Agency claims ‘money transfer scheme’ in latest enforcement action
By Dave Rauf
The vast majority of participants in Success By Health lost money as the company’s compensation plan rewarded distributors based on how many new recruits they could sign up and how much inventory they could sell to those same recruits, not from retail sales.
—Paraphrased from FTC suit against Success by Health
“The FTC is trying to rewrite the law through enforcement proceedings.”
—Brent Kugler, partner, Scheef & Stone
The Federal Trade Commission (FTC) has dropped the hammer on another MLM, marking the third pyramid scheme case brought against a direct seller in the last several months as part of a series of enforcement actions that have rattled the industry.
Insiders say the cases represent a new front of heightened regulatory scrutiny, one in which regulators are expanding legal interpretations for what constitutes a pyramid scheme on a seemingly case-by-case basis. They include the remarkable examples of AdvoCare agreeing to bow out of direct selling as part of a settlement and Neora taking the unprecedented, and polar opposite, step to fight the FTC with a countersuit. Both cases were filed in late 2019.
The FTC’s most recent case was brought against Health By Success, a Nevada-based MLM with a flagship product line that consists of coffees and teas blended with mushrooms the company claims have health benefits.
The company has been temporarily shuttered as regulators say it swindled more than $7 million from customers in recent years, and pressured distributors to borrow or max out credit lines to finance inventory and costly training programs. Meanwhile, the FTC says company owners pocketed more than $1.3 million.
According to the FTC, Health By Success advertised to distributors that they could replace their full-time income in six months by selling its coffees, teas and supplements. But the vast majority lost money as the company’s compensation plan rewarded distributors based on how many new recruits they could sign up and how much inventory they could sell to those same recruits, not from retail sales.
The FTC’s economist determined that Health by Success’ compensation plan “creates a perpetual chain of recruitment and that, as a result, it is a ‘money transfer scheme that siphons money from later entrants to compensate earlier entrants, delivering easily foreseen losses to the vast majority of participants,’ ” according to a court filing.
A federal judge in January temporarily shut the company down and froze its assets.
FTC Focusing on Compensation Plans
In a blog post announcing the enforcement action, the FTC noted that it was one of several instances of the regulator cracking down on an alleged pyramid scheme since October. Industry insiders and officials have also taken notice—and they say, now more than ever, before regulators are probing compensation plans for strings that could lead to a pyramid scheme case.
“The FTC is on to compensation plans like they’ve never been before. That’s why everybody needs to be taking a look at them,” says Brent Kugler, a partner at Scheef & Stone who represents direct selling companies. “They are scrutinizing comp plans more than they ever have. And they are coming up with some wild notions on what is a compliant comp plan and what is not.”
Kugler says in the past the FTC was more focused on product and income claims: “It was the claim that would put you on the FTC radar.” Now the regulator has added compensation plan review to its arsenal.
Kugler says he advises his clients to review their plans to “make sure there’s no glaring problem that could get flagged immediately.”
“What I’ve been surprised to find is a number of compensation plans out there even have antiquated language or have loose terms that allow a regulator to draw some very troubling and negative conclusions just based on how the comp plan is written,” he says.
Kugler added: “Some companies could probably make some optics changes to their plans and be fine. But for other companies there need to be some structural changes.”
Andi Sherwood, director of plan design and strategy at Dan Jensen Consulting, a firm that specializes in working with the direct selling industry, said there’s no shortage of direct sellers “taking a hard look” at their compensation plans to figure out what they can do to make them more less prone to regulator scrutiny.
“But there are also companies out there saying ‘we’re not the big guys, it’s not going to happen to us.’ Or that they have the mentality “if the FTC says something we’ll change, but we’ll keep doing it for now because it’s driving growth,’ ” she says. “If the FTC comes to slap your hand, it’s too late.”
Daryl Wurzbacher, CEO of ByDesign Technologies, a firm that develops software for direct sellers, says companies are reacting to the regulatory landscape by looking for ways to simplify their compensation plans. Increasingly, he says “people don’t want to be part of something that looks and smells like a traditional MLM.” While a simple plan is easier for distributors and consumers to understand, success has been difficult to achieve in some cases, he says.
“I have not seen anybody that has come in with a two-to-three level affiliate plan that has blown up or seen amazing growth,” says Wurzbacher.
New companies on the other hand, Wurzbacher says, could be positioned better to simplify their compensation plans.
“The biggest struggle you have is how do you pay the leaders that have been there from the beginning,” he says, noting one of the hurdles that an established company will face by transitioning to a simpler compensation plan. “When you go change that payout there’s going to be winners and losers. And the losers tend to be the big income earners.”
The Business Case for Comp Plan Changes
At Mannatech, a direct seller of nutritional supplements, executives decided to revamp the company’s compensation plan following Herbalife’s settlement with the FTC in 2016. Al Bala, Mannatech’s CEO, says the North Texas-based company stopped offering best-value packs to avoid signing up participants that wanted to be customers, not distributors. The company also addressed payouts for those packs to avoid the appearance people were being paid to recruit.
