Network Marketing Legal Issues

by Jeffrey A. Babener
MLM Legal Attorney
©2011

Although not without its challenges today, as a general matter, legitimate network marketing companies are well received throughout the U.S. With increasing frequency, federal and state governments offer assistance and guidance to the network marketing industry. The IRS releases special publications, videos and has adopted specific regulations recognizing a very legitimate profession. As in the franchising industry, several states have also adopted specific legislation for multilevel distribution companies which set forth objective standards for those companies to follow. Differentiating a legitimate network marketing opportunity from a pyramid scheme should not be a difficult task for the entrepreneur when some basic and objective indicators are observed.

Any industry that offers such dramatic rewards and carries with it a lower dollar cost of entry obviously will tend to attract some of the best and some of the worst entrepreneurs. The industry has not always thrived. Over the years, it has come perilously close to extinction as a result of prosecution by regulators who claimed the industry promoted pyramid schemes under the guise of legitimate marketing. And, in many cases, the prosecutors were correctly chasing and eradicating such scam and scheme pyramids.

Other programs which were in fact legitimate have survived, however. In a classic legal decision in 1979, the Amway Corporation prevailed in such a prosecution and in fact, effectively, received a stamp of approval of its marketing program by the Federal Trade Commission. This particular decision opened the door to many other legitimate multilevel marketing companies.

Because of the abuses of the "rotten apples" of the industry, multilevel marketing has become a closely scrutinized and regulated industry. Regulations regarding multilevel marketing companies in the United States are a constantly changing patchwork of overlapping laws, which lack uniformity and vary from state to state.

The basic thrust of these statutes is that marketing plans are prohibited which require an investment or purchase by sales representatives for the right to recruit others for economic gain. Under these statutes, multilevel marketing companies must be bona fide retail organizations which market bona fide products to the ultimate consumer. Inventory loading and "headhunting," or remuneration for the mere act of recruiting others, are prohibited. Sales kits should be sold at actual company cost to sales representatives.

  1. In the leading legal decisions, a variety of abuses have been targeted as potential elements of illegal marketing plans:
  2. Products which have "no real world" marketplace, i.e. the marketing program is a facade for a scam.
  3. Products which are sold at inflated prices.
  4. Plans which result in inventory loading or "buy-in" qualification by distributors.
  5. Substantial cash investment requirements.
  6. Mandatory purchases of peripheral or accessory products or services.
  7. Plans in which distributors are left with substantial unsold inventory upon cancellation of participation.
  8. Plans in which fees are paid to distributors for headhunting and emphasis is on recruitment rather than sale of product.
  9. Earnings misrepresentations or inflated earnings representations.

In determining whether or not a program is a legitimate multilevel marketing opportunity, the would-be participant or the entrepreneur, who is considering a multilevel marketing program, should consider several important points:

  1. Product or Service. The company should offer a high quality product or service in which consumer satisfaction is guaranteed. It must have a "real" demand in the marketplace. If the product is consumed by distributors themselves, it must be one that distributors would want to buy on its own merits, irrespective of participation in the marketing plan.
  2. Price. The price of the product or service must be fair and competitive in the marketplace. Distributors should be able to purchase the company product at wholesale or at a substantial discount from prices found in retail stores.
  3. Investment Requirement. There should be no investment requirement at all, except a sales kit or demonstration material sold at company cost.
  4. Purchase and Inventory Requirement. A legitimate marketing program should have no minimum purchase requirement, nor any inventory requirement, for one to become a distributor or sales representative. Once in the business, however, ongoing activity or qualification requirements are typical of leading network marketing companies - i.e. minimum monthly personal and group wholesale purchase volume.
  5. Use of Product. Products should be used by consumers and not end up in a garage or basement.
  6. Sales Commissions. Sales commissions should not be paid for the mere act of sponsoring other distributors.
  7. Buy-back Policy. A legitimate multilevel marketing company will agree for some reasonable period of time to buy back inventory and sales kit materials in resalable condition from distributors who cancel participation in the program.
  8. Retail Sales. The focus of the marketing program should be to promote retail sales to nonparticipants. Many states and programs recognize that purchases for personal or family use in reasonable amounts by distributors are also retail sales.
  9. Distributor Activity. Many of the new statutes regarding multilevel distribution companies require that distributors perform a bona fide, supervisory, distributive selling or soliciting function in moving the product to the consumer, i.e. that they have meaningful contact and communication with their downline sales organization.
  10. Earnings Representations. The basic rule is that a legitimate marketing program should not make any earnings representations unless those representations are based on a track record. Testimonials by individuals of their own experiences are not uncommon, however.
  11. Training. A good network marketing program should offer solid training in sales and recruitment to its distributors.

The future of the network marketing industry will require cooperation by companies, distributors and those governmental agencies charged with regulating the industry to assure that legitimate practices prevail and pyramiding schemes are stamped out. Every network marketer should apply the above principles in evaluating a new program or working within their existing program.

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About the Author:

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. His firm has focus on startup and emerging MLM companies. He has been adviser to such companies as Avon, Nikken, Discover Toys, NuSkin, Excel, Fuller Brush, Cell Tech, Kaire, Sunrider, Melaleuca, etc. He is editor of the industry resource internet site www.mlmlegal.com.  He is a frequent lecturer and has been interviewed on the industry, and published, in many publications. Babener & Associates, 121 SW Morrison, Suite 1020 Portland, OR 97204, www.mlmlegal.com.

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