In a post-Neora landscape, regulatory risk remains a primary concern
By: Jenna Lang Warford
“…you have to know right now that there is nothing that you can do to successfully run a direct selling business that will keep the FTC from potentially knocking on your door. Nothing.” — Deb Heisz, Co-CEO, Neora
In the wake of a federal court decision favoring data-driven analysis over subjective judgments in the Neora vs. Federal Trade Commission case, the FTC appears to be intensifying its campaign to overhaul direct selling practices and multi-level compensation structures.
FTC staff issued two letters on March 15, 2024, regarding a change in their interpretation of its evaluation of pyramid schemes (the Koskot definition) and income disclosure statements.
The letters, which were addressed to the Direct Selling Association (DSA) and the Direct Selling Self-Regulatory Council (DSSRC) of the BBB National Programs, underscore the FTC staff’s determination to recreate how the channel operates, despite a previous court ruling that rejected such a standpoint—upheld in a Federal court district in Texas.
Brent Kugler, a partner at Scheef & Stone LLP, says, “[Associate Director] Lois Griesman’s March 15 letter disavowing the Commission’s 2004 guidance is the latest example of the FTC’s attempt to expand the definition of an illegal pyramid so that it can cast an even wider net over otherwise compliant business practices.
“While the Koscot definition of an illegal pyramid scheme remains the law of the land, the FTC in recent years has applied its own interpretation to Koscot to conclude that several (multilevel-marketing) companies were operating as illegal pyramid schemes, primarily by focusing on the recruiting aspect regardless of whether rewards paid to participants were tied to product sales,” Kuglar continues.
“MLM companies and legal experts have challenged the FTC’s position on this issue, arguing that FTC is attempting to impermissibly ‘fence in’ the MLM industry by expanding the definition of illegal pyramid beyond the parameters established by Koscot.”
He adds, “The Koscot definition, after all, expressly allows for a participant to receive rewards for recruiting other participants if those rewards are related to the sale of products or services to ultimate users.”
Peter C. Marinello, vice president of DSSRC, adds, “While the letter certainly underscores an area of concern, you have to remember that it doesn’t represent formal FTC guidance or codified rules and regulations from the agency.”
He continues, “Nevertheless, we take any communication from regulatory authorities very seriously, and we use information to inform our ongoing efforts to really provide this clear guidance to direct selling companies and their sales force members.”
Companies reacting to these letters by enacting policies that lean on arbitrarily strict guidelines to appease the FTC may find growth unnecessarily compromised.
“You have to make your own decision about what you’re willing to risk,” Deborah Heisz, Co-CEO of Neora, says. “But you have to know right now that there is nothing that you can do to successfully run a direct selling business that will keep the FTC from potentially knocking on your door. Nothing. We followed the law, we proved in court that we followed the law, and we didn’t keep them off our doorstep. So you just have to acknowledge there’s a business risk.”
Innovation, rather than ignoring risk, may be the better answer.
Heather Chastain, former chair of the Ethics and Self-regulation Committee for the DSA states that the channel is used to keeping a watchful eye on ever changing legislation.
“We’ve always been impacted by outside regulatory influences and internal compliance questions, guidance from the DSA,” Chastain says. “But I don’t view anything from the FTC as a barrier to innovation whatsoever, and I think any company that’s using that as a reason not to innovate just isn’t trying hard enough.”
Jonathan Gilliam, founder and CEO of compliance management firm Momentum Factor, points to the outdated concerns that regulators have about the channel.
He explains, “At the core of regulator concerns is the sense that direct selling companies tend to over-promise and are not upfront about our opportunities and products. Many of the conditions that bred that concern are relics of the pre-internet past, yet the concerns still linger. This was highlighted in the overreaching charges against Neora.”
Gilliam advises that the best practice of any direct seller in the modern age is to be honest and transparent in messaging, and to be sure this translates to the field with consistent training, care and enforcement.
