The Gathering Storm Over MLM Industry – Seeking Alpha

Federal Trade Commission

RiverNorthPhotography/iStock via Getty Images

RiverNorthPhotography/iStock via Getty Images
Here, I present two related theses: 1) in recent years FTC enforcement activity against the MLM industry has become more aggressive and more specifically focused on truth-telling, and 2) the macro environment has become increasingly hostile to the MLM model and represents sustained headwinds for the foreseeable future.
Since the 1979 Amway decision, FTC actions can be viewed in four distinct eras.
The Warning, Surveys, and Cases period followed written FTC concerns in the form of the 2004 Staff Advisory letter. In the letter, a response requested by the DSA, the FTC wrote: “Modem 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.”
An additional industry warning came in 2011 when, while adopting language that excluded the MLM industry from the Business Opportunity Rule, the FTC wrote (p. 76822), “Commission acknowledged that some MLMs do engage in unfair or deceptive acts or practices, including operating pyramid schemes or making unsubstantiated earnings claims that cause consumer harm.” And (p, 76823) “The Commission has not made a finding that there is little or no evidence of fraud within the MLM industry; to the contrary, it has specifically recognized, through its own law enforcement experience, that some MLMs may be pyramid schemes in masquerade and may make false and unsubstantiated earnings claims.”
Between 2004 and 2011 the FTC began collecting consumer harm data with three consumer fraud surveys, each documenting many hundreds of thousands of pyramid scheme victims annually (2004, 2007, 2011). The 2004 survey noted, “Although such a business may look like a legitimate multi-level marketing program, it differs because the income earned by distributors comes ultimately from recruiting, rather than the sale of products or services to consumers.” The incidence of pyramid scheme fraud placed seventh among the ten types of consumer fraud, second in terms of individual loss, and first in terms of the hesitancy of victims to complain. The survey estimated the number of pyramid scheme victims to be 1.55M annually, the midpoint of a 95% confidence interval with endpoints of 800K and 2.3M. Though any point within a confident interval has equal probability of being the actual or true measure, even 800K victims a year is worth noting.
The two latter surveys reported reduced consumer harm but the decline can be solely attributed to a change in the definition of a victim. As opposed to defining a victim as someone who failed to earn the “Promised level of earnings” (2004 survey), subsequent surveys defined a victim as someone who “failed to earn at least half of the amount the promoter promised would be earned.” MLM companies do not generally make promises. The conservative estimate of many hundreds of thousands of pyramid scheme victims annually increases when including expenses that offset the modest earnings received by the vast majority of those who do receive most earnings (the surveys did not collect expense data). It can be shown statistically that had the original definition been applied in all three surveys the results would have been statistically the same. Over an eight-year period FTC consumer fraud surveys documented millions of MLM pyramid scheme victims in the United States. The industry appeared to be unimpressed.
During the Warning, Surveys, and Cases period the FTC also brought just two MLM pyramid scheme enforcement actions, BurnLounge and Fortune Hi-Tech Marketing (FHTM). The former is notable because the firm refused to settle and the case went to the Ninth District Court of Appeal, where the court affirmed the lower court decision noting that compensation to participants was “not tied to the consumer demand for the merchandise.” The FHTM case was brought with sufficient evidence to gain an “ex parte” court-ordered cease in operations. The case provided evidence of: a) an MLM with an advisory board that included two former Attorneys General and one long-standing individual member of the DSA, and b) prompted the FTC to re-emphasize consumer harm from “making false earnings claims.”
The current A Focus on Truth-Telling period brings more cases against DSA member companies, repeated industry warnings issued by FTC, and an ANPR specifically directed at the MLM industry and others prone to making misleading money-making and earning claims. Consider the following:
Using FTC data and available research Figure 1 separates MLM companies into three groups. The green circle contains MLM distributors identified as pyramid scheme victims in multiple Commission surveys. The next larger blue circle contains all distributors in MLM companies with misleading earnings claims. Within it, the circle in yellow represents the high percentage of DSA-member firms with documented misleading earnings claims, and the red circle represents successful pyramid scheme enforcement actions brought by the Commission, the SEC, and states Attorneys General. The overlap between yellow and red represents the DSA firms that faced successful enforcement actions. Data currently unavailable may show an overlap between the red and green circles. MLM distributors in the outer grey circle are those in companies that do not make misleading earnings claims. All circles are illustrative with sizes not intended to be proportional.

