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October 01, 2015

News in Brief

News in Brief, October 2015

Caught in the Cross Hairs

On Dec. 4, 2014, Matthew Thacker logged onto a computer in Dallas and signed up as an Affiliate for Arizona-based Vemma Nutrition Co. Seven days later, three boxes arrived containing his starter kit, which consisted of a variety of products and materials for launching his business. Over the course of the next few months, he spoke with his up-line enroller for guidance on establishing his business, attended two training events, received regular product shipments and spent considerable time studying online Vemma training materials.

But Thacker was far from being a new, engaged company recruit.

As Vemma learned in late August, Thacker is an investigator with the Federal Trade Commission. He signed up for Vemma using an undercover name, contact information and credit card account, documenting each step along the way with screen recording software, and he continued to use his undercover identity as he participated in telephone calls and events, which he also recorded. His experience with Vemma generated hundreds of pages of exhibits the FTC used to make its case to the court, accusing the company of being a pyramid scheme, making false and misleading income claims, and failing to provide appropriate income disclosures.

The case is the FTC’s first significant action against a direct selling company since the Ninth Circuit of the U.S. Court of Appeals’ 2014 ruling that BurnLounge Inc. was an illegal pyramid scheme, and executives across the industry are monitoring the case closely. Final judicial resolution on the case, and the legal precedence it will provide, could be years away, but already there is much to learn.

In the few weeks since the case was filed, the public has been given a window into how the FTC approached its investigation and the vast power the FTC and the federal courts have to take action against a company. To gain a better understanding of that process, Direct Selling News reviewed case documents filed with the court, attended the Sept. 15 hearing on the FTC’s request for a preliminary injunction and spoke with several lawyers familiar with direct selling case law.

INSIDE AN FTC INVESTIGATION

The FTC has acknowledged that its active investigation was in place for more than a year prior to filing its suit. Using his undercover identity, Thacker recorded and downloaded dozens of videos and other documents, including much of the material available on the Vemma back office, and the FTC made heavy use of selected transcripts and other excerpts from these materials in formulating its case. The FTC also issued civil investigative demands to Wells Fargo Bank, American Express and the Arizona Department of Economic Security, which gave it access to certain company financial records.


The Vemma case is the FTC’s first significant action against a direct selling company since the Ninth Circuit of the U.S. Court of Appeals’ 2014 ruling that BurnLounge Inc. was an illegal pyramid scheme.


Another prominent piece in the FTC’s case is the analysis of the Vemma compensation plan conducted by Stacie Bosley, an assistant professor of economics at Hamline University who has conducted research on multilevel marketing, direct selling and pyramid schemes. In her declaration to the court, Bosley said it was her judgment that the company’s marketing program and business model meet the test for being a pyramid scheme. “All forms of compensation are driven by recruitment or purchase volume, and there is no direct connection between this compensation and retail sales or market demand,” she wrote. “This structure incentivizes participants to purchase product for the purposes of maintaining eligibility for recruitment rewards (inventory loading) and to encourage their ‘downlines’ to do the same.”

What the FTC didn’t do during the investigation was contact Vemma management, seek to interview executives or employees, or request sales information or income statements from the company. On cross examination during the preliminary injunction hearing, both Thacker and Bosley acknowledged that they did not have nor seek to obtain access to the company’s actual sales data. Other aspects of the investigation may come to light as the case proceeds through court. In a press release, the FTC thanked the offices of the attorneys general of Arizona, South Carolina and Michigan, the Tempe, Arizona police department, and the nonprofit organization Truth in Advertising in assisting in bringing the case.

EX PARTE POWER

Once the investigation was complete, the FTC pulled all of the documentation together and filed a complaint for permanent injunction under seal with the U.S. District Court for the District of Arizona on Aug. 17. On Aug. 21, Judge John J. Tuchi granted an ex parte temporary restraining order with asset freeze and the appointment of a receiver. What happened next was swift and, experts say, very difficult for any company to recover from.

