MLM Companies Cannot Require Their Participants To Buy Inventory
Thomas Ritter is an associate attorney at Thompson Burton. His practice area focuses primarily on business transactions and direct selling law. As MLM attorney has published an awesome article about the Pay to Play dilemma in MLM or Network Marketing.
The short version: Companies cannot require their participants to buy inventory as a condition to participation…..
When I sense a gap in the industry’s understanding on an issue, I see it as an opportunity to learn more and write content that sets the record straight.
I’ve been fielding a lot of questions lately on the subject of whether a company can require monthly product purchases as a condition for pay plan qualification. When I give the answer, I’m sometimes met with surprise.
They’ll often say, “They’re doing it over here and over there…..are you telling me they’re a pyramid schemes!?” Here’s the truth: multilevel marketing companies cannot require their participants to buy inventory as a condition to participation. This is black letter law, meaning it’s a rule not subject to any dispute.
Whether this principle comes as a surprise or makes no difference, an understanding of why it exists and where it comes from is crucial to the avoidance of regulatory trouble.
The best definition for what constitutes a pyramid scheme arises out of the 1975 FTC case, In re Koscot Interplanetary, Inc. What separates a legitimate MLM from an illegal scheme boils down to two basic elements:
(1) a participant’s payment of money in return for the right to sell a product/service; and
(2) the right to receive rewards unrelated to the sale of product to ultimate users.
For companies, any sort of required purchase invokes the pay to play / quid pro quo (“this for that”) dilemma. By requiring a distributor to buy this (inventory) for that (right to participate), Companies mistakenly believe they’ve created a surefire way to push product and generate commissions.
In the two most recent and high-profile FTC cases in which MLM companies were accused of running a pyramid scheme (BurnLounge and Vemma), courts found fault with the companies’ endorsement of the pay to play model. With BurnLounge, participants (called “Moguls”) were explicitly “required to purchase a package” to have the “ability to sell music, merchandise, and packages.”
The Court held that “the sale of packages thus conveyed the right to sell a product,” satisfying the first Koscot element. In the action against Vemma, however, the Company didn’t directly require an Affiliate to make a purchase or pay a fee in order to participate. Nonetheless, the Court found the Company was designed and marketed in such a way that the purchase of inventory, for all intents and purposes, wasn’t optional (as per the court).
“Vemma’s bonus structure and training materials are designed to make new Affiliates buy a $600 Affiliate pack, which makes payment for the right to sell a Vemma product if not a written requirement, a practical one.” The Vemma case is a clear illustration that courts and regulators alike look beyond a Company’s policies on paper. The true crux of the matter lies within the Company’s operational realities, i.e., how the Company really operates in practice.
While BurnLounge and Vemma represent real world examples of the pay to play dilemma, a 2004 FTC Advisory Opinion provides the best basis for understanding the regulatory aim behind its prevention.
Modern pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise these payments to appear as if they are based on the sale of goods or services.
The most common means employed to achieve this goal is to require a certain level of monthly purchases to qualify for commissions.
While the sale of goods and services nominally generates all commissions in a system primarily funded by such purchases, in fact, those commissions are funded by purchases made to obtain the right to participate in the scheme. Each individual who profits, therefore, does so primarily from the payments of others who are themselves making payments in order to obtain their own profit.
Essentially, the FTC is saying the implementation of pay to play requirements inevitably leads to pyramiding — bonuses based on recruitment as opposed to legitimate product sales.
Under a value driven paradigm, no restrictions exist so as to dictate a participant’s intent behind his/her underlying consumption of a product. In stark contrast, the opportunity driven paradigm features the pay to play element: without payment, one cannot participate and if one cannot participate, one cannot earn commissions.
Pay to play requirements produce ambiguity behind why a participant buys. Is it because he/she really wants the product? Or is because he/she just wants to participate in the income opportunity? In our view, if there’s ANY sort of requirement, courts will easily find that the motivation driving consumption is the opportunity (not the value). If you don’t believe me, look at how the Court handled Vemma.
Under the current bonus system there is no way to unbundle the intent to consume products as ultimate users from their desire to remain qualified for bonuses.
THE ANSWER TO COMPANIES’ PAY TO PLAY DILEMMA
Having forced you to read why inventory purchases cannot be a requirement to participation, I’ll answer the question you’ve been repeatedly asking yourself: what choice do I have? For me, it’s rather simple. Three choices clearly exist and are the same choices we’ve written about in the past regarding the post-vemma world.
For the sake of brevity I will quickly summarize:
- Stand pat, do nothing, and hope you don’t get caught. Just excuse me when I politely say, “told you so,” when the FTC suddenly receives unilateral control over your company; or,
- Require that at least half of the required inventory purchase come from legitimate and verifiable customers; or,
- Eliminate required inventory purchases altogether. What better way to see if your product really does, in fact, have intrinsic market value than by no longer requiring volume goals. I call this the Kevlar approach, because a company choosing to eliminate PV (personal volume) has made a regulator’s job of shooting it down as a pyramid scheme A LOT more difficult.
To conclude, one of the first things I notice when I evaluate an MLM’s business model is whether or not it charges participants for the right to participate. As I’ve studied regulators arguments, the companies they’ve pursued, and how the court proceedings have shaken out, there’s no way around it — quid pro quo / pay to play is the logical starting point to the pyramid scheme determination.
If companies really want to stay on the right side of the law, the quid pro quo dilemma isn’t a dilemma at all. The choice is easy — it’s just not worth the risk.