MULTILEVEL MARKETING ( MLM ) PLANS, BUSINESS OPPORTUNITIES & EARNINGS CLAIMS LIABILITY

Transcription

1 MULTILEVEL MARKETING ( MLM ) PLANS, BUSINESS OPPORTUNITIES & EARNINGS CLAIMS LIABILITY By Philip A. Nicolosi, J.D. Table of Contents I. MLM & Pyramid Marketing Schemes A. Pyramid Marketing Schemes B. The Amway Safeguards C. State Anti-Pyramid Laws D. Guidelines: Avoiding Pyramid Schemes II. Business Opportunities A. The Business Opportunity Rule B. State Business Opportunity Laws 1. In General 2. Minimum Initial Investment Exception III. The FTC Franchise Rule A. Requirements B. Franchise Rule Exceptions C. Work-at-Home Schemes IV. Securities Laws & MLM s A. Does Multi-Level Marketing Invoke Securities Laws? B. Avoiding Securities Laws V. Earnings & Income Claims A. Types of Claims 1. Specific Earnings & Income Claims 2. Vague & General Claims 3. Lifestyle & Hypothetical Claims B. Using Earnings Disclosures C. Using General Earnings Disclosures D. Earnings & Income Claims: MLM Plans & Business Opportunities 1. Misleading Earnings Claims Violate the FTC Act 2. State Laws Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 1

2 Selling through independent sales representatives, consultants or distributors is known as direct selling. Multilevel marketing, which is commonly referred to as MLM or network marketing, is more or less a type of model found in direct selling. A multilevel compensation plan typically pays its distributors based on the productivity of their recruits. Under a typical MLM plan, someone or some business essentially sells, distributes or supplies goods or services through independent agents, contractors, or distributors at different levels. Generally, participants in the plan recruit other participants and compensation is paid as a result of the sale of such goods or services to new participants or based on the recruitment, actions or performance of other participants. The problem is that Internet MLM s usually offer business opportunities. In fact, the FTC has two rules that specifically address offering business opportunities that are often invoked in the context of Internet MLM type plans: The Franchise Rule and the Business Opportunity Rule. The other big problem is that MLM s often engage in illegal pyramid schemes under state and FTC laws. I. MLM & Pyramid Marketing Schemes Multilevel marketing plans are evaluated by the method which the products or services are sold and the manner that participants are compensated. Essentially, if a MLM plan compensates participants for sales by their recruits, and their recruits, that plan is multilevel. If a program compensates participants only for bringing new recruits into the plan, it is an illegal pyramid scheme. Pyramid schemes are illegal under the FTC Act and under specific state anti-pyramid and MLM laws. A. Pyramid Marketing Schemes There is no federal anti-pyramid law in the United States. However, through enforcement actions, the FTC has defined pyramid schemes generally as the payment by participants of money to the company in return for which they [the participants] receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users." (In re Koscot Interplanetary, Inc. (1975)). According to the FTC, direct sellers should pay commissions for the retail sales of goods or services, not for recruiting new distributors. Any type of opportunity or system that involves paying compensation to members primarily if they recruit new members or for non-retail is a Pyramid scheme and a deceptive practice under the FTC Act. Prohibited marketing schemes can be pyramid schemes, ponzi schemes, chain marketing schemes or other deceptive marketing plans or programs. New investors must buy into the opportunity and those funds are actually the primary (and usually only) source of income for those higher up in the pyramid. In order to fall below the minimum threshold of the Franchise Rule or Business Opportunity Rule, sellers are careful to charge less than $500 to buy into Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 2

