or operation rather than from the sale and consumption of goods, services, or intangible property by a participant or other persons introduced into the plan or operation; and

(B) Includes a plan or operation under which:

…. (ii) A participant, on giving any consideration, obtains any goods, services, or intangible property in addition to the right to receive compensation.

(C) Nothing in this part may be construed to prohibit a plan or operation, or to define a plan or operation as a pyramid promotional scheme, based on the fact that participants in the plan or operation give consideration in return for the right to receive compensation based upon purchases of goods, services, or intangible property by participants for personal use, consumption, or resale so long as the plan or operation does not promote or induce inventory loading and the plan or operation implements an appropriate inventory repurchase program.

(House Bill 2356 approved by the Governor, April 25, 2014 and effective July 1, 2014)

For the complete language of the new Tennessee legislation, visit the Tennessee Statute page located at MLMLegal.com’s MLM Law in 50 States section.

In the last 10 years, distributor personal use, as a legitimate end destination for product/service has been increasingly recognized by courts, legislatures and regulators:  In 2013 and 2014, two EU tribunals; now counting, more than a dozen U.S. states have amended MLM statutes; in 2004, an FTC advisory opinion applauded efficiencies of MLM “buying clubs”; even the most recent U.S. Ninth Circuit Court of Appeals decision, BurnLounge, recognized personal use purchases that were not merely incidental to the business opportunity. The emerging legal standard, legitimate vs. pyramid, is not the existence of personal use, but rather, whether the predominant motivation for distributor expenditure is to qualify for reward in the MLM program as opposed to purchase for personal use or resale.

Read Tennessee State Law at our website.

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By Jeffrey A. Babener
© 2016

On June 2, 2014, in the case of FTC v. BurnLounge, the U.S. Court of Appeals for the Ninth Circuit issued a seminal decision, affirming a lower court finding that the BurnLounge MLM (multilevel marketing) program was an illegal pyramid scheme, in violation of section 5(a) of the Federal Trade Commission Act, a decision that will dramatically impact the landscape of direct selling to provide guidance on two fundamental legal issues:

(1) What activity constitutes a “pyramid scheme?”

(2) What is the role of “personal use” (by distributors) in pyramid case analysis?

Stakeholders: “We Won!!” Proxy Wars…….

Victory has 100 fathers and defeat is an orphan. John Kennedy (1961)

As with any inconclusive war, the stakeholders offered immediate statements of victory or vindication.

That is, other than BurnLounge. BurnLounge lost, and a permanent injunction was affirmed.

However, BurnLounge was a proxy war on the tests for “pyramid” and the role of “personal use” in pyramid analysis, among the interested parties, short sellers of publicly traded direct selling companies, publicly traded direct selling companies, industry spokespersons such as the DSA, the FTC, MLM critics, etc.

Each, in turn, issued press releases or statements claiming victory and validation of their respective positions.

The BurnLounge decision offered guidance for all stakeholders and a clear message for “going forward.”

To Short Sellers:

Rethink your criticism of direct selling companies. Distributors’ personal use is a legitimate end destination for product sales. Criticism of personal use is not a valid criticism. So long as distributor purchases are not merely incidental to the business opportunity, such purchases in reasonable amounts for personal use, coupled with rewards for one’s own purchases, as well as use by non-distributors and other distributors is as legitimate as a sale to a non-distributor customer, and is not a basis for a pyramid.

To the FTC:

Congratulations, you won this case on the facts presented. However, since the Omnitrition case (1996), you have been arguing the wrong legal standard on personal use for more than 15 years, albeit a slight diversion in a 2004 FTC Advisory Opinion that recognized legitimacy of personal use. The court pointed out: “The FTC counters that ‘internal sales to other Moguls cannot be sales to ultimate users consistent with Koscot.'” The court proceeded to roundly reject this contention noting that this argument is not “supported by the case law.” And so the message to the FTC is that personal use criticism will not be accepted in the future and the FTC should look back to its 2004 Advisory Opinion position.

