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December 01, 2015

New Perspectives

The Vemma Case: Is the FTC’s Target a Company, a Compensation Plan, or the Industry?

by Mark Rawlins

Click here to order the December 2015 issue in which this article appeared or click here to download it to your mobile device.

As the Vemma case unfolds, I grow increasingly concerned about the impact it could have on the industry’s future. What first appeared to be a case about income claims, targeting college students, and questionable statements made by company leaders, has turned into a case with groundbreaking compensation plan restrictions. While the industry did not jump to defend those practices which drew the FTC’s attention to Vemma, we should respond to the dangerous positions the FTC is trying to establish as precedent.

No federal law specifically regulates most aspects of direct sales compensation plans, so the most useful guidance we have are the arguments and rulings generated during previous actions against MLMs. However, since these opinions are specific to the facts of the cases they are a part of, the picture painted by them is ambiguous and at times even contradictory. Therefore, it can be difficult to know what is allowed and what isn’t.

In the past, industry-relevant rulings seem to have focused on specific actions, like paying for the recruitment of distributors, not selling a real product, front-end loading, or other practices that were so clearly fraudulent that the only remedy the FTC saw was to shut the company down. This case is different. It appeared to start the same way; the FTC claimed that the actions and claims of Vemma’s owners and some of its distributors were so outrageous that the company needed to be shut down. But Vemma successfully argued to the judge that it had a legitimate product and legitimate consumers, and the judge ruled that within certain restrictions Vemma could restart operations as long as it changed its compensation plan and agreed to oversight by a court appointed monitor. 

This is where it gets scary. On Oct. 16, Vemma filed documents proposing changes meant to align their compensation plan with the Preliminary Injunction Order. On Oct. 20, the FTC filed its response, strongly implying that the FTC believes binaries are de-facto illegal. It is a truly frightening document. Over and over, the FTC uses the word “binary” as a criticism, and implies that Vemma can’t be legal because it is a binary. It is troubling to see the FTC directly attack one of the industry’s three primary compensation models. Even more troubling, on Oct. 28 the judge ruled against Vemma’s proposed changes. The judge did not go so far as to say binaries are illegal, but the FTC may still use this ruling to try to give their position credibility.

If the arguments put forward by the FTC become the standard by which the industry is judged it will create problems for most modern compensation plans—but they really wreak havoc with binaries. To understand why, you have to know a little bit about how binary plans work.

The modern binary is built around a very simple concept. A distributor is only allowed two downline legs and is paid approximately 10 percent on the pay leg, which is the leg with the least amount of sales volume. (There are plan rules that keep a company from paying too much but we won’t go into that.) So a distributor need only focus on the balance of sales volume between his two downline legs. In the diagram on p. 82, Al receives 10 percent of the total downline volume of the leg that begins with Betty. The commission percentage is the same on all volume regardless of level. So Betty’s sales are exactly as valuable to Al as Joe’s sales.

Once Al has built this downline, he can go to Betty, Frank, and Suzan and point out the amount of volume under them that they are not capitalizing on because they haven’t built a second downline leg or pay leg. The higher the amount of the volume in this leg, the more volume Betty, Frank, and Suzan can receive commission on in a second downline leg if they build one. This is the essence of the standard binary build strategy. (It’s important to note that not all binaries are the same, and some companies have built a unique version of binary that doesn’t behave this way.) Put Betty in the tree and if you or other people under Betty continue to build, eventually Betty will have enough volume underneath her that she will want to build that second downline leg and get paid on it.

This feature is what the detractors of binaries really dislike, because irresponsible distributors and companies oversell this feature. It’s hard to overstate how much trouble this has caused; there have been cases of distributors promising to put hundreds or thousands of people under promising prospects. It becomes a bidding war for new distributors.

So here is the major problem that I see for binaries: the FTC wants retail customers to be pure retail customers, people whose decision to buy product was not influenced by the possibility of making money—and that completely goes against the theory of operation for most modern binary companies. The idea behind a binary is that everyone goes in the tree. If they build a pay leg, great they get paid; if they don’t, they won’t get paid. But by all appearances, the FTC’s argument is that retail customers cannot be in the downline tree. If that becomes part of the case law that governs the industry, it will be open season on binaries. Case by case the FTC will be able to accumulate precedents, making it harder and harder for a company to have a binary compensation plan.

Even though the FTC is targeting binaries now, most of the issues raised in this case affect virtually every multi-level marketing company out there. The way I read these filings, the FTC wants retail sales to customers to be the primary focus of any compensation plan; they want a “structure that [rewards] Affiliates for direct retail sales.” (FTC Response to the Revise Compensation Plan, page 2.) In this case, the FTC went so far as to argue that unless at least 51 percent of a distributor’s total downline sales came from these retail sales they could not be paid any commission. Furthermore, the court rejected the argument that anyone who signed up as a distributor but had not actually sponsored anyone could be counted as a retail customer, even though in most cases they had not purchased a distributor kit, or engaged in any other “distributor” type behavior.

So where does this leave us? It is impossible to overstate how much it would change the industry if these FTC positions become a standard against which MLM companies are judged.

More than almost anything I have seen in my 35 years in this industry, this case has the potential of remaking the rules that define how direct sales companies can operate, but as far as I can tell the industry has left Vemma to fight this battle alone.

When the TRO and asset freeze went into effect, the DSA chose to distance itself from the case, rather than take a stand. Given some of the allegations against the CEO and top distributors, that may well have been a reasonable choice at the time. But make no mistake, this case is now about the FTC trying to ban industry standard compensation plan practices, and still the industry hasn’t responded.

Several years ago the FTC proposed a set of rules that would have created real problems for the industry, and, led by the DSA, the industry responded. In my opinion this case needs the same type of response. This isn’t just about Vemma, and it’s not just about binaries. I really don’t see how the industry can stand by and watch. Maybe collectively we’re hoping that Vemma has the money and will to fight to the bitter end. But we should all stand up to protect the industry from case law that will be a thorn in our sides for the foreseeable future.

Note: As this article goes to print, Vemma has released its revised compensation plan, which according to previous court action had to be approved by the FTC and the court.

  • No personal purchases whatsoever can count toward qualifications.
  • No affiliate will be paid any commissions—at all—unless 51 percent of the volume in his entire downline organization comes from customer purchases.
  • No one who has ever been registered as an affiliate can be automatically reclassified as a customer.
  • No product packs can be sold.
  • Autoship can continue but it cannot be tied to compensation.
  • No fast start bonuses can be paid for the recruitment of new affiliates.

Once again I asked the question: Are these rules that we, as an industry, can live with? If Vemma does not prevail when this goes to trial, the FTC will use this agreement as precedent against other companies in the industry. Can we live with that?

Disclaimer: Mark Rawlins is not a lawyer.

Mark RawlinsMark Rawlins is Founder and CEO of InfoTrax Systems and author of the book, From Commission Plan to Compensation Strategy: Success for Today’s MLM Enterprise.