Herbalife Hit with Civil Investigative Demand – Is the FTC Finally Turning up the Heat on Multi-Level Marketers?

BY: David Deitch

For many, the announcement two weeks ago that the Federal Trade Commission has commenced a formal investigation into Herbalife was not terribly interesting.  After all, nutritional supplement company Herbalife has been the focus of intermittent media attention since December 2012 when Wall Street hedge fund manager Bill Ackman claimed that it was  an illegal pyramid scheme, and its business practices have already drawn the scrutiny of the Securities and Exchange Commission.

On the other hand, because the FTC focuses on deceptive trade practices, its investigation into Herbalife– and the allegation that it constitutes a pyramid scheme – may offer a valuable opportunity for the FTC to clarify its rules on what constitutes a pyramid scheme and what a multi-level marketing (MLM) company can or must do to protect itself from the accusation.

The MLM industry has been an established networking sales model for several decades. The FTC defines “multi-level marketing” as networking that uses individuals to sell products by word of mouth or direct sales where distributors typically earn commissions not only for their own sales, but for sales made by the people they recruit. MLM has become increasingly popular in recent years – and for good reason given that it has become extremely profitable:  A 2012 study reported the MLM industry was worth approximately $30 billion.

The sole FTC guidelines for MLM arose from litigation in 1979 when the FTC accused the MLM Amway of operating an illegal pyramid scheme.  (Amway ultimately prevailed four years later.)  The case gave rise to what is known as the “Amway Safeguard Rules”– a set of rules relating to distributors that Amway had in place that protected itself from the FTC accusation that the company was a pyramid scheme.  As described in the administrative law judge’s decision, these three critical criteria provided an “umbrella of legal protection”:

1.         Amway required its representatives to engage in retail selling, under the “ten retail customer police,” which appeared in the agreement that representatives signed upon enrollment.  This rule required that representatives make 10 sales to retain customers as a qualification for eligibility to receive commission and bonuses on sales/purchases made by other representatives in their personal sales organization.

2.         Amway required its representatives to sell a minimum of 70 % of previously purchased products before placing a new order. (Amays’ rules recognize “personal use” for purposes of the 70% rule.)

3.         Amway had an official “buy-back” policy for unsold, unopened inventory.  This policy had some reasonable restrictions, including a specified maximum length of time since the item was originally purchased by the representative and that the item was still current in the company’s product offerings to consumers.  The policy also included a minimal “restocking” fee.  (Buy-back policies are significant especially for protection of representatives who choose to terminate their affiliation with a company, and do not want to be “stuck” with unsold inventory.)

By adhering to these rules, MLM companies gain some protection from pyramid scheme accusations.  And, aside from a staff advisory opinion in 2004, the FTC has offered little or no further guidance on what it perceives as a pyramid scheme and what companies can or must do to show that their businesses are legitimate and legal.

Will the FTC use the Herbalife investigation to provide greater guidance for MLM companies?  To do so would be in the interests of MLM companies, the regulators themselves, and those in the financial services industry who have taken great interest – and large financial positions – in MLM companies.

Investigating For-Profit Edu: Are Government Agents Going To Start Tripping Over Each Other?

BY: Nicole Kardell

Things look a bit bleak for the for-profit education industry: it seems like every other day a new federal or state agency is launching an investigation or proposing new regulations. The latest news is that a coalition of 32 state attorneys general, along with the Consumer Financial Protection Bureau, is expanding a probe into lending practices at for-profit colleges. This news follows pronouncements by the Securities and Exchange Commission, the Justice Department, the Federal Trade Commission and the Federal Communications Commission of stepped-up initiatives to combat alleged predatory practices by for-profit colleges. In the midst of this full frontal assault, the industry is facing a major new regulatory scheme under the Department of Education’s impending Gainful Employment rule. What the new regulatory scheme will cover and require remains to be determined, but the released drafts of the rule portend extensive record keeping and reporting requirements.  With mounting investigations and regulatory scrutiny, no wonder shares in for-profit education have been on the decline: how can these companies turn a profit in the midst of all this costly government intervention?

