Stock Plunge on Internal Consumption: Whose Fault?

In one day in May 2012, the stock and capitalization value of leading direct selling companies shrank by billions of dollars. The cause of this was the simple and reasonable investor question, “What percentage of product is consumed personally by MLM distributors as opposed to resold to non-participants?” With some sound groundwork over the last 15 years, this question need not have been asked. Or, at least, it need not have provoked a tsunami of financial world discussion and billion-dollar stock market downturns.

The stock market’s reaction to the question suggests a vacuum of leadership on the personal use/internal consumption issue. The industry should have addressed this issue when the U.S. Court of Appeals for the Ninth Circuit first raised it by criticizing personal use in the 1996 Omnitrition case.

At that time, people thought that a timid industry response would escalate the personal use issue to federal and state court decisions, class actions, adverse U.S. and foreign press, adoption of adverse rules by foreign regulators, and so on. In a series of articles over the next 15 years, the direct selling industry was urged to “get bold” and seek remedial federal legislation or administrative rule-making to legitimize personal use/internal consumption. See 15 years (1996-2012) of advocacy on this topic in the law library of www.mlmlegal.com, their article index, and any of the articles below:

• Proposed New Federal MLM Statute: Personal Use OK
• Industry Applauds New Montana Legislation
• FTC v. Direct Sellers – The Snail That Got Mugged
• FTC v. Equinox
• FTC v. Futurenet
• FTC v. JewelWay – New Concerns for the Industry
• The AuQuest Case – A Wake-Up Call to the Industry
• The Omnitrition Appeal – An Industry Issue
• Personal Use – A Call to Action
• FTC vs. BurnLounge: Lessons Learned for MLM/Direct Selling

From 1996 to 2012, the industry missed multiple opportunities to promote federal legislation that might have averted a repeating saga. Instead, it addressed the issue only at the edges with a few helpful changes to several state pyramid and multilevel statutes, while completely missing the big picture at the federal level:

1. The industry started and then abandoned proposed remedial federal legislation in 2003.
2. A favorable FTC Staff advisory opinion on “personal use” was received in 2004, but, inexplicably not publicized nor utilized for the public discourse. See the actual document produced pursuant to FOIA (Freedom of Information Act)  request.
3. Notwithstanding the absence of “personal use” criticism by the FTC vs. BurnLounge trial court, the industry missed its timely opportunity to object to inconsistent and errant language in the 2012 Final Order, which actually provided that “sale of products or services to ultimate users” does not include sales to other participants or recruits or to the participants’ own accounts.” As with the fallout of Omnitrition, these few “errant” words could be devastating to the industry in the future, even if the industry’s position is that the language should be limited to BurnLounge.

In all these situations, the industry missed a big opportunity to retake ownership of the conversation on personal use and internal consumption.

In the end, it was external events, not the industry, that framed the discussion on personal use and internal consumption. The industry was reactive rather than proactive time after time. When the crisis of the day abated, the industry became complacent and seemingly unaware of the ticking time bombs surrounding it. The most recent collapse in the markets, occasioned by a simple question on personal use, resulted in hyper reaction, which included new website defenses on personal use and internal consumption. Again, the industry was not in control of the conversation, but rather reacting to events.

Blaming the stock market for picking on the direct selling industry is not necessarily a fair criticism, in light of the fact that the industry has abdicated its opportunities to educate the public, the markets, and legislative and administrative organizations on the direct selling model. It is also not a fair criticism in light of the fact that, as recognized by the FTC’s own Staff Advisory Letter, personal use and internal consumption is legitimate if products are purchased in reasonable amounts for actual use rather than for the mere purpose of qualifying in a business opportunity.  In fact, legitimate purchases for personal use are the hallmark of many of the world’s largest direct selling companies.  But the industry has not done a good job explaining this to the world.

The industry needs to help defend “personal use and internal consumption” in federal legislation and federal administrative rule making. Has the window of opportunity passed for reclaiming the conversation? It is hard to say. Since the 1996 Omnitrition case, if there was a number-one priority for companies and distributors to urge upon their “trade association,” the issue of personal use and internal consumption legitimacy was it.

Ironically, the issue of recognizing personal use is not new, and the industry had a running head start on capturing the dialogue on personal use and internal consumption long before Omnitrition even hit the courts. As far back as 1986, the State of California entered into a Stipulated Order with Herbalife that provides good direction on this subject. The order provided:

5(c). The term “retail sale” as used in this Section 5 means a sale at defendants’ product(s) in any of the following situations: (1) to persons who are not part of defendant’s marketing program or distribution system; or, (2) to persons who are not buying to become part of defendants marketing program or distribution system; or, (3) to persons who, although desirous of becoming or who are a part of defendants’ marketing plan or distribution system are buying for their own personal or family use.

The following model pyramid language, relating to personal use, might serve as a synthesis of trending state legislation, FTC staff advisory, and reasoning set forth in various federal and state court opinions:

Prohibited Marketing Scheme means an illegal pyramid sales scheme, … Ponzi scheme, chain marketing scheme, or other marketing plan or program in which participants pay money or valuable consideration in return for which they obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users. Prohibited payment or consideration does not include payment for non-commissionable “not for profit” or “at cost” sales and marketing materials support. For purposes of this definition, “sale of products or services to ultimate users” include sales to participants, in reasonable amounts, for actual personal or family use.

To its credit, the Direct Selling Association (DSA) immediately responded to the stock downturn with a press release on internal consumption. And, for the first time, the association set up a complete section dedicated to “internal consumption” at its website. Was this reactive as opposed to proactive? Absolutely. Was this a good start at regaining the conversation? Absolutely. Has the political opportunity passed for meaningfully addressing this long term issue? Only time will tell.

As the famed economist Milton Friedman noted, “the future is longer than the present.” And as less distinguished, but no less prescient, Marty McFly noted, it is time to get “back to the future.” Proactive rather than reactive is a good strategy.

By Jeffrey Babener  © 2012
Jeffrey A. Babener, of Portland, Oregon, is the principal attorney in the law firm of Babener & Associates. For more than 25 years, he has advised leading U.S. and foreign companies in the direct selling industry, including many members of the Direct Selling Association. He has lectured and published extensively on direct selling and many of his writings will be found at www.mlmlegal.com, of which he is Editor.  He is a graduate of the University of Southern California Law School, where he was an editor of the USC Law Review.