On Monday, Aug. 24, the FTC served Vemma with the temporary restraining order, or TRO, which meant the operations of a 10-year-old, $200 million company came to a halt without warning. The court’s designated receiver—Robb Evans & Associates LLC, a company specializing in serving as appointed corporate fiduciaries that also served as the receiver in the FTC’s case against Fortune Hi-Tech Marketing—stepped in right away to take control of the business. The receiver’s actions over the next week are documented in a report to the court and in the testimony of Executive Vice President Kenton Johnson during the preliminary injunction hearing. According to these sources, the receiver called an employee meeting at approximately 11:30 a.m. on Aug. 24, at which time he stopped all sales and sent most employees home. Customer service representatives stayed on to answer phones, but they were not permitted to fill orders or to access the computer system, and some IT and other personnel also remained to assist in gathering documents. At the time of the initial government action, Vemma had approximately $6 million worth of inventory on hand, about half of which was fully packaged and ready for sale. Some of that inventory was set to expire within the month.

The receiver asked management to provide information on 2015 sales to Affiliates and non-Affiliate customers in the U.S. and Canada, the company’s consolidated income statements, and a brief description of inventory and the quality of accounts receivable. Based largely on the fact that Vemma’s data showed that about 22 percent of sales in 2015 were to non-Affiliate customers and that the company had been operating at a loss, the receiver determined that he could not continue any aspect of Vemma’s operations under the terms of the TRO. The receiver put a notice on the company’s website and phone system and also sent an email blast to the Affiliate network saying that the operations of the company had been temporarily suspended. In total, Johnson testified, the receiver spent approximately 90 minutes with company management over a series of meetings spanning less than two days before reaching that conclusion. The inventory would sit, unsold even in Vemma’s existing retail outlets.

With the TRO in place, the FTC requested a preliminary injunction that would have essentially continued the asset freeze and receivership through the duration of the case. With their assets frozen and the company essentially shut down, Vemma and the other named defendants—CEO B.K. Boreyko and top distributors Tom and Bethany Alkazin—had little time to respond.

WHAT’S NEXT?

During the preliminary injunction hearing, Vemma’s lawyers made compelling arguments that the government agency had failed to prove that the defendants were likely to hide assets, destroy documents or otherwise not comply with an ongoing investigation. At press time, the judge had lifted the asset freeze and downgraded the temporary receiver to a position as a court-appointed monitor. The judge granted part of the FTC’s request, however, placing deep restrictions on how management could operate the business.

It will take a final court ruling on the FTC’s allegations before the full impact of the case becomes clear. There are a number of key issues before the judge that, depending on his ruling, could have widespread implications for the direct selling channel, including how the court views compensation for personal consumption and what constitutes appropriate income disclosure.

What also remains to be seen is what, if any, changes the FTC will make in how it conducts its investigations and brings them to court. Observers say the fact that there was any relief from the terms of the TRO was significant, putting Vemma on better footing than other multi-level marketing companies in similar circumstances. “It’s a very clear signal that the FTC’s draconian methods of attacking the industry are overstepping the bounds,” said Spencer Reese, a partner in the law firm Reese, Poyfair, Richards PLLC, who specializes in direct selling law. But will that signal be enough to change the FTC’s tactics? Only time will tell.


After 20 Years, Reliv Kalogris Foundation Supplies Nutrition to 40,000 Daily

During Reliv International’s annual salesforce conference in August, the nutrition company celebrated the 20th anniversary of the Reliv Kalogris Foundation, which currently provides free, daily nutritional supplements to 40,000 malnourished people in nine countries. In the past two decades, the charity has donated more than $42 million in product and established upwards of 250 feeding programs across the nine countries where it operates. The Reliv Kalogris Foundation—named for the creator of Reliv’s first product, the late Dr. Theodore Kalogris—has also supported relief efforts in the wake of natural disasters, such as the 2010 earthquake in Haiti and the typhoon that struck the Philippines in 2013.


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