3 the opportunity. So, the Franchise Rule does not apply in these instances and the seller has no duty to disclose any information. In addition, the wholesale and training buy-back exceptions are also used to avoid invoking the requirements of the Franchise Rule. This does not mean you are free to use untrue or unsubstantiated earnings claims, as I discuss later. B. The Amway Safeguards Scams falling within the exceptions to the Franchise or Business Opportunity Rule are attacked by the FTC generally as unfair or deceptive acts. However, in a landmark case, the FTC decided Amway s business model was not an illegal pyramid scheme and created what are known as the Amway Safeguards. (In re Amway Corp. (1979)). According to the FTC, Amway was not a pyramid scheme because of the following consumer protection safeguards: (1) Amway bought back goods of terminating distributors, (2) it required distributors to have sales to at least ten customers per month, and (3) it required distributors to sell seventy percent of the products they purchased each month to non-distributors. Because of the Amway decision, MLM s, affiliates and other sellers of business opportunities now routinely implement the Amway Safeguards to ensure they are not engaged in an illegal pyramid scheme. As long as the Amway Safeguards are utilized, MLM s and affiliates have generally been able to avoid prosecution by the FTC. This is true even where earnings of participants come primarily from the payments of new recruits. However, this is not a guaranteed safety net to avoid being classified as a pyramid scheme. Practices that do not deter inventory loading and promote retail sales to the degree necessary to insulate the company from operating as a pyramid will not avoid liability even with the Amway Safeguards in place. Webster v. Omnitrition International, Inc. (1996). The Webster case was a groundbreaking case that set new standards in the MLM industry. It set forth two basic lessons: 1) MLM s and businesses must place a primary emphasis on retail sales rather than recruiting; 2) enforcement of policies which deter inventory loading and encourage retail sales are of paramount importance. Without enforcement, even the most perfectly drafted policy against it is useless (you must proactively monitor sales reps to ensure that retail sales requirements are satisfied and that all programs emphasize retail sales over recruitment. C. State Anti-Pyramid Laws Some states specifically define and regulate multilevel marketing plans. They generally include plans where participants are compensated for retail sales or for new recruits. Most states define certain types of MLM plans, such as a pyramid scheme, "chain distributor scheme" or "endless-chain scheme" and restrict such practices. All state laws are meant to restrict the same thing: MLM plans or programs that compensate or reward participants, either directly or indirectly, for recruiting or enrolling other participants rather than compensating them for sales of products or services to end consumers. In other words, MLM plans must base compensation on retail sales to legitimate third party customers. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 3

4 Most state laws generally provide that a business which employs the Amway Safeguards does not amount to an illegal pyramid scheme. However, following the Amway exceptions may not be enough to violate state law in some instances. There are definitely some guidelines you should follow, as established by the courts, as I discuss below. D. Guidelines: Avoiding Pyramid Schemes The following guidelines are not expressly stated in state anti-pyramid laws. However, these common principles are typically considered by both federal and state courts in determining the existence of an illegal pyramid scheme. -Avoid Inventory Loading. "Inventory loading" Is essentially a practice that attempts to get around the legal definition of a pyramid scheme. This practice involves new participants being required to purchase large quantities of products, which are usually nonrefundable and sometimes overpriced. This produces a commission for upline participants. The emphasis in such a program is not on the sale of products, but rather on recruiting of new participants with the goal of "loading" them with as much inventory as possible. It is usually not very likely that the average participant would either use or be able to resell the inventory that he or she is required to purchase. Because of this, courts across the country have determined that this practice is essence recruiting and is a pyramid scheme. This has been true even where participants are compensated for sales. Because of this, it is important that sales requirements to participants are not unreasonable (volume and price) sot that it won t be considered to be inventory loading. -Require 70% of Retail Sales to non-participants in MLM program. Many MLM programs base commissions off of the sale of products to downline participants rather than genuine retail sales to third persons. The courts have determined that personal consumption by downline participants does not satisfy the requirement that sales be to the "ultimate user." The safest approach has been to require that at least 70% of all purchases result in true retail sales to third party customers. -Repurchase Inventory at 90% of the original Price. Georgia, Louisiana, Massachusetts, Maryland, Puerto Rico, and Wyoming require an MLM business provider to repurchase inventory that is returned by the members. Some states require repurchase when a participant terminates his relationship with the MLM provider. In other states (i.e. Maryland and Puerto Rico) the company must repurchase returned inventory if any participant is unable to sell it within three months from obtaining the inventory. Some states Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 4

