The FTC Gets It Right – Almost

On Tuesday, March 18, the FTC dropped the other, long awaited, shoe in its efforts to enhance federal regulation of business opportunities. It issued a Revised Notice of Proposed Rulemaking (“RNPR”) for a substantially rewritten version of the new business opportunity rule it had previously proposed in 2006. Some background:

In April 2006, the Commission invited public comments to its proposed rewrite of the business opportunity part of the Trade Regulation Rule which had, since 1978, governed both traditional franchises and business opportunities. A significant revision of the franchise part of the Rule had earlier been done and was nearing final enactment at the time (later announced in January 2007).

The Network Marketing community was threatened with serious harm by many of the provisions of the proposed new rule. The most potentially damaging requirements of the Proposed Rule as then written would have:

  • Required that the seller of a business opportunity provide a “disclosure statement” at least seven days before any prospective purchaser signs a contract or makes payment to the seller;
  • Required that the disclosures include information such as previous lawsuits, the number of direct sellers who cancel within two years and a list of “references” i.e., purchasers of the opportunity in the previous three years;
  • Required business opportunity sellers who make earnings claims to provide an additional “Earnings Claim Statement” to prospective distributors, which would include extensive earnings disclosures which would need to be frequently updated and
  • Created new definitions of “business opportunity,” “business assistance” and “earnings claim”, using broad language that encompassed many direct selling practices, and virtually all Network Marketing opportunities.

Network marketers responded with an impressive display of democratic chutzpah. By July 2007 (the extended deadline date for submission of comments), some 17,000 written comments had been submitted to the Commission by individuals, companies, consultants, and Trade Associations whose lives and businesses were directly impacted by this Rule. Then the lobbyists went to work. Among other things, a letter signed by 14 U.S. Senators was delivered to the Commission noting that the vast majority of comments were opposed to the rule and expressing concern for the potential that the proposed rule might over-regulate and severely restrict the legitimate activities of American businesses, including direct selling companies.

The community’s voice was heard. In its news release last Tuesday, the FTC reported that it has decided to narrow the scope of the new rule so as to exclude from coverage multi-level marketing companies and other companies that were “inadvertently” swept into the scope of coverage of the initial proposed rule. In its 117 page commentary on the newly rewritten Rule, the Commission Staff lays out the reasoning for its decision to exclude MLMs as follows:

“As the Commission’s cases demonstrate, the sale of goods and services alone does not necessarily render a multi-level system legitimate. Modern pyramid schemes display endless ingenuity in finding ways to disguise payment of participation fees to appear as if they are for the sale of goods or services. The source of the income typically is not easy to discern from a facial examination of a company’s compensation structure and the safeguards it purportedly has in place.

Economic analysis of the MLM business model suggests a continuum with clearly legitimate MLMs at one end and clearly fraudulent pyramid schemes at the other. With some basic company information, a company residing at one pole or the other can be identified. Nevertheless, in the middle is a substantial gray area where differentiating the two is much more difficult because the source of income is both sales of products or services and participation fees. Indeed, the question of whether a purportedly legitimate MLM is, in reality, only a pyramid scheme in masquerade is a highly fact-intensive inquiry.

That being the case, the issue is a particularly difficult one to address via industry-wide rulemaking, as opposed to case-by-case enforcement.” 

The “case-by-case enforcement’ the Commission refers to in this statement would be, essentially, a continued application of the practices and policies it has employed over the last several decades when enforcing Section 5 of the FTC Act against various multi-level marketers, including many whose opportunity programs were otherwise excluded from coverage because their initial required payment fell below the $500 threshold of the original (and still current) Rule regulating Business Opportunities.

Based on a cursory reading of the RNPR, one might think the Network Marketing community could now relax, that the threat has been averted. But as with most bureaucratic endeavors, beware the devilish details. In the RNPR and in its commentary, the FTC indicates that the revised proposed rule will cover those business arrangements previously covered by the Rule and will be expanded to also cover work-at-home schemes, but, as revised now, it would not reach MLMs. This is said to be accomplished by more precise crafting of the definition of a covered “business opportunity”. In the staff comments, the following description is given:

” The three definitional elements of the term “business opportunity” in the [revised rule] are: (1) a solicitation to enter into a new business; (2) a “required payment” made to the seller; and (3) a representation that the seller will provide assistance in the form of securing locations, securing accounts, or buying back goods produced by the business.

This change will exclude from the definition business relationships in which the only required payment is for inventory at bona fide wholesale prices. Second, the [revised rule] definition eliminates two types of “business assistance” that formerly would have triggered the Rule’s strictures and disclosure obligations, namely tracking payments and providing training. Third, the [revised rule] no longer links the definition of “business opportunity” to the making of an earnings claim.”

The comments go on to remind us that the $500 threshold of the current Rule will be eliminated. Hence, the “required payment” reference in element number (2) of the proposed new definition might, theoretically at least, be as little as one cent. Still, this description looks fairly acceptable to me. Few, if any, MLM opportunities that I have reviewed would meet the above definition. But…. just to be certain, one should check the actual language of the regulation itself. That’s in the final 8 pages of the 117 page full Notice document. Here, in the definitions section of the actual revised proposed rule, we find the following pertinent excerpts (with my highlights added):
Ҥ 437.1 Definitions.
The following definitions shall apply throughout this rule: . . .
(c) Business opportunity means:
(1) A commercial arrangement in which the seller solicits a prospective purchaser to enter into a new business; and
(2) The prospective purchaser makes a required payment; and
(3) The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will:
(i) Provide locations for the use or operation of equipment, displays, vending machines, or similar devices, on premises neither owned nor leased by the purchaser; or
(ii) Provide outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or
(iii) Buy back any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example, stuffing envelopes from the purchaser’s home.

. . .

(l) Providing locations, outlets, accounts, or customers means furnishing the prospective purchaser with existing or potential locations, outlets, accounts, or customers; requiring, recommending, or suggesting one or more locators or lead generating companies; providing a list of locator or lead generating companies; collecting a fee on behalf of one or more locators or lead generating companies; offering to furnish a list of locations; or otherwise assisting the prospective purchaser in obtaining his or her own locations, outlets, accounts, or customers.

. . .

(o) Required payment means all consideration that the purchaser must pay to the seller or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the business opportunity. Such payment may be made directly or indirectly through a third-party. A required payment does not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.”

OOPS!
It looks for all the world as though the FTC really did (does?) intend to exclude MLMs from coverage under the operative definition of “business opportunity”. But we lawyers and other community commenters may still have some work to do. Unfortunately, it seems to me they may be “inadvertently” pulling back into coverage those MLMs that: (1) require their new recruits to make a payment to obtain a “Starter Kit” of program literature or materials; and (2) promote (or at least offer) some sort of leads program or anything that might be termed “internet outlets”. Individuals or companies wishing to comment on the Revised Proposed Business Opportunities Rule should not delay. The Commission will be accepting comments on the RNPR until May 27, 2008. Thereafter, rebuttal comments can be made by June 16, 2008.

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