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State of supplements: FTC drops direct sellers as target
This is an archived article that was published on sltrib.com in 2011, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

Washington • For federal regulators, the idea seemed like a no-brainer.

People thinking of selling Avon, Utah-based Nu Skin or some other multilevel marketing (MLM) products should know how likely they are to make a profit. They should know about any lawsuits against the company and the number of independent sellers who ended up demanding a refund.

After years of study, the Federal Trade Commission in 2006 formally proposed a "business opportunity rule" to protect people from fraud by requiring such disclosures of MLMs, also known as direct sellers, along with companies pitching vending machine routes and letter-stuffing campaigns.

Then regulators asked the public to comment. And they did. First by the hundreds, then by the thousands, almost all of which were sent by direct selling companies or their distributors clamoring that the rule would hurt their home-to-home business, if not kill it all together.

Two years later the FTC dropped any reference to MLMs and forged ahead with its proposal. The commission expects to finalize the business opportunity rule sometime later this year.

So what happened? That depends on your vantage point.

The direct selling industry says it demonstrated that the proposal was unnecessarily onerous and persuaded federal regulators to back off.

The FTC's staff say they decided the rule wouldn't help consumers determine if a MLM was a good bet.

And then there's a small group of critics who believes the FTC caved to political pressure from a questionable industry.

"It defies reason and the experience of millions of people to take the most common form of business-opportunity solicitation and exclude it," said Robert FitzPatrick, president of Pyramid Scheme Alert, based in Charlotte, N.C. "This rule was snuffed out with a political lobbying campaign."

That campaign was waged largely by the Direct Selling Association (DSA), which counts 16 Utah businesses as members. And the group doesn't hide that it helped direct most of the 17,000 comments the FTC received.

"We certainly facilitated those communications. I'm not abashed about that at all," said Joseph Mariano, the incoming president of the DSA. "We felt that the regulatory burdens they were going to place on legitimate businesses in an effort to weed out the scams were just too high."

The drawn-out debate over the business opportunity rule shows how aggressive direct sellers respond to regulations they find threatening, but also how the government has struggled to fashion rules for an industry that regulators regard skeptically.

Such regulatory dust-ups are of particular interest for Utah, which has more MLM companies per capita than anywhere else in the nation. Companies like Nu Skin, USANA and XanGo employ thousands and rack up annual revenues of $4 billion. They also enjoy the support of Utah's political elite. Sen. Orrin Hatch, Reps. Jim Matheson and Rob Bishop and former Rep. Chris Cannon sent letters to the FTC questioning the business opportunity rule and how it applies to direct sellers.

The thousands of comments, including those from Utah political leaders, almost exclusively focused on three areas: a seven-day waiting period to sign up, the financial and legal disclosures and a required list of references.

The companies felt a weeklong waiting period would zap the excitement of potential distributors, making it harder to recruit new people into their sales force. They also felt the earnings and lawsuit disclosures would make it look like the company was sketchy.

"There is sort of a feeling like 'Why do you have to do this? Have you done something wrong?'" said James Bramble, general counsel for USANA Health Sciences, based in Salt Lake City.

As for the list of references, their complaints covered both privacy concerns and issues unique to the MLM world.

Distributors get more money when they add new distributors to their "downline," so encouraging someone to call independent sellers to check on the validity of the business could start a recruitment war.

"We were ultimately able to persuade the FTC that the direct sellers should not be covered," said Nu Skin General Counsel Rich Hartvigsen. "There are several million independent direct sellers in the United States. When they get involved in an issue that impacts their business, they have a fairly loud voice."

Monica Vaca of the FTC's Bureau of Consumer Protection said the 17,000 comments were far more than the commission normally receives on a proposed rule, but she didn't believe the industry arguments resulted in the policy change.

"At its core what the business opportunity rule does is provide prospective purchasers with disclosures. Things we think are important for people to know before they invest money," said Vaca. "Some of those disclosures are going to be more difficult to apply in the MLM context."

She said the big one is the earnings disclosure. According to Vaca, MLM companies and even their distributors have an incentive to exaggerate annual earnings, making it easier to recruit others into the business.

"If they are engaged in some kind of collusion to inflate these earnings, then the earnings disclosure is not going to be really that useful," she said.

Vaca did agree that providing references to other MLM distributors could be counterproductive.

"If they have an incentive to recruit you into their downline, then you don't have somebody who is necessarily giving you the full, honest picture," she said.

Beyond the details of the regulation, Vaca said the commission had a change in heart through the rule-making process.

"Initially, we felt like there was really quite a lot of evidence there, that there are some bad practices in this industry. However, identifying bad practices of 14 companies is a little bit different than identifying that as a prevalent problem affecting the entire industry," she said, referring to past FTC lawsuits against 14 direct selling companies, none of which was from Utah.

The FTC decided that it would continue its case-by-case approach to rooting out the bad companies from the legitimate ones, focusing on how much of the money is made by recruiting others rather than selling products.

FitzPatrick, the vocal MLM critic, called that "absurd."

"The original rule was not to prove that each scheme was a fraud," he said. "The point of the rule was to provide disclosure so the consumer could know if it was a viable business opportunity."

He said the biggest need is for more information on potential earnings, because he said people envision making big money selling the products and recruiting other distributors, but the overwhelming majority makes little or no money at all. He thinks the FTC should have tried to tweak the disclosure, not jettison it entirely.

FitzPatrick also lamented the political involvement in the rule making, including a direct selling company in Georgia that hired past FTC Chairman Timothy Muris and former Consumer Protection Bureau Director Howard Beales to argue on its behalf.

Vaca rebuffed the claim that the FTC caved to industry pressure, saying: "I think our report really stands on its own. We talk about all the reasons why it was not a good fit."

But she also promised that the FTC would keep a vigilant eye on direct sellers.

"We are going to be active in the MLM world for a long time," she said. "The two main issues are the potential for a possible pyramid scheme, and the making of false or unsubstantiated earnings claims."

mcanham@sltrib.com Business opportunities

The FTC's proposal was a play off the already established franchise rule, which requires chains to provide lengthy disclosures to a prospective buyer. This time, the FTC wanted to target much less expensive ventures such as at-home work companies and multilevel marketing.

Disclosures required

Any earnings claim made by the company

A list of lawsuits concerning fraud or deceptive practices

Description of any refund policy

The number of purchasers in the past two years and the number who sought a refund

A list of references, usually the 10 geographically closest to the new recruit

Multilevel marketing • Hatch, Matheson, Bishop and Cannon send letters questioning proposed regulations.
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