5 (6) require MLM providers to repurchase resalable products from their distributors for not less than 90% of their original purchase price. Georgia law also requires that a MLM provider repurchase goods that are no longer marketed if they are returned to the company within one year from the point in time the marketing has stopped for the goods. -Have an extended buy-back period. You should allow a refund so long as the merchandise remains currently marketed by the company and is returned in resalable condition. As stated, Maryland and Puerto Rico require as little as three months or 90 days for buyback policy for inventory repurchase. You probably shouldn t take back all inventory regardless of when it was purchased or with a no questions asked policy. But, four states (Louisiana, Wyoming, Massachusetts and Georgia) require companies to take back products as long as the goods are "resalable. -Prove Enforcement of buy-back policies. Keep detailed records of the returned merchandise they have taken back and the refunds that have been issued. A monthly refund report should be maintained by every company so that if its program is challenged, the company can provide the court with compelling evidence that distributors do not have to take unwanted inventory if they elect to cancel their participation. II. Business Opportunities There are certain requirements to be followed for offering a franchise or a business opportunity. We have all seen the following types of claims on websites: Be Your Own Boss!.. Work Part-Time from Home.. Earn $5,000 a month with our System 100% return on your investment guaranteed! or Quick and Easy!.. Start Earning Today. These are all just a few examples of a typical ad by an affiliate or MLM that promote some form of business opportunity. All of these types of opportunities carry special and significant legal liability from a consumer protection standpoint. A. The Business Opportunity Rule The FTC has a rule that governs offering business opportunities called the Business Opportunity Rule that is separate from the Franchise Rule. Before March 1 st, 2012, this rule was an interim rule that dated back to March, 2007 (FTC s Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities, Federal Register, March 30 th, 2007).The FTC s Franchise Rule used to cover both franchises and certain business opportunities until the interim rule was made effective.. However, franchises typically involve Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 5

6 more complicated relationships where some form of intellectual property is licensed to the franchisee and involves significant support by the franchisor. Business opportunities are much simpler and the business opportunities most MLM s and affiliates promote over the Internet are not franchises. The FTC recognized this and called for the need for a separate rule not covering franchises. The FTC proposed a new Business Opportunity Rule back in 2006 and the final rule has now been made official effective March 1 st, (FTC s Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunities, Federal Register, March 30 th, 2007). The term business opportunity means a commercial relationship created by any arrangement where: 1) the seller solicits a prospective purchaser to enter into a new business opportunity (a new business is a business in which the prospective purchaser is not currently engaged, or a new line or type of business); 2) the purchaser is required to make some payment as a condition of obtaining or commencing the business opportunity; 3) The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will: (i) Provide locations for the use or operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or (ii) Provide outlets, accounts, or customers, including, but not limited to, Internet outlets, accounts, or customers, for the purchaser s goods or services; or (iii) Buy back any or all of the goods or services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to providing payment for such services as, for example, stuffing envelopes from the purchaser s home. Under the Business Opportunity Rule, unless you are exempt, anyone who offers or sells business opportunities must make the required disclosures to the purchaser at least seven (7) calendar days before one of two events: either (1) the execution of any contract in connection with the business opportunity sale; or (2) the payment of any consideration to the seller. If you offer any business opportunities as defined above, you will have to make the required disclosures under the Rule to each prospective purchaser within the required timeframe. MLM s are essentially exempt from the new Business Opportunity Rule. Instead, the FTC will rely on Section 5 of the FTC Act to enforce any deceptive practices against MLM s. In the analysis that accompanied the Rule, the FTC decided that the proposed Rule was too blunt an instrument to alleviate fraud in the sale of MLMs. The Commission therefore determined to continue to challenge unfair or deceptive practices in the MLM industry through law enforcement actions alleging violations of Section 5 of the FTC Act and not through the Business Opportunity Rule. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 6

7 What must be disclosed? Here are the following disclosures you must make if you area seller of business opportunities: First, sellers must state their name, business address, and telephone number, the name of the salesperson offering the opportunity, and the date when the disclosure document is furnished to the prospective purchaser; Second, sellers must disclose whether or not they make earnings claims and, if so, must state the claim or claims in a separate earnings claims statement attached to the basic disclosure document. (Note: making deceptive earnings claims is the most common problem in the offer and sale of business opportunities); Third, sellers must disclose prior civil or criminal litigation involving claims of misrepresentation, fraud, securities law violations, or unfair or deceptive business practices that involve the business opportunity or its key personnel; Fourth, sellers must disclose any cancellation or refund policy; Finally, sellers must provide contact information for at least 10 of their purchasers nearest to the prospective purchaser s location. Again, MLM companies are exempt from any disclosure requirements. Can I have my customers waive the rights to disclosure? I have been asked this quite a bit recently. It is against the Rule to have any prospective buyers waive or disclaim receipt of the disclosures required to be made under the Rule. Making Earnings Claims There are earnings claims disclosures required to be made if you make any earnings claims. According to the FTC, an earnings claim is any oral, written, or visual representation, to a prospective purchaser that conveys, expressly or by implication, a specific level or range of actual or potential sales, or gross or net income or profits. See my section on specific earnings claims a little later in this Chapter for some examples of what constitutes an earnings claim. When calculating the number and percentage of purchasers who attained at least the represented level of earnings, the business opportunity seller must include all purchasers who purchased the opportunity prior to the ending date of the time period on which the representation is based. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 7