To the Industry:

Accept your victory on recognition of personal use as a legitimate destination for product and representative of “sales to ultimate users.” However, “get your act together,” and adopt “best practices” methods and rules that promote product use over mere recruiting. The presence of personal use is not “a free ticket out of trouble.” It will be viewed as part of a legitimate MLM, but it is only one factor for the case by case fact based analysis of the “economic reality” of an entire program in which the acid test will be that the predominant and primary motivation of distributor purchases is for personal use or resale and not merely to qualify for rewards in the program by personal purchases and recruitment of others to do the same.

Major Impact of the BurnLounge Case…

To read the full article, visit MLMLegal.com.

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Our next Starting and Running the Successful MLM Company Conference takes place October 27 and 28, 2016 in Las Vegas. Call 503-226-6600 or 800-231-2162 to register. If you’d like to see how you can get free tickets to the next MLM Startup Conference, visit our Innovation Campaign page.

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Next MLM Startup Conference takes place February 27 & 28, 2014 in Las Vegas.

Herbalife Belgium:

In a dramatic turn, a Belgian appeals courts reverses a lower court ruling and hold that Hebalife is no pyramid, but is in fact a legitimate direct selling business opportunity. The court validates “personal use” by distributors in pyramid analysis.

Herbalife: Belgian Appeal Court: Herbalife is No Pyramid, Validates Legitimacy – The Next Chapter in Personal Use

Herbalife: What the Short Sellers Missed:

This article tracks major regulatory actions over two decades to suggest that short sellers reliance on criticism of “personal use” may be misplaced.

Herbalife: What Short Sellers Missed on the Way to the Press Conference…

BurnLounge: Personal Use Recognized

In this case, a federal court expresses validity to distributor personal use, but rejects purchases of packages and sales tools where the predominant reason for purchase is merely to qualify for recruiting commissions in the opportunity.

FTC v. BurnLounge: Lessons Learned for MLM/Direct Selling

Editor and direct selling attorney, Jeff Babener of Babener & Associates, discusses these issues in his trilogy of articles on personal use and network marketing.

The pivotal issue of “personal use” will be thoroughly covered in the next  Starting and Running the Successful MLM Company Conference taking place February 2014.

The conference will be held February 27th & 28th, 2014, which is quickly approaching!

For more than 26 years, leading industry experts have educated the executives of starting and existing MLM, direct selling, network marketing, and party plan companies on how to structure their compensation plans, legalize their companies, recruit key employees and top-ranking distributors, develop business models, generate leads, fund their business, establish their website and technology platforms, better understand the direct selling industry, and so much more.

The next MLM Startup Conference takes place February 27th & 28th, 2014 in Las Vegas. View the conference flyer page at  http://www.mlmlegal.com/srs2.html  to learn more.

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Over the course of two days, attendees will hear from scores of industry experts, and if they choose, can sign up to meet with the speakers for individual one-on-one time. A full list of speakers and their biographies/credentials can be found at  http://www.mlmlegal.com/bio.html .

The educational information gained by attending this event is invaluable. Here are just a few of the testimonials from past attendees:

“We have a traditional business at the moment and we are looking to take it into the realm where it’s more personalized, it’s more about building people and an experience. It has been absolutely worth our trip. We are looking to take our business to the next level and build relationships.”

“The reason I came to the show was to learn more about how to launch my direct sales company. I’m very comfortable and accustomed to selling through more traditional networks; however, I believe that the product that I’m launching is more suitable for direct sales; to get direct-to-consumer faster and in greater sales.”

“[I’ve] been in network marking for 30 years [but] we are learning a lot of things about how to launch, how to reach the people we need to have, and again, the things that are required to make a successful company, not only for us but especially for our customers and for our affiliates.”

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The next MLM conference will be held February 2014 in Las Vegas (keep a look out for the May and October conferences as well). Each day will begin at 9:00AM and end at 4:00PM, when the one-on-time will begin and end around 7:00PM. For more information visit: http://www.mlmlegal.com/srs2.html  or call 800-231-2162/503-226-6600. Registrations are taken by phone and questions are always welcome.

