Fall 2019 was an ominous period for the MLM industry. In October 2019, the FTC announced that it had simultaneously filed an enforcement action and entered into a stipulated judgment with industry juggernaut AdvoCare. Pursuant to the judgment, AdvoCare and former CEO Bryan Connelly agreed to a $150 million fine and lifetime ban from MLM business activity. The FTC announcement followed AdvoCare's decision to abandon its MLM compensation model, a decision that stripped away the economic livelihoods of thousands of AdvoCare distributors literally overnight. At a press conference announcing the FTC enforcement action against AdvoCare, then FTC Director of Consumer Protection Andrew Smith promised further aggressive enforcement activity against “non-compliant” MLM companies operating in the United States.
Smith reiterated this point while speaking at the Direct Selling Association Legal and Regulatory Seminar in Washington DC on October 8, 2019. In his remarks, Smith emphasized the FTC’s ongoing concern with misleading earnings representations by both companies and independent sales representatives. Smith also discussed the FTC’s concerns with unlawful MLM compensation structures. Smith highlighted certain characteristics of MLM compensation plans that the FTC views as indicative of an unlawful compensation plan. Some of the compensation structure characteristics outlined by Smith, such as "threshold-based" and "duplication-based" rewards represented new views never before expressed by the FTC in prior enforcement actions or in published guidance to the industry. Smith's comments followed industry concerns that the FTC was seeking to "flatten" multilevel compensation plans. In a study published a few weeks later entitled The Alchemy of a Pyramid, two FTC economists opined that an incentive to recruit is the key characteristic in differentiating between a lawful MLM compensation structure and an illegal pyramid scheme.
FTC vs. Neora
On November 1, 2019, the FTC sued Texas-based Neora, LLC f/k/a Nerium International and its Founder/CEO, Jeff Olson, alleging that Neora and Olson have violated Sections 5 and 12 of the FTC Act by making unsubstantiated earnings and product claims and that Neora operates as an illegal pyramid scheme. But rather than allow FTC to bully them into an AdvoCare-like settlement and jeopardize the livelihoods of thousands of Nerium Brand Partners, Nerium and Olson decided to fight back. On the same day of the FTC's lawsuit, Neora filed its own lawsuit against the FTC challenging the FTC’s interpretation of laws and regulations governing MLM companies as well as the FTC’s enforcement authority under Section 13(b) of the FTC Act. Neora's lawsuit alleged that it had been under FTC investigation for a number of years and during this process FTC was seeking to impose changes to Neora's business practices that are not supported by existing law governing MLM companies.
Neora’s lawsuit against the FTC was the first challenge by an MLM company to the FTC’s enforcement authority in more than two decades. It was not, however, the first recent challenge to FTC's enforcement authority under Section 13(b) of the FTC Act. When the FTC filed its lawsuit against AdvoCare, also named as defendants were several AdvoCare distributors. While AdvoCare and several other distributor defendants settled with the FTC, former AdvoCare distributors Danny McDaniel and Diane McDaniel chose to litigate instead. In November 2020, a federal judge granted the McDaniels' Motion to Dismiss the FTC's claims, finding that the FTC's allegations against the McDaniels pertained only to past conduct and, as a result, FTC lacked authority to bring an enforcement action under Section 13(b) of the FTC Act. Section 13(b) only gives the FTC authority to act when there is "reason to believe" that a defendant is currently engaged in, or about to engage in, conduct violating the Act. Federal Trade Commission v. AdvoCare International, L.P., et al, 2020 WL 6741968 (E.D. Tex. 2020).
Back to the Neora case. The FTC’s pyramid allegations focused on, among other things, the fact that new Brand Partners are encouraged to purchase higher-priced “Success Packs” ($500, $750 or $1000) at the time of enrollment rather than the $49.95 Basic Kit which is the only required purchase to become a Neora Brand Partner. The FTC further alleged that Neora’s compensation plan incentivizes Brand Partners to purchase a specified volume of products each month, regardless of need or demand. The FTC further alleged that “less than 1% of all rewards paid by the company consist of commissions paid on the sale of products to Retail Customers.” The FTC alleged that Neora’s compensation plan provides “much greater compensation” for recruiting new Brand Partners than for sales of products to Preferred Customers or Retail Customers. Consequently, the FTC alleged that Neora encourages its Brand Partners to recruit new members rather than sell products or services to ultimate users.