8 What happens if your business opportunity doesn t have an earnings track record? The Rule lets you use industry information, but only if it is able to measure the performance of existing purchasers of your offered business opportunity and document that those existing purchasers typical performance equals or exceeds the average performance of purchasers of other business opportunities available in the industry. If you offer a business opportunity with no or very limited prior sales, you probably would not be able to use industry statistics. In this case, using industry stats would lack a sufficient basis to demonstrate that these statistics reflect the typical or ordinary experience of your prior purchasers. B. State Business Opportunity Laws 1. In General Business opportunities alone are not illegal, but most states (26) have adopted "business opportunity" laws. These laws typically cover every type of business opportunity that one can think of. Many specifically cover MLM plans as well. State laws restrict sales of business opportunities or MLM plan unless the seller gives potential purchasers disclosures before the purchase and/or registers the opportunity with some state agency. If the business is not subject to the disclosure requirements under the Franchise or Business Opportunity Rule, it could be under these 26 states. Under state laws, a business opportunity is generally defined as a sale or lease of any products, equipment, supplies or services for which the seller represents that: (1) the purchaser may, or will derive income which exceeds the price paid for the opportunity; or (2) it will provide a sales or marketing program to enable the purchaser to derive income which exceeds the price paid for the opportunity. As stated, most states will require registration with the state where such opportunities are being provided. More importantly, significant personal disclosures about the promoters, their backgrounds, and their personal finances are required to be made in many cases. These financial disclosures required are usually abbreviated versions of the disclosures required under the Business Opportunity Rule. Purchasers typically have the right to rescind their contracts under these laws also and have other important remedies. Some states even require that the promoters of business opportunities establish an escrow account into which all or a significant portion of the purchase price must be placed until the goods are received by the purchaser. 2. Minimum Initial Investment Exception State laws imposing these requirements were adopted to prevent significant losses from the consumer. Accordingly, there is a minimum initial investment threshold that must be met before these laws will apply. Under the FTC Franchise and Business Opportunity Rules, and under most state laws, the minimum threshold is $ But, the minimum threshold in Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 8

9 some states is as low as $ (i.e. Maryland). Most Internet MLM providers of business opportunities are sure to charge less than the minimum amount to avoid state disclosure and registration requirements. The problem is that the states and FTC. differ on what constitutes an "initial investment." Under various state laws, these costs often extend beyond those initially needed to "acquire the opportunity." The FTC rule, followed by most states, is that any required purchases within the first six months of joining a program are part of the initial investment. But, other states specify that the "initial investment" extends for the duration of the term of the contract governing the parties' relationship. The bottom line is that your business won t be exempt if you offer a business opportunity with a total initial investment of more than $200 in the first 6 months. III. The FTC Franchise Rule A. Requirements The FTC s Franchise Rule (16 C.F.R ) seeks to prevent fraud by requiring franchisors, and other business opportunity sellers, to disclose material information to purchasers before selling a franchise, or other business opportunity. Under the Franchise Rule, a seller of a business, including a franchise, is legally obligated to disclose the following prior to a sale: 1) The seller s name, address, principal place of business, type of business, and the name of parent company, if any; 2) The seller s background, litigation history, and bankruptcy history; 3) The offer s terms and conditions; 4) a statistical analysis of existing outlets of the business; whether company-owned or franchised; 5) The name, address, telephone number of the one-hundred closest franchise outlets; and 6) Audited financial statements. In addition, the seller must disclose certain specific financial information if it chooses to make any representation regarding projected financial performance of franchises. There are also detailed disclosure requirements in connection with making earnings claims that must be followed if you re a franchisor. MLM s and direct seller are usually exempt from the requirements of the Franchise Rule. B. Franchise Rule Exceptions: In order to minimize the compliance costs for smaller businesses, there are exceptions to the Franchise Rule. i. Minimum Threshold Exception. The rule does not apply to business opportunities which the purchaser does not need to make a payment of $500 or Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 9

