Is Network Marketing Legal

The legality of Network Marketing has been a burning question for decades and so it should be given the concerns of misrepresentation, unreasonableness and loss that many people have experienced and discussed for decades. That's not to say that Network Marketing itself is illegal, rather the way some have interpreted it to their will for personal gain.

We know the biggest market for Network Marketing is in the United States and it is here that the Federal Trade Commission (FTC) has responsibility for protecting the interests of consumers… that’s nearly 16 million people involved in direct selling in the United States in 2013, with estimated retail sales reaching $31.63 billion.

Remember back in 1975 the FTC accused and sued Amway Corporation for operating as an illegal pyramid (see definition below). After four years of litigation the court ruled that Amway’s multi-level-marketing (a.k.a. Network Marketing/Direct Selling) program was a legitimate business and not a pyramid scheme. This does not mean that ALL companies that claim to be a “Network Marketing company” are legal.

But it’s important to note that the PROFESSION OF Network Marketing AND THE Network Marketing BUSINESS MODEL IS INDEED LEGAL.

Legal Network Marketing v Illegal Pyramid Scheme

Federal and state multilevel marketing and anti-pyramid statutes in the US are components of a comprehensive consumer protection umbrella. These laws are designed to protect individuals from being defrauded through illegitimate programs which lure participants with the promise of easy money by compensating them from the investments of additional participants rather than from legitimate product sales.

These programs have been called “Ponzi schemes,” “airplane plans,” “pyramids,” “chain letters,” and many other names. Although known in the United States only during the twentieth century, pyramid schemes have cost participants hundreds of millions of dollars, which is why Federal and State regulatory agencies have sought to ban such illegal activity including the use of anti-pyramid, mail fraud, business opportunity, franchise, lottery, and securities laws.

Whether a program is a legitimate multilevel marketing plan or an illegal pyramid depends principally on:

  • The method by which the products or services are sold
  • The manner in which participants are compensated

Essentially, if a marketing plan compensates participants for sales by their Distributors and/or their downline Distributors, that plan is multilevel.

If a program compensates participants, directly or indirectly, merely for the introduction or enrolment of other participants into the program, it is a pyramid scheme.

The popularity of direct selling sometimes motivates dishonest individuals and organisations to misrepresent themselves as legitimate direct selling businesses in hopes of enticing victims.

Koscot Test and Amway Safeguard Rules

In order to understand if a Network Marketing company is legal or not, one must study what a pyramid scheme and that means going back to 1976, to FTC vs. Koscot Interplanetary. Koscot Interplanetary was the name for a cosmetic company ran by a man called Glenn Turner. This is how it worked:

You join the company by paying $2000; you then have to buy $5400 worth of cosmetics (supposedly for resale). However, you don't get paid for selling cosmetics. You get paid by recruiting others who also pay $2000+$5400 just like you did. The more you recruit, the more you got paid.

The FTC sued Koscot in 1976, calling it an "entrepreneurial chain", and it helped the Court to formulate what became known as the Koscot Test. The Koscot Test has four parts to it; if all four of the following apply to any Network Marketing Company then it is a pyramid scheme.

The four parts are:

  • A payment of money is made to the company
  • The participant receives the right to sell a product (or service)
  • The participant receives compensation for recruiting others into the program
  • The compensation is unrelated to the sale of products (or services) to the ultimate user.

When the FTC sued Amway, the Koscot Test was used. After a long legal battle, the courts decided that Amway was not a pyramid scheme and allowed it to stay in business; however a new set of requirements which became known as the Amway Safeguard Rules were created:

  • Rule 1: That 10 retail customers are required to get paid a commission; if you don't sell to ten different people every month, you don't get paid any multi-level commissions
  • Rule 2: The 70% rule; you have to sell or personally consume at least 70% of all the products purchased before you can order more. Though this “70% rule” was directed only at Amway, most other Network Marketing companies, have adopted the principal to avoid drawing negative attention from the FTC.
  • Rule 3: Buyback: guaranteed buyback of unused inventory for at least 90 days, for 90% of original price (i.e. no more than 10% restocking fee)

Rule 1 is to enforce the existence of retail sales. While rule 2 and rule 3 are written to prevent "inventory loading" in which sponsors encourage downlines to buy up inventory that the downline cannot possibly sell or consume, just so that the upline can qualify for his/her commission.