Misleading Claims in MLM

Source: Author
Various source data document the substantial potential for consumer harm that has increased FTC concerns during the current A Focus on Truth-Telling period. Over decades the DSA has presented itself as the gold standard for the MLM industry. But it has become increasingly clear that the king has no clothing. In 1995 the DSA commissioned an academic monograph touting the development of its code of ethics, a document alternatively described as either “one of the great, positive business stories of the 20th century” and “as part of the positive promotion of the DSA and its Code…not an analysis of the effectiveness of self-regulation per se (though the publisher might hope some readers see it that way).” In 2019 the ongoing failure of member firms to adhere to the DSA code of ethics motivated a new partnership with the Better Business Bureau, yet another complaint-based toothless form of self-regulation. If most MLM pyramid scheme enforcement actions are against non-DSA members yet research shows a very incidence of misleading earnings claims among DSA members then just how big is the problem?
But what about consumer harm? Had the FTC consumer fraud surveys included expenses the results would have been a greater incidence of pyramid scheme victims. Based on the available data, most MLM distributors earn no income and a sizable group earns little income, excluding expenses. To illustrate the point, Figure 2 shows earnings data from one DSA-member company documented by TINA.org to “use or have used misleading income claims.”
The two horizontal and two vertical axes in Figure 2 show the relationship between: 1) percent of Active Distributors and Average Monthly Earnings (e.g., 81% of Active Distributors earned “$0” average monthly compensation; .2% (i.e., .002) of Active Distributors earned $37,474 average monthly compensation – read top horizontal to bottom horizontal axes), 2) Active Distributors as a percent of All Distributors (e.g., 81% of Active Distributors equal 35.27% of All Distributors; .2% (i.e., .002) of Active Distributors equals .09% (i.e., .0009) of All Distributors – read top horizontal to left vertical axes), and 3) percent of Active Distributors and percent of Total Annual Compensation (e.g., .2% (i.e., .002) of Active Distributors earned 47.4% of Total Annual Compensation – read top horizontal to right vertical axes).

Distribution of Earnings in MLM

Source: Author based on Nu Skin 2020 data
Active Distributors are defined as Distributors “who either made a personal purchase, sponsored another account, or received a Sharing Bonus during the most recent three-month period.” The company reports average monthly compensation to all Active Distributors to be $160.05; however, 94% of Active Distributors received average monthly compensation of $6.17, excluding expenses. Even modest expenses put 94% of Active Distributors in a financial loss position, excluding required product purchases.
Figure 2 actually underrepresents the potential of consumer harm from misleading claims. MLM companies experience high distributor turnover year-to-year resulting in a large percentage of distributors ending with a financial loss – earning little or no income while incurring expenses. Given their annual earnings, top earners have an incentive and the large downlines that allow them to persist year-after-year. Thus, a multiyear view would show the large percent of total annual compensation paid going to a fraction of the low percent of Active Distributors indicated above.
Of course, the industry actively works to shape how it is perceived. A growing gap between the FTC and the DSA is apparent in the issue the purchases that generate earnings, a topic not unrelated to misleading earnings claims. Distributor earnings derive from distributor purchases whether or not those purchases result in sales to a retail customer unaffiliated with the MLM. In 2017 the Commission clearly stated its position, “Who do we mean by ‘real customers’? People unaffiliated with the company who actually buy and use the product the MLM sells – real retail sales, in other words. And by ‘real sales,’ we mean sales that are both profitable and verifiable – retail sales that can be confirmed. Contrast that with MLMs built primarily on bringing in more and more recruits and racking up sales to other insiders. Very few people are going to make money and most participants will be left in the lurch.”
In response, the DSA argued that distributor purchases are analogous to “purchases by salesclerks of products they sell in a retail store.” For the analogy to fit the DSA’s “salesclerks” would derive their earnings not from an hourly wage or commissions on sales to customers who come into the retail store but, instead, from the purchases made by other salesclerks. That is not how salesclerks in retail stores earn income. Apparently, it is the DSA’s understanding that “real customers” (as defined by the FTC) can be incidental to the retail store business model.
Finally, the MLM industry faces headwinds of its own making that it cannot control. I am, of course, referring to the #antiMLM movement. Readers above the age of thirty-five may not be familiar with the social media advocacy of former MLM participants. A quick search on any social media platform and be illuminating and the industry has noticed. The Social Selling News (April 1, 2021) provides some interesting observations:
In this article I argue that the MLM industry faces multiple environmental forces, each demanding greater transparency and “truth telling” indicative of the typical MLM participant experience. While independent of each other, these forces have a complementary impact that will not abate in the face of typical industry platitudes about creating “entrepreneurs” and “business owners.”
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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