10 more within six months of purchase; ii. Wholesale Exception. Voluntary purchases of reasonable amounts of inventory at wholesale prices do not count toward the $500 minimum threshold; iii. Training and buy-back Exception. Finally, the Franchise Rule does not apply if the purchaser is merely paying for training or if the buyer and seller agree that the seller will buy back and resell goods assembled by the buyer. Since the inception of the Franchise Rule, the FTC has brought more than two hundred enforcement actions under the rule. The FTC has been particularly successful at stopping fraudulent business opportunities related to the sale of vending machines and rack displays. However, the Franchise Rule has been unsuccessful at stopping many work-at-home and pyramid marketing schemes. Note: There are also 15 states with disclosure and registration responsibilities for offering franchise type opportunities. C. Work-at-Home Schemes The Franchise Rule does not cover most work-at-home schemes because of the training and buy-back exception. The rule does not apply if the purchaser is able to sell the goods he/she purchases back to the business opportunity seller. In addition, the wholesale exception often exempts these schemes because most purchasers are required to pay large amounts to buy supplies. For instance, the Franchise Rule does not usually apply to business opportunities such as craft assembly and envelope stuffing. As you can imagine, most Work-at-Home sellers require that the purchaser must purchase the materials necessary to assemble products up-front. Some unscrupulous sellers assure buyers that once they assemble the products or stuff the envelopes, the seller will then repurchase the products to sell to the general public. Of course, the seller misrepresents the market for these goods and suggests that the goods will likely be repurchased. That usually never happens and purchasers are left with worthless products. These sham practices are still deceptive under Section 5 of the FTC Act. In fact, the FTC has recently gone after and even shut down envelope-stuffing operations, do-it-yourself Internet business set up kits and other websites falsely promising guaranteed jobs or that the consumer could make substantial income working home based jobs. Obviously you should avoid conducting scams as they can be prosecuted under the FTC Act for deceptive practices. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 10

11 IV. Securities Laws & MLM s Any offering that is considered as a security must be registered with the SEC pursuant to the 1933 Securities Act. Section 10(b) and Rule 10b-5 of the 1934 Securities Exchange Act prohibits persons from making materially untrue or misleading statements in connection with the purchase or sale of any security. Failure to comply with federal securities laws is a crime, and a single violation may result in up to a $10,000 fine and up to five years in prison. Furthermore, the SEC can stop a company from conducting business under its compensation plan, freeze the company s assets, place the company into a receivership, suspend the trading of the company s stock (if it is publicly traded), and order the company to return any ill-gotten profits. Typically, the SEC or another plaintiff will first attempt to demonstrate that the MLM in question is a security. Then the SEC will attempt to prove the business violated least one of the Securities Acts, which amounts to fraud. The two primary areas where the SEC can make a showing of fraud are: (1) the company makes a material omission in failing to disclose that a pyramid must eventually collapse and most participants will lose their investment and (2) the company deceptively misleads investors into believing they can earn the income represented by the sellers when few, if any, actually earn that amount. MLM s can land into trouble with the SEC by making materially false or misleading statements. But, the business opportunity has to be considered to be a security in the first place. A. Does Multi-Level Marketing Ever Invoke Security Laws? The definition of security in the 1933 Securities Act includes a laundry list of terms, the most inclusive of which is the investment contract. MLMs that don t offer investment contracts won t be considered to be offering securities. There are three possible tests to determine whether the amount paid by a new distributor to an MLM is a security under the Securities Act: (1) the Howey test; (2) the risk capital test; and (3) a pyramid scheme analysis The principle test of whether there is an investment contract is the test developed in SEC v. W.J. Howey Co. Under the Howey test, to be considered an investment contract, the contract, transaction or scheme under scrutiny must be one in which a person: (1) invests his money (2) in a common enterprise and (3) is led to expect profits (4) solely from the efforts of a promoter or a third party. No federal court has applied the risk capital test yet. However, many states use this test to enforce state securities laws. Under the risk capital test, a security exists if all four of the Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 11