Visit our website to find out how to receive two free tickets to the event by participating in our February 2014  Innovation Campaign :  http://www.mlmattorney.com/innovationcampaign.html .

Presented by one of the most trusted individuals in direct selling and MLM, Jeffrey Babener, Editor of  www.mlmlegal.com .

About Attorney Jeffrey Babener : Conference Host and Chairman, Editor of  www.mlmlegal.com , as well as the leading direct selling attorney in the United States – With over 25 years of experience as a direct selling attorney, Jeffrey Babener has advised leading companies in the MLM/Direct Selling industry, ranging from Avon to Nikken, to Herbalife, to Melaleuca, to USANA, and to Excel Communications, plus many more. He’s been published in national magazines such as  Money, Inc. ,  Atlantic Monthly ,  Entrepreneur  magazine,  Direct Selling  News,  Direct Sales Journal ,  Success  magazine,  Money Maker’s Monthly , among countless others. He’s authored several books, including his most popular  Network Marketing: What you should know . Mr. Babener has chaired more than 64 national conferences on direct selling.

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That was the last the industry heard from the FTC, for the most part, other than various product-related issues. That is, until the mid-1990s when the FTC started to revisit the question of personal use by distributors. Some of the consent decrees with companies that were really egregious violators, were not in adjudicated rulings, but consent decrees, the FTC’s position was that at least 50 percent of product needs to be sold outside of the distributor network for a company to be legitimate. This put a lot of tension on a lot of companies, particularly health products companies that have a lot of personal use. There has been a lot of debate back-and-forth and a number of states, at the request of the industry, have changed their pyramid statutes to recognize personal use as a legitimate end-destination and an ongoing dialogue still occurs with the FTC.  In fact, in a 2004 FTC Staff Advisory Opinion, the FTC actually recognized the validity of personal use by distributors so long as the purchases of product are founded on the actual desire for the product as opposed to pyramid schemes in which distributor purchases are often primarily to merely qualify in the business opportunity.  Said the FTC, “..the purchase of goods and services is not merely incidental to the right to participate in a money-making venture, but rather the very reason participants join the program.”

Today, at industry conferences, the FTC is a participant and it always tends to assure the industry it recognizes its industry. As a matter of fact, just a couple of years ago, the FTC sought to modify its Business Opportunity Rule and considered some options that would have made it much more restrictive for MLM companies to recruit. After an onslaught of letters and comments to the FTC, the FTC modified its position on the Business Opportunity Rule and came into agreement for the most part with the industry on how things should go.

There will always be tension between the FTC and the industry on the issue of personal use, and overall, there seems to be a consensus. It is the observation in the industry that the FTC chases after egregious companies and does not chase after what we would normally consider legitimate companies.

For more information about network marketing and the FTC, watch the companion video to this blog post: What is the Relationship between MLM and the FTC?

Or, read one of our many articles on the Federal Trade Commission:

FTC Guidelines on Endorsements and Testimonials
FTC Guidelines Resource Center
FTC Guidelines Endorsements and Testimonials: Detailed Analysis
FTC News Release on Endorsements and Testimonials
FTC Complete Guidelines Release
FTC Short Version Guidelines Release
FTC Examples of Material Connection
FTC Regulation of Advertising

FTC Proposed Business Opportunity Rule: Analysis and Updates:
New! The FTC Final Business Opportunity Rule: Still Work to Do
FTC Exemption Draft Falls Short … MLMLegal.com and DSA Suggest Revisions
FTC Exempts MLM from Proposed Business Opportunity Rule
DSA Position on FTC MLM Exemption Proposed Business Opportunity Rule
Analysis and Industry Response
Actual Text of Proposed Rule
FTC Speaks Out
DSA Speaks Out
DSWA Speaks Out
MLMIA Speaks Out
DRA Speaks Out
MLMLegal.Com Speaks Out

FTC v. BurnLounge: Lessons Learned for MLM/Direct Selling

For more information on the direct selling industry, visit www.mlmlegal.com or www.mlmattorney.com.

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