The FTC further alleged that the rewards in the Neora compensation plan increase as a Brand Partner advances in rank and such advancement is based on recruiting other Brand Partners or by satisfying increasingly higher targets based on downline volume. The FTC also alleged that there are some rewards that are only available to participants who have achieved certain rank levels, and that approximately 1/3 of all Brand Partner compensation is generated from “Team Commissions” which are based “primarily” on participant product purchases. The FTC's allegations against Neora mirrored the controversial public statements by FTC’s Andrew Smith in which Smith described “threshold-based” rewards and “duplication-based” rewards to be indicative of what the FTC considers to be a deceptive or illegal compensation structure. FTC's lawsuit also targeted any rewards that bear any relation to recruiting, even if the rewards cannot be earned absent a sale of product to an ultimate user.
The FTC’s allegations that Neora has published false and misleading income representations involved claims by Neora (and formerly by Nerium) on company-created promotional materials as well as social media posts by Neora Brand Partners. Among other things, the FTC highlighted claims promising “significant earning potential,” “lifestyle-changing income” and videos in which Brand Partners state that they earned significantly more money in their first few months with Neora than they earned at their previous jobs, that some have become millionaires, or ads suggesting that women can earn a six-figure income or “make thousands of dollars a month.”
FTC v. Neora, et al proceeded to trial in Texas in October 2022 before U.S. District Judge Barbara Lynn. To support its pyramid scheme allegations, the FTC relied on the testimony of economist Dr. Stacie Bosley. The trial concluded in late October 2022. Nearly a year later, on September 28, 2023, Judge Lynn published a 56-page Opinion finding, among other things, that Neora is not an illegal pyramid scheme and denying FTC's claim that Neora has published false or misleading earnings claims. The Neora decision is a landmark victory for both Neora and the MLM industry. Here are some key takeaways:
FTC's Pyramid Scheme Allegations
Judge Lynn's Opinion squarely takes aim at FTC's attempt to apply a subjective, unpublished standard for what constitutes an illegal pyramid scheme. The Court first discusses, in some detail, the FTC's published interpretative statements on the factors distinguishing between a legal MLM compensation structure and an illegal pyramid. This includes a 2004 Advisory Opinion in which the FTC states "....the amount of internal consumption in any multi-level compensation business does not determine whether the FTC will consider the plan a pyramid scheme. The critical question .....is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate..." Stated differently, the 2004 Advisory Opinion focuses not on internal consumption but whether the commissions paid to program participants are funded by participant payments to participate in the program. The Court also cites the FTC's 2018 Guidance to the MLM Industry, which states that products "purchased and consumed by participants to satisfy their own genuine product demand...is not in itself indicative of a problematic MLM compensation structure."
Further, because the Fifth Circuit has never expressly adopted the Koscot test for determining what constitutes an illegal pyramid structure, the Texas court applied a similar but slightly different test announced by the 5th Circuit in Torres v. SGE Management. Under the Torres pyramid test, (i) a court must look at how a MLM company is operating in actual practice; and (ii) the primary factor is whether the business focuses exclusively or almost exclusively on recruiting as opposed to sales."
In its analysis of the Neora Compensation Plan, the Court noted that some rewards under Compensation Plan "require some recruitment element" and the Court is therefore required to determine whether such rewards are "unrelated to the sale of the product to ultimate users." FTC witness Bosley testified at trial that product purchases by Neora Brand Partners should never be considered as legitimate internal consumption by an ultimate product user. Bosely further testified that Neora was a pyramid scheme because 96% of its Brand Partners have or will "lose money."