“The field’s behavior is a primary risk to a knock on the door from the FTC,” he says. “True, compliance starts at the top, but its risks come from the thousands out there making false claims, even when they believe what they are saying is true.”
What might compliance to the law look like, post-Neora?
Chastain says, “I think the Neora ruling is our very best guidance we have right now. With the staff letters, the FTC is deliberately unclear in their guidance. This ruling is the first clear indicator we have regarding how the courts are interpreting the FTC guidelines.
“The common thread through it is that it is about the data,” she continues. “You have to understand what’s actually happening in your business. We’re not going to worry about what it looks like on paper. We’re going to look at what’s happening in reality. What does your data show? Depending on your company, that is the most positive or negative thing that could have come out of that? I believe that is where the energy should be spent.”
John Sanders, partner at Winston Strawn, says, “Effectively addressing compliance today is really simply doing what my firm and others have been saying all along. You need a demand for your products and a really good compliance system that basically takes your field to task when people make misleading income and lifestyle and product claims.
“If you can show that there are real sales to retail customers and that your field is not out there making misleading claims, you’re going to be okay,” he says.
The Two Keys to Compliance
Risk tolerance assessment is the first key; the second is having a strong compliance department.
“When it comes to risk tolerance, do what we did,” Heisz says. “Take a look at the guidance. Take a look at the law, at the former court cases. Take a look at our case and the numbers that are reflected in our case and say, ‘Okay, they won. Can we meet those numbers?’
“At Neora we have 80% sales to customers outside the comp plan,” she elaborates. “If you’ve only got 20%, that should be a red flag. Do you have a legitimate opportunity for people to make money purely by selling product and not having to recruit a whole lot of people?
Now, if they recruit a whole lot of people who sell product, yes, they’ll make more money. But do you have a legitimate opportunity where someone who just wants to sell product to their friends can make money doing that? That’s a demand for your product outside of people who enrolled just to be part of your company.”
Heisz continues, “When we talk about customers, these are people whose social security numbers we don’t have, they don’t get a check from us. Do you have true customers? Because what true customers show you is we have true product demand.
If everybody is only buying the product so that they get a commission check, that isn’t true product demand. So take a look at our case, and if you can meet this standard, you’re going to be in the same place we are, which is, we’re doing it right. And we can and will defend ourselves.”
Chastain further defines risk tolerance. “Addressing risk tolerance as an open topic of conversation is really important. The idea that there are solutions on a spectrum isn’t really how many compliance decisions are made in companies. I would encourage executives to introduce this idea of a range of solutions based on the risk you want to take.”
She continued, “Too often compliance departments, and also frankly the leadership levels within the compliance, are (too technical) about how they issue guidance. ‘Yes, you can say that. No, you can’t say that.’ If compliance heads and legal teams start to frame all discussions around compliance with the lens of risk tolerance, then it becomes a more productive conversation.”
Categories for Risk Tolerance
Chastain elaborates, “I believe it begins with C-suites really engaging in an initial session on ‘Let’s identify what our risk tolerance is going to be in this category.’ Product claims tend to be more straightforward. Then there’s documentation risk, the level of risk tolerance within the training documentation we require for our fields. Companies can vary greatly in their approach, from lax to highly regulated.
“Then, we need to consider risk tolerance for income opportunity claims, including imagery,” she says. “What level of risk are we willing to accept in terms of imagery used? How committed are we to ensuring our fields engage in proper training and internal monitoring? How do we address issues outside our risk profile with our fields? And what is our tolerance for field monitoring?”
Field monitoring, as the Neora and AdvoCare cases proved, is crucial, and can require a significant amount of time when done manually. Software programs and platforms can be an important part of the process.
“We use our field monitoring software heavily,” Heisz says. “For us, it’s a huge savings as opposed to having 20 people in the building. And a lot of our compliance effort is put into education.
