FTC Act Section 5: Unfair or Deceptive Acts or Practices
An MLM with an unlawful compensation structure, which is sometimes called a pyramid scheme:
The most widely-cited description of an unlawful MLM structure appears in the FTC’s Koscot decision, which observed that such enterprises 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.” In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975).1
How the FTC distinguishes between MLMs with lawful and unlawful compensation structures:
At the most basic level, the law requires that an MLM pay compensation that is based on actual sales to real customers, rather than based on mere wholesale purchases or other payments by its participants.
In evaluating MLM practices, the FTC, in accord with established case law, focuses on how the structure as a whole operates in practice, and considers factors including;
Incentives that the compensation structure creates.
The assessment of an MLM’s compensation structure is a fact-specific determination that the FTC makes after careful investigation.
“Inventory loading” explained. Do buyback provisions cure inventory loading?
“Inventory loading” is a term that may be used to describe a participant’s wholesale product purchases that are made in an attempt to advance in the marketing program, rather than made to satisfy actual consumer demand in the marketplace for those products. Just as MLMs involve a variety of structures and products, payments that participants make to advance in the marketing program rather than to purchase product to satisfy actual consumer demand can take many forms, such as expenditures to purchase inventory.
As in any business opportunity, it can be a beneficial practice if an MLM allows participants to return unsold product to the MLM because the ability to return product can decrease the risk of losing money for participants who take advantage of that policy.
Allowing participants to return product, however, does not in and of itself shield an unfair or deceptive compensation structure from law enforcement. As a general matter, money-back guarantees and refunds are not defenses for violations of the FTC Act. Even where such policies are offered, dissatisfied participants may not seek a refund for a number of reasons, including because they are unaware of their right to a refund, the refund process is too complicated or obscure, or they blame themselves for not being able to sell the product.
How an MLM approach representations to current and prospective participants:
An MLM’s representations and messaging concerning the business opportunity it offers must be truthful and non–misleading to avoid being deceptive under Section 5 of the FTC Act.
An MLM’s representations about its business opportunity, including earnings claims, violate Section 5 of the FTC Act if they are false, misleading, or unsubstantiated and material to consumers.