The Court rejected these arguments by first noting that they sharply diverge from the "Goal Posts" established by the FTC for industry compliance in the 2004 Advisory Opinion and 2018 Business Guidance. The Court further rejected FTC and Bosley's "theoretical" assumptions and instead focused on how the Neora Compensation Plan operates in practice. Neora offered evidence showing that the primary motivation for participants enrolling as a Brand Partner is to purchase Neora products at a discount rather than participate in the MLM compensation plan. Neora further presented evidence that between 75-80% of total company sales are to non-Brand Partner Preferred Customers.
The Court rejected Bosley's conclusion that 96% of Brand Partners "lose money" by comparing Bosley's analysis with a simple trip to the grocery store. The customer will always leave the grocery store with less money than they had when they entered, but this is not characterized as a loss because the customer obtained groceries in exchange for their payment. The Court found the same to be true for those who enroll as Neora Brand Partners to be able to purchase Neora products at a discounted price rather than sell products.
The Court found that the fact that Neora can demonstrate that more than 70% of its products sales are to non-Brand Partner consumers distinguishes Neora from prior FTC enforcement actions against Vemma (2015) and BurnLounge (2007). In Vemma, there was evidence that 86% of total product sales were made to participants in the company's business opportunity. In BurnLounge, evidence was presented showing that BurnLounge's program participants purchased products at a much higher rate than non-participants.
The Court concludes its pyramid scheme analysis by observing that that the fact that 80% of Neora's revenues are generated by sales to ultimate users "weighs heavily" against a finding that Neora focuses exclusively or almost exclusively on recruiting as opposed to sales. Further, the Court relies upon this evidence in finding that Neora is in no danger of collapse because it does not rely on Brand Partner enrollments or purchases to sustain itself.
FTC's Deceptive Earnings Claim Allegations
FTC alleged that Neora has published deceptive and misleading income claims in various Neora videos, audio recordings, magazines, social media posts and live presentations. FTC alleged that these claims were misleading and material and thus a violation of Section 5(a) of the FTC Act because the vast majority of Neora Brand Partners do not earn any money.
The Court agreed that some of the examples cited by the FTC were problematic, but the Court noted that much of the FTC's evidence pre-dated 2019 or referenced discontinued programs and rewards. With respect to more recent claims cited by the FTC, the Court noted that those claims were accompanied by a prominent disclaimer stating that Neora "does not guarantee any level of income for any Brand Partner" and directing the viewer to a URL to access Neora's Income Disclosure Statement.
Importantly, the Court found notable that Neora has updated its policies regarding permissible income claims to align with interpretative statements from FTC in the 2018 Guidance to the MLM Industry and guidance and suggestions from the Direct Selling Self-Regulatory Council (DSSRC). Just as importantly, the Court noted that the FTC has not yet promulgated a formal rulemaking providing guidelines as to how direct sales companies may describe earnings or income opportunities in compliance with Section 5(a) of the FTC Act. In finding that Neora has not made improper earnings claims that violate Section 5, the Court placed emphasis on Neora's efforts to improve compliance and monitoring of earnings claims and the absence of clear guidelines on what the law is regarding deceptive and misleading earnings claims.
Conclusion
Neora and Jeff Olson are to be congratulated and credited for their decision to fight back against FTC overreach. The Court's decision is a rebuke of FTC's efforts to impose an unpublished, unsupported, subjective and more expansive test of what constitutes an illegal pyramid scheme. In finding that Neora is not operating as an illegal pyramid, Judge Lynn appropriately based her analysis on existing case law as well as FTC's 2004 Advisory Opinion and 2018 Guidance to the MLM Industry. In other words, the Court rejected the FTC's attempt to "move the goal posts" delineating what constitutes an illegal pyramid through an enforcement action relying on unpublished, subjective criteria. Just as importantly, the Court cited Neora's robust compliance efforts and the FTC's lack of published guidance to industry on permissible earnings claims as key factors in finding that Neora is not liable for publishing deceptive or misleading income or lifestyle claims.
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