12 following requirements are met: (1) An offeree furnishes initial value to an offeror, and (2) a portion of this initial value is subjected to the risks of the enterprise, and (3) the furnishing of the initial value is induced by the offeror s promises or representations which give rise to a reasonable understanding that a valuable benefit of some kind, over and above the initial value, will accrue to the offeree as a result of the operation of the enterprise, and (4) the offeree does not receive the right to exercise practical and actual control over the managerial decisions of the enterprise. (Hawaii v. Hawaii Mkt. Ctr., Inc. (1971)). B. Avoiding Securities Laws MLMs with the advice of Internet attorneys have minimized the risk of liability under these 3 approaches, at least on paper. In practice, however, these companies commonly promote investments in securities. But, given, the SEC s limited resources, enforcement based upon company practice is difficult. Furthermore, proof of these violations is difficult to obtain, so actual instances of the SEC going after MLM s is infrequent. Still, if you are an MLM, you should absolutely take steps to avoid being classified as offering a security under both the Howey test and the risk capital test. This generally can be done by stating that it takes work and effort by the purchaser of the opportunity to build the business and make earnings, which has to be true. Many MLM attorneys have stated that distributors should perform the sales and enrollment functions themselves to accomplish this. MLM attorneys also generally recommend that no company should ever present its program with the claim that the company, the structure of the compensation plan, or the prospect s upline will be performing the work. In simplest terms, you want to ensure your distributors are not relying on the efforts from some third party with an expectation of profits. This also means each distributor should have some degree of work and level of responsibilities. The primary purpose of any MLM opportunity should center upon generating sales to actual end users of the products or services being sold. The primary purpose should not be on the recruitment of new participants into the MLM pyramid. MLM s should not pay commissions which are actually bonuses for recruiting new members in disguise. So, if you re an MLM seller, do not pay a commission for any new membership or sign up under the program. In reality, most MLM schemes do rely heavily on the sign up fees generated by new members as the primary source of revenues for the operation. If you are engaged in a pyramid marketing scheme in actuality, you operate at your own risk. In Webster v. Omnitrition International, Inc., the court set aside the Howey and the risk capital tests altogether and instead ruled that any pyramid scheme is a per se security. As you can imagine, the pyramid scheme analysis causes much more problems for MLM s than the Howey or the risk capital tests since many MLMs are in fact disguised pyramid schemes. If most of the money paid in an MLM model is from soliciting new recruits, it is a pyramid scheme under any analysis. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 12

13 IV. Specific Earnings & Income Claims Part of not being misleading and deceptive under Section 5 of the FTC Act is not lying about or exaggerating any potential earnings or income of any product or service you sell. This is what gets most Internet businesses (and affiliates/marketers) into trouble. Specific earnings and income claims entice the customer. They are always material claims and they are usually always used in a misleading manner. Typically, these claims are made in connection with offering business opportunities and with MLM plans. Misleading earnings/income claims are deceptive and illegal in general. But, they pose other concerns in connection with offering business opportunities and in selling MLM type plans. You learned about having to disclose the generally expected results in connection with any customer endorsements last Chapter. The basic premise behind FTC endorsement disclosure requirements is that the advertiser cannot claim through an endorsement anything that cannot be claimed directly. As you learned, you must have a reasonable basis and can back up any specific claim you make on your website. Exaggerated earnings claims are deceitful and are always deceptive. Claiming extraordinary results by making a specific earnings/income claim that is not representative of the results achieved by the common or a substantial number of consumers is also deceptive. Advertisers are not free to make such direct claims without properly qualifying them through the use of appropriate disclosures. A. Types of Claims 1. Specific Earnings & Income Claims These are basically claims based on your own or others specific amount of earnings achieved by using some product or service you sell. Earnings claims are any statements from which a prospective purchaser can reasonably infer that he or she will earn a minimum level of income. Earn up to $10,000 each month, Make over $3,000 a week from your couch! or I made $22,222 my first month using this powerful system and so can you are all examples of specific earnings claims. Not all truthful income claims are improper; the key is presenting proper disclosures to support the claim so that it is not deceptive. The problem is that usually these claims are exaggerated where the advertiser has no reasonable basis for making the clam. When they aren t exaggerated, the claim usually boasts about extraordinary results and, of course, fails to mention this fact prominently to the consumer. Both practices are deceptive and violate Section 5 of the FTC Act. The FTC s believes earnings claims are highly relevant to consumers in making their decisions and typically are the single most decisive factor. Due to the significance of earnings claims in a purchaser s decision and the number of complaints that it receives about earnings claims, the FTC scrutinizes them. (Earnings claims also include any chart, table, or calculation that demonstrates possible results). You should really avoid advertising any specific earnings/income claims on your website altogether. Unfortunately, for most Internet Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 13

