Multilevel Marketing – Legal Pitfalls to Avoid

Laws and standards are still evolving for this popular business model 

by Shelley Tolman and Marvin Ruth

For decades, multilevel marketing has permeated not only the business landscape but the American home. From Tupperware to jewelry to dietary supplements, the concept is familiar and widely utilized to grow brands from the mom-and-pop level to national powerhouse. 

Essentially, a multilevel marketing business model is one in which the company sells products directly to the public through a network of entrepreneurial salespeople (rather than retail establishments) — often through one-on-one selling, social media platforms and in-home product demonstrations. These salespeople are not employees and do not receive a salary. Instead, compensation is often based on personal sales, as well as the sales of each individual’s sales organization. 

The nature of these compensation models and the manner in which additional salespeople are added to the salesforce can often be the target of state and federal regulators, as well as dissatisfied salespeople who may assert that certain compensation structures are unfair or deceptive. Specifically, the Federal Trade Commission condemns models in which salespeople pay for product and, as a result, earn the right to be compensated for recruiting other salespeople rather than for selling products to consumers. 

Businesses entering this space need to be especially attuned to the evolving laws and standards governing the industry, in addition to potential roadblocks that are landing companies in legal hot water. To help ensure profitability and compliance, businesses should do the following:

Keep track of all retail sales. One of the FTC’s focuses is on actual consumer demand, and the payment of compensation based on sales to retail customers. However, many direct selling companies are unable to fully quantify the amount of retail consumer demand for their products, particularly when many of those sales take place out in the field through in-person transactions. While a direct seller may be able to track sales placed through the company’s website, it will often have minimal records of sales made directly to consumers out of the product inventory of its salesforce. 

Businesses typically use one of two options: require salespeople to provide receipts for every sale or direct all sales to take place over the company website. However, these options may not be realistic, depending on the marketplace. In these cases, there may be opportunities to use technology, such as developing a mobile app for salespeople, which could provide helpful information in the event of an investigation or litigation. 

Distinguish between customers and salespeople. It is permissible, subject to certain potential limitations, to pay compensation based on a participant’s purchase of product for personal consumption. The FTC, however, will look askance at claims that large wholesale purchases are being made primarily for the purpose of personal consumption. Further, demonstrating to the FTC (or a court) the extent to which purchases were made for purposes of personal consumption is much more difficult when customers are lumped into the same category as salespeople. As a result, it is important for companies to differentiate as much as possible between individuals enrolling with the company in order to solely purchase product at a discount, and those persons enrolling with the company to pursue a business opportunity as an entrepreneur. To create this distinction, companies may enroll individuals who are solely purchasing products at a discount in a preferred customer program.

Monitor and confirm the accuracy of marketing and income statements. The FTC has broadly construed misleading income statements to include unsubstantiated income claims, unrealistic lifestyle imaging and inaccurate representations regarding the work necessary to achieve income. Robust disclosures and disclaimers are often not enough in the event of an FTC investigation. 

Ultimately, multilevel marketing regulations, and the manner in which they are enforced, are complicated and nuanced. We recommend speaking to an attorney before wading into these issues. However, the more accurate data on consumer demand that a direct seller can maintain, the better prepared that company will be in the event of an investigation or litigation.  

Shelley Tolman and Marvin Ruth (l to r) are partners with Phoenix-based business law firm Coppersmith Brockelman, in the commercial litigation practice. They represent direct selling companies and direct sellers in a variety of litigation and regulatory manners.

Note of interest: According to the Direct Selling Association, 18.6 million people are involved in direct selling in the United States, generating $34.9 billion in estimated retail sales (2017).

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