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MLM Defense: FTC Earnings Claims and Nonsolicitation Clauses

August 03, 2022

Nicole Westbrook, Jones & Keller in Denver, Colorado, and Spencer Reese, Reese & Richards in Utah, discuss FTC proposed rules on earnings claims and nonsolicitation clauses for network marketing companies and their independent distributors.  

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By Nicole Westbrook and Spencer Reese

Nicole Westbrook, commercial trial attorney at Jones & Keller in Denver, Colorado, and Spencer Reese from the law firm of Reese & Richards in Utah discuss two matters pertinent to network marketing companies and their independent distributors, including significant proposed rules at the federal trade commission and nonsolicitation clauses.

FTC Going After Earnings Claims  

Last June, the Federal Trade Commission (FTC) lost its authority under section 13(b) of the FTC Act. That section of the statute had traditionally been used to get injunctive relief against defendants whom the FTC deemed bad. The problem was of course that it denied due process to the defendants.

The U.S. Supreme Court issued a decision last June that stripped the FTC of its 13(b) authority. To rebut that ruling, the FTC has been seeking other means to obtain injunctive and monetary relief against defendants. The Commission has decided to attack deceptive earnings claims against network marketing companies as the most likely avenue for their success.

The FTC has taken two steps in that direction. First, the FTC has relied on their penalty offense authority, something it has had for a long time. The second is that they issued a proposed notice of rulemaking in March 2022. If a deceptive earnings claims rule is promulgated, the FTC will be entitled to automatic injunctive relief and damages.

A deceptive earnings case is a slam dunk compared to a pyramid case. We do not know when the rule will be issued — it could take years but network marketing companies should use this time judiciously and prepare for a rule.

We have seen rules at different multilevel or network marketing companies cover deceptive income or earnings claims in 40+ page manuals. In this regard, we must ask if it is really reasonable to expect distributors to read through all of those pages? Of course not! Multilevel Marketing (MLM) companies know that distributors are unlikely to read the manual.

Within all those policy pages, MLMs may try to explain what deceptive earnings claims are in two paragraphs. Without detail, read or not, it is difficult for distributors to understand what deceptive earnings claims are without a much deeper dive into the subject and policy.

As the FTC ramps up pressure on the network marketing companies, the companies in turn are ramping up pressure on distributors, who can take some preventative measures to stay safe from these policies that are not well-written for deceptive income practices. In this regard, a distributor must use the income disclosure statement issued by the company. The income disclosure statement typically contains the information necessary to fix or prevent what could otherwise be punished as a deceptive earnings claim unknowingly made.

The FTC  proposed rule will essentially be shoved down the throats of network marketing companies if MLMs continue to fail to provide transparency into their income opportunities and distributors continue to make improper earnings claims. Unfortunately, companies sometimes play hide the ball in their income disclosure statements rather than promoting transparency. Generally, distributors do not have the wherewithal or information necessary to make a proper disclosure. The best they can do is rely on the income disclosure statement issued by the company.

MLMs want to avoid any review by the FTC. So, in light of the proposed rulemaking, many are moving forward with writing new policies and procedures for their distributors. There are measures network marketing companies can take to better protect the company from FTC attack.

  • Companies must provide transparency into their income opportunity. That means providing an honest, clear and open income disclosure statement.
  • Don’t play a game of hide the ball. Companies should be frank about what the income opportunity provides or offers. The reality is that most distributors do not earn very much money, if any at all. And that is a critically important revelation in any income disclosure.

Litigating and defending FTC actions and other regulatory or distributor actions is costly. Companies that fight against the FTC may win a battle or two but will lose the war! It is an unfortunate reality but it is reality.

MLMs must get out in front of where the FTC is going by reviewing their income disclosure statements and drafting future contracts with the proposed rulemaking in mind.

We know distributors are going to make income claims. They are going to do what they are paid to do, not what they are told to do. So the best protection for the company is to issue a transparent, clear income disclosure statement.

Nonsolicitation Clauses

Nonsolicitation clauses come into play with MLMs when a distributor leaves one MLM to join a separate network marketing company. It used to be easy for an MLM to pick out a solicitation in correspondence between a distributor and his or her former downline.

However, solicitation is much more subtle today. Social media has drastically changed the landscape. Social media is how distributors communicate and is a tool for raiding. Some distributors will post on their social media page a seemingly innocuous item, such as, “I had a great run with Company X and its products are wonderful. I will always use them. But I am moving on to my next project.”

That alone is a very subtle invitation for followers to contact them in a way that allows the distributor not to technically violate the nonsolicitation agreement. Instead, the distributor was contacted by individuals and simply responded to their inquiry.

That explanation will not cut it. The activity is going to be a violation of a nonsolicitation policy if Company X’s policies properly address social media usage. If there is ambiguity in the contract, however, this activity can lead to costly litigation. The more open to interpretation the policy, the more likely a company and its former distributor will go to trial.

Where distributors get caught up and confused by nonsolicitation clauses is thinking that their social media presence while serving as a distributor for Company X is their personal database. But if a distributor’s followers on Twitter or Instagram include customers or downline of company X, their use of social media can easily lead to litigation with company X.

The legal issue is who owns these social media databases? Do these databases become company property as soon as a distributor signs up? Does it apply to pre-existing accounts? Distributors will argue that these accounts and related databases pre-existed their enrollment in a network marketing company, but they have likely recruited friends into company X using their social media accounts (which is what company X wants them to do) but nonsolicitation claims are then triggered when distributors contact people for their next MLM using their pre-existing social media accounts.

Company X will claim that the distributor is riding its coattails by soliciting and recruiting people to another company. This claim has become a significant issue as MLMs enforce their nonsolicitation policies on the recruiting efforts by former distributors that use social media databases that were partially developed during the distributor’s time with Company X to accelerate success in their next venture.

Nonsolicitation clauses in distributor contracts cause more anguish and angst between companies and distributors than all other policies combined. These policies must be narrowly tailored to a certain amount of time and sometimes a certain geographical area. How long should a distributor wait until they resume activity? Or, is that decision based on geography, type of product or type of company? Answers vary based on the policies and rules that govern distributor activities and state laws, so there is no single correct answer.

As technology progresses, the answer will morph in response to that progress. We will see different interpretations and applications by the courts and how they treat the social media activities of distributors. MLMs must write their policies so that they address social media usage. Ultimately two courts may not agree, resulting in different opinions on the same rule.

Nicole Westbrook is a litigator in the law firm of Jones & Keller. She practices complex commercial litigation in all facets of plaintiff and defense work for large, national cases with multiple parties as well as high stakes litigation. She is an instructor for NITA and a frequent writer and speaker on legal issues and litigation practices. Reach out to Nicole at nwestbrook@joneskeller.com.

Spencer Reese is a partner in the law firm of Reese & Richards, where he counsels and represents start-up businesses and established firms in the direct sales and multilevel marketing fields, as well as companies marketing dietary supplements and cosmetics through traditional distribution channels. He regularly contributes articles to industry publications and is a frequent speaker at industry events. 

This information is not intended as legal advice. Readers should seek specific legal advice before acting with regard to the matters addressed above.