June 21 (Bloomberg) -- For years so-called multilevel or direct-selling marketers, which enlist individuals to flog vitamins, cosmetics, and weight-loss supplements to their friends and acquaintances, have drawn criticism from consumer advocates who liken the businesses to illegal pyramid schemes.
That’s because distributors also make money by recruiting other sellers and getting a cut of their revenue, and newcomers are often encouraged to invest in training materials and supplies, Bloomberg Businessweek reports in its June 25 issue.
Those practices have led to class actions filed by former distributors who claim they were defrauded and calls for increased regulation to protect them. Two years ago, Amway Corp., among the largest and best-known direct sales retailers, agreed to settle a class action in California with a $56 million payment, without admitting any wrongdoing. The Federal Trade Commission has brought more than a dozen actions against multilevel marketers since 1994.
Because multilevel marketers “don’t have to make disclosures, they’re widely deceptive,” says Robert FitzPatrick, who runs the nonprofit Pyramid Scheme Alert.
A new FTC rule was supposed to protect prospective distributors by requiring companies to provide a one-page disclosure form that includes support for earnings claims, a list of previous legal actions against the firm, and its cancellation or refund policy. Still, the regulation, which went into effect in April, excludes multilevel marketers.
Critics of the $28.5 billion industry -- which also includes Avon Produucts Inc., Herbalife Ltd., and Tupperware Brands Corp. -- say that’s because of intense lobbying.
“The industry raised a firestorm of opposition to a rule that for any legitimate company would not have been too burdensome,” says Douglas Brooks, a Boston franchise attorney who says he has brought 10 class actions against multilevel marketer, or MLM, companies over the past 20 years.
On the front line of the lobbying effort to secure an exemption were three lawyers who had previously held high-level positions at the FTC: Timothy Muris and J. Howard Beales, both working on behalf of Primerica Financial Services; and Joan Bernstein, who represents Amway’s North American unit.
“The fix was put in here,” says FitzPatrick, who submitted comments to the agency in favor of the rule as it was originally proposed. “It was astounding to many of us to watch this process undergo a direct reversal.”
Monica Vaca, assistant director of the FTC’s Division of Marketing Practices, denies the letters from the former commission officials were given any special consideration, noting that all comments, pro and con, were taken into account.
Vaca says an internal study commissioned by the agency concluded “the rule would not work very well with the MLM business model.” The FTC will continue with its practice of suing MLM companies when they violate federal laws against unfair and deceptive acts, Vaca says.
Joseph Mariano, president of the Direct Selling Association, which claims 200 member companies, says the FTC regulation, as originally written, would have burdened businesses with costly and unnecessary paperwork.
“We were very concerned that the original incarnation of the rule would have had deleterious consequences for the 16 million distributors in the United States,” Mariano says. Direct selling “is a very innocuous and simple activity. Most people only get involved for a few hours a week on an informal basis, and there’s little upfront cost, if any.”
Chris Willis, a lawyer representing Primerica, which sells insurance and mutual fund investments, concurs.
“The expense of complying was going to be very large,” says Willis, a partner at Ballard Spahr in Atlanta. “The FTC agreed that the burdens of the rule would outweigh any benefit.”
Anna Bryce, a spokeswoman for Amway, declined to comment, saying the DSA is the voice of the industry.
At least one critic is optimistic the FTC will eventually come around.
“I truly think it’s unfortunate that this industry has continually escaped regulation,” says Brooks, who adds that he has represented clients suing MLMs who have lost homes, maxed out their credit cards, and gone bankrupt trying to achieve success as distributors.
“I don’t believe this is over,” Brooks says. “The FTC did a beautiful job in 2006 with an extremely careful and detailed justification for the need for regulation and the basis for doing it. They were subjected to a tremendous amount of pressure to change that, but none of the reasons for regulation went away.”
To contact the reporter on this story: Karen E. Klein in Los Angeles at firstname.lastname@example.org
To contact the editor responsible for this story: David Rocks at Drocks1@bloomberg.net