FTC v. JewelWay - New Concerns For Industry
The Fifty Percent PLUS Rule

By Jeff Babener, Copyright 2017

While You Were Sleeping.

It was a June night. When the owners of JewelWay went to bed, they were on top of the world. Over a period approaching a decade, the company had become one of the larger members of the direct selling industry, marketing its jewelry products in several countries, boasting tens of thousands of distributors, more than 200 employees, and hundreds of millions of dollars in sales volume over its many years in business.

To say that they must have been surprised the next day is an understatement. Without notice to the company, the Federal Trade Commission marched into federal court in Tucson, Arizona, armed with lengthy documentation and legal memoranda that had obviously taken the FTC some significant time to prepare. The FTC asserted that the JewelWay operation was an illegal pyramid scheme in violation of the FTC Act and requested the federal court to issue a temporary restraining order against the company and its activities, appointing a federal receiver to take over the company's business and occupy its building, and freezing the assets of both the company and its owners. As might be expected, the request was granted.

The "New" 50 Percent Plus Rule.

For those observers who understand the network marketing industry, they would also understand that that type of interruption spells death to a network marketing company, unless some relief comes immediately. With a gun to its head and precious little time to save its business, the company quickly acceded to the FTC's demands for changes in its business and marketing structure and to the FTC's view of how a network marketing company must be run. The company agreed to a stipulated preliminary injunction order containing 20 pages of onerous micro-management restrictions on such topics as access to building and files, freeze of assets, earnings claims, refund policies, supervision by the receiver, etc.

Although many of the restrictions are of keen interest, one rule in particular should be of greatest concern to the industry. The FTC demanded and the company agreed that JewelWay 's sales revenue must come "primarily from retail sales" to nonparticipants.

Thus, under live or die pressure, the company adopted a numerical percentage rule for sales to nonparticipants which required that in excess of 50 percent of sales of company products be made to nonparticipants. This "50 percent plus rule" is a standard previously unseen in the industry, not consistent with how many leading companies operate, and likely to put such a company at a competitive disadvantage in the direct selling industry. However, in this ambush-type scenario, there was probably little choice for the company.

Rule Making by Ambush.

The approach in the new JewelWay case represents a trend of activity by the FTC during the previous year that has not been seen since its famous dispute with the Amway Corporation in the 1970s. Several companies during the previous year had been hit by the restraining order/receiver approach, which dealt virtual death blows to their businesses overnight. Whether the businesses were right or wrong in their marketing practices, or whether the FTC was right or wrong, is not as significant as the ambush-type approach by the FTC that left very little time or room for intelligent and deliberate discussion of the respective companies' marketing practices. Few federal judges could resist the request of a major federal agency to immediately shut down a marketing program described by that agency as a pyramid scheme. As a result, the companies had zero leverage or bargaining power with the FTC as to changes mandated by the FTC. For the industry, the concern should be. that this approach could happen to any company and, secondly, that the 50 percent plus rule imposed by the FTC did not reflect how leading companies in the industry operate, nor an effort by the FTC to work with the industry on the issue of "personal use.

FTC v. MLM - A Rocky Road.

It has been a rocky road traveled together by the FTC and the network marketing industry. For those who may forget, it was not that long ago that the FTC equated multilevel marketing with pyramid schemes. After a round in the early 1970s with Glen Turner, Dare to be Great, and Koscot programs, the FTC pointed its gun at the mainstream and standard bearer of the industry, the Amway Corporation.

The FTC attempted to deal a death blow to legitimate MLM programs by its prosecution of the Amway Corporation marketing program as an illegal pyramid. The position of the FTC attorneys was set forth in the famous 1979 administrative opinion ruling on the Amway program:

"Pyramid

"Complaint counsel argue that the Amway Sales and Marketing Plan is inherently unlawful because it is 'a scheme to pyramid distributors upon ever increasing numbers of other distributors.' They argue that the Amway Plan, even without actual proof of economic failure is 'doomed to failure' and contains an 'intolerable potential to deceive.'

. . .

"Saturation

"The complaint alleges that distributors are not long likely to recruit other distributors because 'recruitment of additional participants must of necessity ultimately collapse when the number of personal theretofore recruited has so saturated the area with distributors or dealers as to render it virtually impossible to recruit others.'"

In what is perhaps the most classic decision on MLM, In the Matter of Amway Corporation, the four-year lawsuit culminated with an FTC administrative decision that the Amway program did not constitute a pyramid.

The FTC, 1980s, "We Have Moved On."

After Amway dealt a decisive blow to the FTC's position that multilevels are pyramids, the FTC adopted a "live and let live" attitude. For almost the next 20 years, the FTC stayed out of the business of examining the structure of MLM companies, and instead focused on whether or not such companies made deceptive claims regarding their products or earnings opportunities. Companies such as NuSkin entered into consents on such issues without the question of pyramiding even arising. In fact, for a number of years the FTC sent its representatives to industry meetings and even extolled the virtues of this type of marketing. In the mid-1980s, in a presentation to the corporate members of the National Association for Multi-Level Marketing, the executive assistant to the chairman of the FTC, Ms. Marcy Tiffany, brought even more encouragement to the industry from the FTC. She indicated that the FTC, at that time, actually applauded MLM as being beneficial to the consumer for several reasons:

The ease of this method for shopping for products,

MLM makes products available to consumer who are house-bound for reasons of age or illness, etc.