The “segmentation” that Mannatech put in place has become an increasingly common tool among direct sellers to simplify their compensation plans. It’s also turned into one way for companies to point out their customer base to the FTC and the general public.
“Simplifying the compensation plan is a challenge we all need to take on,” Bala says. “The more simple, straight forward the plan is, the less it creates mythical feelings about what we do.” He added: “For us, we are obviously very concerned about segmentation, but that’s not just an FTC issue. That’s a business issue. Our ability to know why people are coming into our business and what makes them happy is very important. We want to make sure nobody is being brought in with false expectations of what they would get.”
The changes to Mannatech’s compensation plan were prompted, in part, by one of the landmark direct selling and FTC cases. After the Herbalife settlement, it became clear that regulators were focusing on how direct sellers differentiate between those joining just to buy products at a discount and those looking to sell products.
Not long after Herbalife, the FTC shut down energy drink seller Vemma on the basis it operated as a pyramid scheme that compensated affiliates mainly for recruiting others, rather than for retail sales.
The FTC’s Moving Goalposts
Attorney Kugler says all direct selling lawyers were of the mindset that operating within the established parameters of those two cases would be a “safe harbor.”
But, he says, with the AdvoCare and Neora cases, the FTC has moved the goalposts: “We definitely don’t have anything in writing that we can rely on other than reading their complaints against AdvoCare and Neora,” Kugler says. “The FTC is trying to rewrite the law through enforcement proceedings.”
Most recently, a top FTC official sent shockwaves into the crowd at an industry event in October with remarks that laid out three types of compensation structures the FTC finds problematic, according to attendees. Among them are threshold-based rewards (reward increases at specific thresholds), convex rewards (reward increases based on more spending by participants) and duplication-based rewards (bigger rewards for participants with larger downlines).
“The vast majority of MLM comp plans feature both threshold-based and duplication-based rewards,” Kugler says.
Sherwood, the direct selling consultant, says there were much clearer rules of the road before some of the recent enforcement actions brought by the FTC.
Regulators were primarily concerned with retail sales, and false income and product claims, she says. However, now “it goes beyond things that have traditionally been acceptable.”
“Our industry is all about duplication. You learn a skill and teach each it to others. We’re built on that basis,” Sherwood says. “It seems like the FTC now is making up rules that they haven’t shared with us.”
Mannatech’s Bala says companies are currently navigating uncharted territory because it’s not clear what the rules are, and the FTC isn’t clarifying anything: “The guidance seems to change with every case,” he says.
“There’s been a long-standing concern at the FTC about our channel. We’ve created some of those issues,” he says. “It is the right time for us to be cleaning up some of those things and rectifying some of those perceptions.”
FTC Pressure Likely to Continue
ByDesign’s Wurzbacher says there’s a lot of “mixed messages” in the industry right now about the FTC’s direction. But, he says, there has been a public perception about the industry for a long time, and now the FTC is clearly “forcing that conversation a lot harder.”
“The FTC is giving companies a catalyst,” he says. Opponents of the direct selling industry expect the FTC to continue applying pressure this year.
A recent online post at consumer advocacy organization TINA.org laid out the argument that the FTC “remains on legally firm and precedent-solid ground in its prosecution of pyramid scheme cases.” The online post wraps up with a prediction: “It’s likely that we haven’t seen the end of this prosecutorial trend by the FTC.”
In the meantime, Kugler recommends MLMs remove the word “recruiting” from their compensation plans because it seems to set off alarms for regulators—even if a company can demonstrate strong retail sales.
He says there are also plenty of companies trying to start accurately tracking retail sales. “Some of them are manually trying to track retail sales.” Kugler says. “Some of them aren’t even trying, and I can’t imagine trying to hold onto that structure moving forward.”
Being able to track retail receipts is becoming crucial, says Wurzbacher, whose company is releasing a tech solution to address that issue. He says companies have tried to do different things to acquire that data in the past.
“Right now, it’s not part of the sale. That’s always been a secondary step,” Wurzbacher says. “If you have a situation with reps buying large sales kits for retail, then being able to track that information is so critical.”
Wurzbacher says he’s seeing more companies making changes such as building customer referral programs into their compensation plans. Al Bala says Mannatech changed its loyalty program in January because there were “unintended consequences” with how it was structured. The company is also in the process of developing a customer referral program.
Even as companies continue to make changes to their compensation plans, Bala says for now the direct selling industry will have to continue to deal with uncertainty from regulators.
“There’s no way I’m going to be able to guess which way the FTC is going to go. And it’s going to change,” he says. “But that means we need to double up on our customer focus. The best we can do is the best we can do, and if the FTC is going to attack us, then that’s what they’ll do.”
Link to share this article: https://socialsellingnews.com/link/ftc-doubles-down-on-compensation-plan-scrutiny-3587/