“One of our main compliance strategies is to educate our field first, as opposed to discipline our field. So having third-party software partners identifying violations of policy helps us to react.”
She continues, “Outsourcing monitoring tasks to a specialized group is advantageous because developing expertise in monitoring software internally isn’t our priority. Having external experts craft queries and manage this process on a global scale for our industry is more efficient than handling it in-house.
“However, we collaborate closely with this team, particularly during product launches or promotions where keyword issues may arise, to enhance our search capabilities. Ultimately, this approach ensures that our staffing remains optimal and focused on core tasks.”
Chastain agrees. “I think monitoring software is 100% a requirement,” she says. “There are fantastic solutions in our space designed specifically for direct sellers, which is really important.
“They can integrate the training aspects along with ensuring quality enforcement of policy. Without Internet monitoring software of some kind, it’s a huge gaping hole in your risk protection.”
Consumer Advocacy Group TINA
Sanders is onboard with this type of monitoring as well. “A monitoring platform is incredibly important. And it’s a push-pull, because these programs are generating lots of hits for you to investigate.
“The problem becomes if you don’t have it configured to provide more results than regulators require, then you have organizations like Truth in Advertising (TINA) who will find them and take you to task complaining loudly that you’re pulling punches and you don’t have a true desire to find them.”
Heisz shares that Neora is proactive. She says, “We’ll work with the DSSRC for anything they find. TINA has its own agenda. There’s just no other way to put it. And I think the more you try and work with them and appease them, the more you open up the opportunity for them to have an opinion.”
Marinello acknowledges that while it’s not possible to quantify the impact consumer advocacy organizations, such as TINA, have compared to the recent past, “We recognize the role that they play in highlighting potential concerns, and they do serve as a reminder to companies to maintain high standards of integrity and transparency within their marketing practices.”
Effective Compliance Departments
Sanders said the FTC staff letters and TINA’s involvement are an opportunity for companies to look at their compliance procedures, their policies, and their data
to make sure compliance teams have what they need to do
their jobs and policies and procedures are actually being enforced.
Chastain believes one of the toughest ideas to communicate to field leaders and members is why their own personal experience might not be compliant. “Messages like ‘I quit my job in nine months, why can’t I say that?’ are the common field complaints,” she says.
“Again, I think that’s where the monitoring software is really absolutely critical,” Chastain continues. “I do, however, believe a more relaxed, casual and friendly touch on the notifications and communications can be helpful.” She agrees with Heisz that the goal is education.
Companies should keep in mind that while the guidance from the FTC should be considered, the overarching goal is to comply with the law, keeping in mind the FTC will most likely change the tactics it used with Neora.
Kugler expands on this. “Companies should expect the FTC to learn from the mistakes it made in the Neora case. Judge [Barbara] Lynn’s Opinion provides a step-by-step deconstruction of Neora’s pyramid scheme analysis.
“The FTC will revise its strategy and analysis to overcome the fallacies pinpointed by Judge Lynn. The next company targeted by the FTC will likely face a very different litigation strategy.”
He continues, “There are, however, some key takeaways for companies in the aftermath of Neora, including not emphasizing the purchase of higher priced enrollment bundles, not imposing minimum purchase requirements, maintaining evidence that a significant percentage of rewards are generated from sales to non-participant consumers, removing structures and language in the compensation plan that can be construed as incentivizing recruiting, and considering reclassifying non-earning participants to preferred customers.”
Sanders says that this last process is handled by his firm through working with an economics expert, who can take all of the business intelligence data from
a company.
“We run models that allow us to identify the income plan participants that are not truly compensation plan participants but are simply consumers.
“Companies have data about the economic conduct of their participants—the volume that they’re doing, how much they’re paying, how much they’re being paid, how often they’re buying. That data allows us to work with an expert to identify the compensation plan participants who are truly volume purchasers at a discount.”
Jenna Lang Warford is a Social Selling News Contributor.
