Supplement Sector Settlements Frame FTC Guidance On Direct Sellers' Compensation Claims

Guidance notes settlements Herbalife and Vemma Nutrition made in 2016 as examples of its enforcement policies. FTC prohibition against misleading claims extends to requiring direct sellers to base claims of distributors' compensation on sales to consumers, not on measures such recruiting more distributors.

Federal Trade Commission guidance on direct sellers' compliance with its prohibition against misleading claims, referencing their practices for paying distributors, notes settlements with two dietary supplement marketers as examples for its enforcement policies.

The guidance published Jan. 4 could be of particular interest to some firms in the supplement sector, though it does not single out any market or sector as particularly prone to noncompliance with regulations in Sec. 5 of the FTC Act. The section's prohibition against misleading, false or unsubstantiated claims extend to requiring direct sellers, or multi-level marketers, to base claims of distributors' compensation on sales of products to consumers, not on other measures such as their own purchases of products or on recruiting more distributors and forming networks that generate ongoing commissions for them as well as additional payments to a firm.

FTC staff include in the guidance, offered in a question-and-answer format, references to the commission's settlements made in 2016 with supplement marketers Herbalife Ltd. and Vemma Nutrition Co. The document also references two other FTC settlements with direct sellers offering other types of products or services.

"Multi-level marketing is a diverse and varied industry, employing many different structures and methods of selling. Although there may be significant differences in how multi-level marketers sell their products or services, core consumer protection principles are applicable to every member of the industry," FTC staff states.

The guidance refers to a 1975 FTC decision on a complaint against a Florida MLM that offered cosmetics as precedent for a regulatory description of "an unlawful MLM structure." The decision states that direct sellers noncompliant with FTC rules are “characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users."

Distributors: Consumers At 'Particular Risk Of Injury'

FTC explains that direct sellers' misleading compensation claims violate advertising regulations because their distributors are consumers put at "particular risk of injury."

"Where an MLM has a compensation structure in which participants’ purchases are driven by the aspiration to earn compensation based on other participants’ purchases rather than demand by ultimate users, a substantial percentage of participants will lose money," the guidance states.

Additionally, the agency says determining whether an MLM or direct seller is noncompliant with its compensation claims swings on "the most basic level" of Sec. 5, requiring that a firm pay compensation based on "actual sales to real customers."

FTC's evaluation of an MLM's practices focus on the operation of the structure as a whole and considers factors including marketing representations, participant experiences, compensation plan and incentives the structure creates.

The agency also notes at multiple points in the guidance that each investigation is "fact-specific" and determinations depend on variety of factors. Still, when evaluating an MLM’s compensation claims and practices FTC is likely to consider whether the structure incentivizes or encourages participants to purchase products for reasons other than satisfying their own or actual consumer demand; and on whether particular wholesale purchases by business opportunity participants were made to satisfy personal demand.

FTC's settlement with Herbalife, announced in July 2016 following an investigation launched in 2013 and limited to the global firm's US business, imposed a $200m fine and required it to determine compensation for its independent distributors based on actual retail sales, rather than on the number of additional product distributors they recruit, and to show at least 80% of its revenues are to end-users. (Also see "Herbalife Claims No Harm, But FTC Hails 'Unprecedented' Settlement's Impact" - HBW Insight, 15 Jul, 2016.)

The settlement also requires distributors to be active for a year before launching "nutrition clubs," the practice of selling consumers daily consumption amounts that has been a key driver for sales in markets outside the US. It also required the weight loss and nutritional supplement firm to limit distributors' initial and monthly purchases, to allow more time for distributors to claim refunds and to hire an independent monitor to audit its compensation practices for seven years under the settlement filed in US District Court for the Central District of California.

The Los Angeles-based firm has framed the settlement as a platform to improve business and enhance distributor earnings. (Also see "Herbalife Forecasts Smoother Sailing Following FTC Settlement Bumps" - HBW Insight, 11 May, 2017.)

In a December 2016 settlement, FTC imposed similar requirements on Vemma and CEO Benson Boreyko, prohibiting paying distributors compensation for recruiting new participants; basing compensation on a participant’s purchases; and paying any compensation to a distributor for sales in a pay period unless the majority of the revenue generated during that period, by the participant and others the participant recruited, comes from sales to consumers. (Also see "Vemma's FTC Settlement Points Out Pyramid Scheme Charge" - HBW Insight, 16 Dec, 2016.)

FTC also ordered not to misrepresent distributors' typical incomes, having assessments from an independent third-party auditor every two years for 20 years, and substantiating claims for its products. The Tempe, Ariz., firm was charged with violations including "operating an unlawful pyramid scheme" and that it agreed it would face more substantial penalties if it later is found to compensate its independent distributors for recruiting others rather than for retail sales based on legitimate consumer demand for its products.

The settlement in US District Court for the District of Arizona imposed but suspended a fine of $238m against the firm and required Boreyko to pay $470,136 in fines and surrender real estate and business assets.

From the editors of the Tan Sheet. Our dietary supplement industry coverage now is published in the Rose Sheet, with articles emailed to readers daily and available on this page of the newsletter website.