14 advertisers, using proper disclosures will defeat the purpose (i.e. the message) of using the exaggerated or uncommon earnings claims to begin with. 2. Vague & General Claims Vague and general claims such as achieve all of your dreams or get everything you ever wanted! may not be deceptive. If those claims are phrased in terms of an opportunity or possibility or a chance that can come true with hard work, maximum effort, etc., they tend not to mislead the reasonable consumer. Of course the entire context of the claim will be evaluated. I would err on the side of caution and simply avoid using these types of claims. Explode your sales may not be misleading given the overall context of the ad. But, explode your sales overnight really makes a specific claim is likely misleading. 3. Lifestyle & Hypothetical Claims Lifestyle and hypothetical income claims are viewed, at a minimum, as implied claims by the FTC. They are usually made in connection with business opportunities. They will be considered income claims and you need to follow the same disclosure requirements as with any other earnings or income based claim. Examples of these types of claims include check out my new Porsche or I vacation 10 times a year. A picture of someone sitting on the hood of a brand new BMW with a mansion in the background presents an implied lifestyle claim. Someone sitting on a yacht on their laptop as an image on your website is yet again an implied lifestyle claim if made in connection with an earnings claim. These claims give off the impression of a certain hypothetical outcome. Avoid making these types of claims as they can be just as deceptive as specific earnings/income claims. B. Using Specific Earnings Disclosures As you have learned, there are different ways to use disclosures on your website. There is no exact placement, magic language or a required manner of making disclosures. But, given the nature of specific income and results claims, I suggest that you not only use a general website disclaimer, but always use an in-line or natural type of disclosure within or immediately after the claim. The disclaimer can flow naturally within the content in order not to disrupt the flow of your message. The bottom line is that income and earnings disclosures are an integral part of the underlying claim. Again, these are hot button type claims from the FTC s point of view. Your customers are likely going to purchase you product based upon their expectations created by the earnings or results claims made. The less likely your customers are to notice a disclosure the greater the probability the claim will be deceptive. Simply put, using disclosures immediately after an earnings claim will greatly increase the odds the disclosure will be effective. As an example, the claim I made $5,322 dollars in my first 6 months and you can too, could be followed by the sentence most customers should expect to make around $100 in the first six months. Similarly, Obtain a credit line in as little as 2 months could be followed by most customers should expect to Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 14

15 receive a credit line within 8 months. Earn up to $1,000 per week with my proven system could be followed by most members earn approximately $50 per week. Of course, you must have a reasonable basis for making any disclosures in the first place. Using natural in-line type disclosures can be a very effective way to disclose necessary information while preserving sales. After all, bulky and awkward disclosure text may scare some people away. Placing disclosures next to each earnings or results claim is a much smoother and easier way to transition to these types of disclosures and you should follow this method where you can if you can. For instance, although these results are extraordinary, some customers have made $5,000 or more each week using this system and we believe you can too. This type of disclosure may not be appealing from a marketing standpoint, but the only legal alternative is disclose what they can expect if when making an exaggerated earnings claim. If the claim you make requires a long disclosure, you obviously won t be able to use a natural disclosure. In that case, refer to the discussion on disclosure placement above to determine where you should place the disclosure. But given the nature of these types of claims, your inline disclosures should not generally be too lengthy anyways. C. Using General Earnings Disclaimers Not only should you use specific disclosure within or next to the claim itself, you should also use a general earnings disclaimer on your website. If you publish these types of claims on your website, you should use an earnings disclaimer. It should state that not every user of the product the subject of the earnings claim will make any money, let alone any amounts claimed. Anything less will land you in hot water since viewers of these types of claims may be led to believe that they too will undoubtedly achieve the same results. Your customers need to understand that there is a degree of risk and that there is no guarantee he or she will achieve the same earnings. If there is a chance even one single customer who purchases your product may not earn income, you should not make an income claim without an appropriate disclosure. In fact, I suggest you assume that there will be purchasers that won t make any money since its dependent upon so many different factors, including individual skill, desire, work ethic, etc. Most of your customers may, in fact, earn money. But, all it takes is one to make this claim technically misleading. Ideally, this language should be placed on the visible portion of all pages you make the claim. However, you can place it on a separate page provided your viewers notice the disclaimer link and are compelled to click on it. Use a separate Important Earnings Disclaimer link somewhere prominently on the website if you don t use language directly on the page. Don t hide the link at the bottom of the page where your viewers may not scroll down and find it. I suggest placing it in the top navigation bar, visible side bar or some other prominent spot on the home page and each webpage any income or earning claim, example or customer testimonial appears. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 15

