"Internal Consumption" Is Not A Disease (but the FTC contends it may not be enough to justify getting paid commissions)
by David G. Eisenstein, Esquire
First, a Little History and a Few Words of Caution: Remember the phrase that you need to be a "product of the product" to be successful in network marketing? Well, that still may be true, but the new buzz word in network marketing legal circles is "internal consumption" and if the Federal Trade Commission is the one using that phrase it can conjure just as much evil sickness as the word "consumption" did in olden times when it was the name of the deadly illness which "consumed" the lungs, long since referred to as tuberculosis.
A few years ago the Ninth Circuit Court of Appeals handed down the Omnitrition opinion containing language which is very scary to network marketing companies, their attorneys, and distributors, most notably declaring payment of commissions based upon downline distributors' purchases for their own use to be one of the characteristics of an illegal pyramid scheme. That came as a shock to the network marketing industry since most of its prominent and not so prominent companies did and still do pay commissions to distributors for volume generated from both downline distributor personal and family usage as well as from sales to those who are not participating with the company as a distributor, also known as third party sales.
The language used by the Court has been discounted as what lawyers call dicta, since it was arguably unnecessary to the actual procedural decision reached in that case sending the matter back down to the District Court for a decision on the merits. Still, state and federal regulators, the most notable of which is the FTC, have used the Omnitrition Court's distaste for payment of commissions on the distributors' own use or consumption as a very sharp sword. This has been done seemingly in an effort to overturn the long standing precedent established by the administrative law judge's decision in FTC v. Amway which is still used as the industry's road map to legality---or was, until it was supplemented, some would argue replaced, by Omnitrition.
In addition to saying that payment of commissions for "internal consumption" by downline distributors had an unpleasant odor, the Court went so far as to cast doubt on the legality of monthly personal maintenance requirements as leading to the dreaded front-load, also known as "garage qualification," as in filling up your garage with stuff you can't sell or use in order to qualify for commissions.
Now, fortified with the Omnitrition language for its new ammunition, the FTC has taken the position in a growing line of cases filed in federal court that it is not enough for companies to offer the Amway protections of 1) guaranteed buy-back of products, 2) the requirement that 70% of the distributors' product be sold before purchasing more, and 3) the requirement of retail sales. This is particularly the case where a company is unable to prove by verifiable records that it has regularly enforced these protections/requirements.
The FTC and other regulators have leveraged the Omnitrition language to add a fourth critical requirement to the three major Amway protections. The FTC interprets Omnitrition to force companies denying they are illegal pyramids to be able to prove that override commissions are paid to distributors on sales volume that is composed of "primarily" sales to non-participant third parties (non-distributors). "Primarily" in this context, presumably means more than 50 percent.
The actions of the FTC suggest that the regulators have not chosen to go after every network marketing company falling short on this "burden of proof" that commissions are paid on sales primarily to non-participants.
If recent enforcement actions in the cases against Skybiz, Equinox, DP Marketing, and 2Xtreme Performance Int'l show us anything, the things that most concern the FTC are what the Commission alleges to be unreasonable and untrue earnings representations. To this point, notwithstanding the apparent inconsistency between industry practices of predominate "internal consumption" sales volume, and the Omnitrition/FTC approach, which seemingly requires that a company's sales be primarily to third parties, the FTC has chosen, in its discretion, to go after some of the companies the Commision feels are the most aggressively making earnings representations.
In what may prove to be a moderating factor, beginning in 2000, the Direct Selling Association (DSA), the industry's oldest and most powerful trade association threw its considerable weight behind straight-talking dialog, both oral and written, with top FTC staff. Subsequently, it has proposed anti-pyramid legislation which would allow network marketing companies to continue to legitimately pay commissions on internal consumption by distributors. The DSA's much anticipated leadership activity in this area came after seeing its 1996 amicus brief ignored by the Ninth Circuit in Omnitrition, and after watching helplessly as the FTC ran rough-shod over some widely recognized "bad actors" but also, in a fashion disturbing to some, over more or less respected companies in cases such as FutureNet and
Jewelway, and others, using the federal courts to get temporary restraining orders, receivers and asset freezes, usually without notice and an opportunity to be heard in advance of such crippling measures, in a frightening blitzkrieg of anti-network marketing regulatory fervor. Now that the DSA has weighed in on the issues of network marketing vs. pyramid scheme and internal consumption vs. third party sales the FTC may further refine its efforts to concentrate on those companies who make earnings misrepresentations and/or do not make adequate provisions for refunds. The FTC may not be so quick in the future to make its allegations against companies based upon Omnitrition internal consumption grounds.
We can be sure, however, that company weaknesses such as failure to emphasize retail sales, assure strong buy-back protection for distributors, prohibit front-loading, and, in particular, earnings misrepresentations by the company and/or its distributors, will continue to lead to regulatory attacks on the legality of such companies' operations.
Now, How Can a Networker Make Practical Use of This Information?
Before starting with a new company or continuing with your existing company:
1. Do make sure the company has a one year buy-back of products guarantee for at least 90 percent of the purchase price for at least one year contained in its distributor agreement.
2. Do make sure the company actually emphasizes sales to third parties as a part of the company's institutions in place, that it's not just giving lip service to retail sales in its policies and procedures but it has a track record of retail sales and trains with an emphasis on such sales, and has extremely reliable and highly verifiable ways of measuring these sales.
3. Do make sure the company and its distributors are not involved in front-loading ("garage qualification") in order to qualify distributors for commissions. Legal network marketing companies require relatively little up front in the way of purchases from their new distributors.
4. Do make sure the personal maintenance requirement is an amount of the company's product purchases which is no more than would be "reasonably" necessary for a distributor and his/her family to comfortably consume each month.
5. Don't sign up with a company which makes, or can't or won't keep its distributors from making earnings representations which are not fully documented and disclosed as median or average earnings for a particular level of attainment within the company's distributor ranks.
6. Don't make any earnings representations yourself, and that includes waiving that commission check around. This information is considered inherently unreliable and misleading in that it does not reflect at all on the actual facts of what an average or median earnings figure is for distributors in the company.
Copyright 2002 David G. Eisenstein, Attorney