August 2015 - FTC v Vemma

There will be individuals and organisations around the World that want to see the unfair elements of Network Marketing gone forever; which is why when they think Network Marketing Companies are in breach of the law, the likes of the FTC will initiate litigation.

One recent activity was against Vemma Nutrition Company. Vemma was a privately held multi-level marketing company that sold energy drinks, nutritional beverages and weight management products. It was founded in 2004 and based in Arizona. In 2013, the company reported revenue of US$221 million.

In August 2015, the FTC took out an injunction to stop Vemma trading, accusing it of operating an illegal pyramid scheme. This was after many complaints from parents who believed their children in college were being unfairly targeted.

At the time of writing, Vemma is operating under an injunction which restricts certain marketing activity and compensation methods. A monitor was appointed by the court to assure compliance. And so the litigation process continues…

Avoiding Pyramid Schemes 

If you are considering whether or not to join an opportunity, ask yourself these questions:

  • Are start-up costs minimal?
  • Can you return unsold inventory?
  • Is income only possible from the sale of products?
  • Does one need to make retail sales?

If the answer to each is yes then you are probably reviewing and considering a legitimate direct selling opportunity.

Direct Selling Association

The Direct Selling Association (DSA) is the name of several similar trade associations in the United States, United Kingdom, Australia, Malaysia, Singapore, and New Zealand that represent direct selling companies, primarily those that use multi-level marketing compensation plans. On behalf of its member companies, the DSA engages in public relations and lobbying efforts against regulation of the multi-level marketing industry, and it funds political candidates through a political action committee.

Founded in Binghampton, New York in 1910 as a trade group for door-to-door salesmen, the association was originally called the Agents Credit Association. It was renamed the National Association of Agency Companies (NAAC) in 1914, and briefly renamed the National Association of Agency and Mail Order Companies in 1917, before returning to the NAAC in 1920.

It became the Direct Selling Association in 1968.  As of 1970, less than 5% of the DSA's members were multi-level marketing companies. By 2009-2011, the DSA's membership had grown to include nearly 200 companies, more than 90% of which were multi-level marketing companies.

The DSA belongs to the National Retail Federation and its member companies pledge to abide by the DSA code of ethics. The DSA’S Mission is to protect, serve and promote the effectiveness of member companies and the independent direct sellers marketing their products to ensure the highest level of business ethics and service to consumers. Organisations want to make it easy and inexpensive for new salespersons. This is unlike pyramid schemes, which are often disguised with direct selling characteristics.

As mentioned, pyramid schemes make their money from fees paid by new recruits or by loading inventory or training aids on them. High entry costs are a tell tale sign. A condition of DSA Membership is that Member Companies have a buy back policy. This means if you quit the business, the Member will buy back unsold marketable products you purchased in the prior 12 months, for 90 percent of what you paid for them.

One should always look carefully at any business opportunity that encourages front end loading, i.e. the buying of large inventories of non-returnable products to reach levels for price or other gains, as this again is a sure sign of a pyramid scheme.

Remember that earnings which come from product or service sales as opposed to recruitment of other Distributors is essential for a legitimate business. If you want to become a Distributor, you should always select a company who is a Member of the DSA as a minimum.

The Future of Network Marketing

What we do with network marketing in the future, whether it deserves changes, greater regulation or even litigation is to be decided. Here at MLMBuyer.Com we want to make network marketing work for ordinary people like you and me.

We will be defined by what we think and what we do... of course, we don't have all the answers, but the MLMBuyer.Com Community might just be a great place to start...