Big, BIG win for the direct selling industry, as Judge Barbara Lynn (N.D. Texas) grants judgment for Neora, LLC (formerly Nerium) on all of the FTC's claims, including that the company was operating an illegal pyramid scheme and made deceptive income and product claims (both directly and through its distributors). Expect the FTC to gather itself and explain that this is one district court case before one judge. But make no mistake about it, Judge Lynn (Clinton appointee) is a respected jurist, with a reputation of being thorough and well-prepared. This decision leaves a mark.
Illegal Pyramid Scheme?
As expected, the pyramiding claim turned on the second element of the Koscot test—the right to receive rewards that are unrelated to the sale of product to ultimate users, in exchange for recruiting other participants into the program. The court rejected the FTC's expansive interpretation, which relied on the assumption of its expert witness and outspoken critic of the direct selling industry, Dr. Stacie Bosley. Dr. Bosley contended that purchases by Brand Partners (Neora distributors) are not sales to ultimate users. Dr. Bosley's assumption was almost entirely based on the face of Neora's compensation plan, which required (among other things) recruitment in some form to be eligible for many bonuses.
Distinguishing Neora from Vemma and BurnLounge where that assumption (including by Dr. Bosley in Vemma) was more persuasive, Neora presented evidence that sales revenue drove the business. Among this evidence, the court highlighted sales data, a survey of Brand Partners, and evidence showing that many Brand Partners enrolled for product discounts. Although not enough to establish the motivations of all Brand Partners, it was enough to rebut Dr. Bosley's testimony—which the court framed as asking it to "slavishly look only to the compensation plan in isolation, with blinders on to the actual operational data and internal structure of [the] business."
[Industry observers have nodded in agreement with this view as this argument has been advanced by Neora, while scratching their heads at the FTC's narrow focus on the wording of the compensation plan.]
As the court put it in criticizing the FTC's evidence and emphasizing what it perceived as a significant hole in the FTC's case: "The FTC provided no evidence from actual BPs or participants, and made no effort to show that Dr. Bosley's rigid theoretical opinions regarding BP purchasing motivations based on the Compensation Plan are borne out in reality." Judge Lynn was unpersuaded by the FTC's reliance on profitability data in a vacuum or that distributors who do not earn compensation are failed distributors, emphasizing that people may enroll as savings seekers looking to enjoy product discounts with no intention of pursuing the business opportunity: "Put differently, we may 'walk away poorer than we started' after a trip to the grocery store, but because we obtained valuable goods or services in return for our money, that exchange is not characterized as a loss."
Income and Product Claims
The FTC has long asserted that its authority to prevent and remedy unfair and deceptive acts or practices encompasses actions against companies for failure to sufficiently monitor affiliates, agents, or other entities that used a company's services or otherwise had a relationship with the company.
The FTC has relied on this authority as it pursued enforcement against companies under similar third party liability theories in a number of contexts, including: (1) claims made by independent distributors or influencers on behalf of a company when the company knew or should have known about the claim; (2) payment processers and money facilitators; (3) debt collection agencies; (4) franchise operators; (5) affiliate marketers; and (6) providers of telemarketing services and equipment. And while the FTC's authority to bring such cases has not been extensively challenged, courts have upheld the agency's capacity to bring these actions on the grounds that unfairness under the FTC Act includes instances where an entity facilitates or provides substantial assistance to another's deceptive or unfair act or practice.
Well, Judge Lynn was not convinced that the line between distributor and company had been crossed. Once again, the court noted that the FTC failed to provide evidence that customers understood that Brand Partners were agents of Neora. She also credited Neora's "rigorous compliance program" while quoting FTC guidance acknowledging that direct selling companies cannot possibly monitor every claim that is made by independent distributors in the field. This part of the decision is especially noteworthy given its focus on the importance of compliance programs—with an emphasis on training, monitoring, and enforcement—as well as continuing efforts to align company practices with the law as it develops and guidance provided through industry self-regulation. (Nicely done, Direct Selling Self-Regulatory Council.)
With regard to income claims, specifically, the court noted that Neora did not "guarantee any level of income for any Brand Partner," disclosed typical earnings in its Income Disclosure Statement, and included the qualification that "the actual income of Neora Brand Partners varies." With regard to product claims, the court ruled that there is no evidence that Neora is currently making claims that their products cure, treat, or prevent human disease. As a result, the court concluded that "enjoining Defendants and Neora's BPs from making misleading income and product claims would have no effect beyond which is already being achieved through Defendants' robust and reasonable compliance program, and thus an injunction is not warranted."
What's Next?
There will be a big sigh of relief (and some well-deserved crowing) by the direct selling industry, and of course, Neora, given what was at stake. Had the FTC won, the bar would have been raised to a dizzying height. But we have seen this before, most recently following the Supreme Court ruling in AMG Capital Management. After what seemed like a mortal blow to the FTC's authority, the agency picked itself off the mat and responded: Notice of Penalty Offense Authority, the stretching of existing statutes, Section 19, collaboration with States, and on and on. What's more, the court here emphasized the FTC's failure of proof—that is, holes in the Agency's case. Do not expect this mistake twice.
Having said that, however, and anticipating the familiar one-judge, one-court refrain, the magnitude of this decision cannot be overstated. It reinforces that sales data remains significant in any pyramiding analysis, permits compensation tied to product use (whether by a distributor or a preferred customer), recognizes the value "savings seekers" receive without earning any profit, and emphasizes that proactive compliance measures and a recommitment to best practices really do matter.
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