But the CFPB and the 32-state coalition could (unwittingly) be the industry’s knights in shining armor. The enforcement agencies’ expanded probe – along with action by the SEC, DOJ, FTC and the FCC – could provide a good argument for why the Education Department’s impending Gainful Employment rule may be redundant. Since there is so much disagreement over the Gainful Employment rule, not only over the prospective text,but also over the rule’s utility in the first place,it may be time to follow the cues of some in Congress who advocate abandoning the rule when the Higher Education Act is next up for re-authorization (this year).And if Congress could be persuaded to nix the rule, educators could allocate more resources to growth that would otherwise need to be focused on compliance with complex new regulations.

This argument initially may sound like a stretch, but consider some of the following points: (1) congressional infighting about the possible effects of the rule, (2) rule making failures as interested parties cannot come together on regulatory language, and (3) current law and enforcement actions that already address the goals of the prospective rule. There are only so many ways to skin a cat, and you can only have so many cat-skinners (poor analogical cat!).

(1)  Congressional Democrats are split on whether the Gainful Employment rule would protect students or negatively impact students.  Thirty Democratic members of Congress recently wrote a letter to Education Secretary Arne Duncan voicing concerns over the adverse effects a Gainful Employment rule could have on students. At the same time, 31 Democratic members wrote a letter in support of the prospective rule. During the back and forth on the Democratic side, many Republicans are advocating abandoning the rule, concerned that it would ultimately hurt students.With so much uncertainty, why press forward with a rule that has been lingering in limbo for years?

(2)  While Congress members deliberate the rule’s ultimate utility, the Education Department and its panel of negotiators have slogged through several sessions of a statutorily mandated negotiated rule making.  They have been unable to reach any consensus on what types of metrics to incorporate into the rule, let alone what metric ranges to use. After several months, three rounds of negotiations, and three very different drafts of the prospective rule, the Education Department is no closer to final language. The third and final round of negotiations, which occurred mid-December, highlighted the extent to which opposing sides remained polarized.

(3)  The Education Department has stated that its goals for the Gainful Employment rule are to:

• Define what it means for a program to prepare a student for gainful employment in a recognized occupation and construct an accountability system that distinguishes between programs that prepare students and those that do not;
• Develop measures to evaluate whether programs meet the requirement and provide the opportunity to improve program performance;
• Protect students and taxpayers by identifying GE programs with poor student outcomes and end taxpayer support of programs that do not prepare students as required; and
• Support students in deciding where to pursue education and training by increasing transparency about the costs and outcomes of GE programs.

These goals are already being addressed in current regulations and current enforcement actions. For instance, in November the FTC released marketing guidelines directed toward for-profit colleges, advising colleges against misrepresenting, for instance, their job placement and graduation rates, graduate salaries, credit transferring, etc.  The announcement was accompanied by guidelines for prospective students on choosing a school. The FTC’s guidelines send a message to the for-profit education industry: ensure integrity in your marketing and advertising or face the consequences of regulatory action. A new FCC rule, which took effect last October, restricts how for-profit educators can make recruiting calls to past, current, and prospective students.The SEC and CFPB are investigating student recruitment and private lending at various for-profit colleges for possible violations of, for instance, the Dodd-Frank Act (which prohibits violations of federal consumer financial laws and unfair, deceptive or abusive acts or practices), TILA and Regulation Z. And numerous states attorneys general have been actively investigating the industry under state laws.

The expanded probe that the CFPB and state attorneys general coalition is but a continuation of the panoply of government actions and initiatives directed at the for-profit education sector. But the probe provides an excellent basis for reconsidering the necessity of the Gainful Employment rule. The for-profit industry is not shy of regulatory oversight.  All the new regulation would achieve is more cost to industry and taxpayers in compliance and compliance reviews.