16 D. Earnings & Income Claims: MLM Plans & Business Opportunities 1. Pyramid Scheme Earnings Claims Illegal Specific earnings claims or income testimonials can pose serious problems when used in conjunction with offering business opportunities and in connection with selling MLM programs. They pose a problem in connection with any activity, but specific earnings and income type claims mainly occur with offering business and MLM type opportunities. Really, any earnings claims in connection with an illegal pyramid scheme are deceptive. These claims fail to disclose that most consumers who invest don t receive substantial income, but actually lose money. In fact, the FTC has said so and has used deceptive earnings claims as a way to go after pyramid schemes in many cases. More MLM plans are likely to resemble illegal pyramid schemes then not. By publishing false or exaggerated earnings representations, MLM s offering pyramid schemes simply that any new participant who pays the sign-up fee can make vast amounts of profit simply by following the blueprint. However, because profits primarily come from new members, it is impossible to earn large profits. This is because of the exponential number of new members needed to sustain the profit stream. The FTC disfavors earnings claims in the connection with offering franchise and business opportunities in general. In National Dynamics Corporation vs. the FTC (1975), the FTC decided that distributors should be allowed to make a wide variety of simple, truthful, nondeceptive statements concerning the earnings of their distributors. At the same time, they must be prevented from bandying about high earnings achieved by a minority of purchasers with no indication of the unrepresentativeness of such earnings. If respondents lack evidence that the high reported earnings of a few distributors are in fact representative of the earnings of large numbers of other distributors, then it is clearly deceptive for them to portray the minority results reported to them without a clear indication of their unrepresentativeness. 2. State laws There are state laws specifically regulating MLM plans and offering business opportunities. You learned about these laws during the discussion of business opportunities. Some states flat out prohibit such claims. For example, Massachusetts and Wyoming restrict earnings claims and income testimonials by MLM companies outright. Georgia, Maryland, Louisiana and Puerto Rico regulate earnings claims by MLM s and in connection with business opportunities. Maryland and Puerto Rico disallow earnings claims unless the results claimed can be achieved by a substantial number or by a reasonable number of participants. Georgia provides that an MLM company or business opportunity seller cannot represent any earning or income potential unless it has documented evidence to back up whatever earnings claims it provides. The MLM must provide this evidence upon request by the customer. Other states also condition, limit or restrict any earnings claims made in conjunction with offering any business opportunities (South Carolina, North Carolina, Indiana, Virginia and Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 16

17 Texas). Of course, any untrue or misleading earnings or income claims are also deceptive under state deceptive practices statutes as well. The Bottom Line: If you re an MLM or offer business opportunities, you should stay away from making specific past or future earnings claims or using income testimonials on your website. If you use specific earnings or income claims, they must: 1) be true; 2) be substantiated somehow-i.e. you need to have a reasonable basis for making the claim; and 3) all claims must be representative of the results achieved by a substantial number of customers. Of course, a few states restrict these claims outright, so you do so at your own peril. Given the restrictions in state laws, you may be better off avoiding these claims altogether. Copyright 2012, Philip A. Nicolosi, J.D. All Rights Reserved. 17