MLM is a viable method of introducing new products to the marketplace, and

MLM provides a good way to supplement income for distributors involved in such programs.

It appeared that the FTC had moved beyond the scrutiny of MLM as a pyramid. Instead, she noted the FTC was most interested in whether or not a program was a legitimate business opportunity and whether the program was in any way deceptive to the prospective participant. With respect to whether or not it was a legitimate business opportunity, Ms. Tiffany indicated the FTC would examine:

1. The cost of investment.

2. The experience needed to sell the product.

3. The marketability of the product.

She remarked that the FTC's principal concern was whether or not the representations on these points were true or false. In other words, is the prospective participant or consumer deceived in any way? The FTC representative noted that the FTC was not so interested in the structure of the program as it was in whether or not deceptive representations were being made. This type of examination was very "livable" for the industry.

We Have Come Full Circle.

Out of the structure business? Well, not exactly. In fact, the cases during the previous year leading up to and culminating in the JewelWay prosecution, indicate that the FTC has forgotten its own history on the subject. The FTC has returned to imposing its view of "what is right and wrong in the structuring of marketing programs." It is again arguing the saturation theory, i.e. that unless companies meet its 50 percent plus rule, they are obviously destined for collapse when they run out of new recruits. Obviously, 20 years after the-FTC first asserted this position against Amway, Amway is still around and thriving. Could the same be said for JewelWay? This will never be known because of the FTC's intervening action. JewelWay will resume its activity, but under FTC supervised rules. Given the fact that the FTC missed the mark so badly with respect to Amway in the 1970s, it is difficult to understand the FTC's argument that it is in a better position than the industry to identify what is a pyramid versus what is a legitimate multilevel marketing opportunity.

FTC v. JewelWay - Three Disturbing Observations.

The merits of the JewelWay case can be discussed in another debate. Was the company too aggressive in its recruiting approach and not aggressive enough in the promotion of retail sales to nonparticipants? Perhaps, yes. Perhaps, no. While these questions may be important, they are dwarfed by larger and more disturbing observations that require an immediate dialog between the industry and the FTC.

1. Environment of Coercion.

An established industry, such as the direct selling industry, has a right to expect that a federal agency will dialog with a company and bring deficiencies to its attention, with opportunity to make changes. This is particularly true of companies that have been in business for several years, operating in several countries, with hundreds of employees and tens of thousands of distributors earning their livelihood. The FTC does a disservice to the industry and itself through ambush litigation, in which restraining order receivers are put into place without any prior notice and any dialog with the companies. The FTC's approach creates an "environment of coercion" in which companies are not permitted an intelligent discussion or debate with the FTC leading to orderly changes, but instead rules and regulations are imposed by an agency holding a gun to the head of the company owners.

2. The FTC Knows Best.

By imposing a rule upon the companies that revenue must be derived primarily from sales to nonparticipants, i.e. the 50 percent plus rule, the FTC unilaterally imposes an artificial standard to companies that is far too simplistic an approach in the analysis of whether or not the company is a pyramid scheme. The FTC has adopted this standard without consultation to the industry, without doing its homework on the industry, and the "take it or leave it" approach is draconian.

3. Relying on Omnitrition.

In its recent cases, the FTC has placed great reliance upon language from the Omnitrition case. In that case, the Ninth Circuit Court of Appeals, in an interim decision, highly criticized by the direct selling industry, took exception to the multilevel marketing format, unless the entire emphasis was on demonstration of sales to nonparticipants. The industry felt so strongly about the court's reasoning that the Direct Selling Association filed an amicus brief seeking reconsideration of the court's ruling. The personal use issue continues to be a problem for the industry. However, recent successes for the industry resulted in recognition of personal use by the legislatures of Texas, Oklahoma and Louisiana. Yet, a comprehensive solution remains to be found. The FTC's extensive reliance on the Omnitrition case in its briefs in recent cases indicates that the FTC will use Omnitrition to impose on the industry its "view of the world" without engaging the industry first in a dialog as to what is good or bad for the American consumer. Interestingly, the FTC never mentions the DSA amicus brief in its court filings.

The Need for Dialog.

The network marketing industry and the FTC have traveled a long road together. Sometimes it has been friendly, often antagonistic. There always has been a delicate balance of tension between an industry with amazing potential, but self-control problems, and with a regulatory agency that has good intentions, but has never really understood how the industry worked, and from time to time has used its leverage to unilaterally dictate the rules to companies. Although the FTC has not entirely come full circle in its condemnation of the industry, its current approach demands dialog between industry representatives and the FTC to forestall a JewelWay episode from happening to leading direct selling companies. The problem is that without dialog, all industry executives must realize that they may wake up the next morning and rind that, while they slept, the JewelWay scenario has overtaken them.

For a copy of the actual JewelWay complaint and injunction documentation, visit FTC's Complaint and Preliminary Injunction, or return to the Jeffery A. Babener Law Library, or to the Main Library.