In re Koskot

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“[T]here is very little positive value to be lost by not allowing such schemes to get started in the first place.”

This case from 1975 offers insight into what divides a legal Multilevel Marketing Company from one that is illegal.  It involved a Florida MLM that sold cosmetics and toiletries.  Distributors were divided into four levels; new distributors can enter as beauty advisor, supervisor and director.  Entry as the latter two requires the investment of thousands of dollars (up to $38,875. in 2018 dollars).

The finding of fault here was not restrained to the behavior of this particular defendant, but rather has ramifications on similarly structured businesses.

“As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed. Cf. Twentieth Century Co. Quilling.”

 

Case Specifics

In this case, distributors were recruited at “Opportunity Meetings” at which they are told they can earn “large sums of money in a relatively short time” by recruiting others. (@1106) The court describes the sales pitch as encouraging people to make an emotional decision to invest. Count I states that misrepresentations of earning potential is an unfair practice.

Notably, “each person entering the program must bring in other distributors to achieve the represented earnings.”@1112 Since each participant must then recruit to profit, a given area will soon be saturated and later recruits will not be able to find other to join.  Therefore, the program, “must of necessity fail.”

“Respondents’ multilevel merchandising program is organized and operated in such a manner that the realization of profit by any participant is predicated upon the exploitation of others who have
virtually no chance of receiving a return on their investment and who had been induced to participate by misrepresentations as to potential earnings. Therefore, the use by respondents of the aforesaid program
in connection with the sale of their merchandise was and is an unfair act and practice, and was and is false, misleading and deceptive.”

In Count II, the Court found that the defendant had hindered open competition among the distributors in violation of the provisions of the FTC Act against unfair trade practices.  By fixing prices, restricting the sellers distributors may sell to, restricting the category of retail outlets, and preventing the distributors to market the products as they wish, Koskot ran afoul of the provisions against hindering competition in a manner injurious to the public.  Many current MLMs continue with practices such as these, especially restricting marketing of the product.

In Count III, the court held that defendant violated  Section 2(a) of the Clayton Act with their tiered pricing structure. The resultant pricing discrimination had the effect of lessening competition.  Count IV deals with the retention of sums gained from participants who had virtually no chance to recover their investment.

Ramifications

The court stated that the ALJ’s holding was correctly based on, among other things, the inherent capacity of respondents’ multilevel marketing plan to deceive.  The holding and discussion inform how the law can and should regard similar MLMs, of which there are many.

Complaint counsel urged that fault be found with the very nature of the plan because”the mere presence of a lucrative right to sell franchises will encourage both a company and its distributors to pursue that side of the business , to the neglect or exclusion of retail selling.”  The court agreed, stating:  “we would conclude that a company which offers its distributors substantial rewards for recruiting other distributors, and charges them substantial amounts for this right, creates overwhelming barriers to the development of a sound retail distribution network and resultant meaningful retail sales opportunities for participants.” MLMs are inevitably deceptive because their promise to recoup one’s investment which is so often untrue.

This was not the first such MLM pursued by the FTC; it has condemned other “enterpreneurial chains” as having an “intolerable capacity to mislead.” (See Holiday Magic, Inc. and Ger-Ro-Mar, Inc.).  The court defined these as:

“characterized by the payment by participants of money to the company in return for which they 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 general such recruitment is facilitated by promising all participants the same “lucrative” rights to recruit.”

This kind of business is such that profit is based misrepresenting earning potential and on exploiting others who have virtually no chance to make back the money they invested.  Even when rewards are based on retail sales, these misrepresentations are inevitably disappointing to those who are at the bottom of the pyramid.

It is regrettably clear that responsible authorities, including this Commission, have acted far too slowly to protect consumers from the manipulations of respondents and others like them. The Court surmises that this is because of the lengthy process of proving financial loss to participants.  ” Only where the law condemns the mere institution of such a plan, without the necessity to demonstrate its consequences, is meaningful relief likely to be obtained.”

FTC Issues Guidance on MLMs.

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Multilevel marketing is distinct from a pyramid scheme in that it involves a products that recruits are supposed to sell. However, the inclusion of a product does not automatically remove a business from the category of illegal pyramid scheme. The FTC has recently issued guidance in this arena.

Two questions are vital in the determination of whether the MLM is legal: 1. Does profit come primarily from retail sales of the product to consumers as opposed to wholesale sales, recruitment commissions, etc? and (2) Does the company use deceptive or unfair representations to recruit new members?

This is evaluated on a case by case basis, and it involves a complex set of factors that includes

“At the most basic level, the law requires that an MLM pay compensation that is based on actual sales to real customers, rather than based on mere wholesale purchases or other payments by its participants.” This appears to encompass a high number of MLMs currently operating. Although most payments are in exchange for product, that product is often purchased by members of the MLM as wholesale items for retail. Often the MLM sets a minimum amount of product a participant must purchase in a period of time, or tie rewards (such as pricing tiers, status, and bonuses) to how much product they purchase.

An MLM cannot circumvent the law by purporting that these participants are consumers. While genuine purchases for personal use are counted as retail, they must be bona fide and cannot simply be termed as such.

DC Circuit Court Decision on Robocalls

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A recent decision by the Appeals Court for the DC Circuit set aside the definition of the types of equipment previously set forth by the FCC, as well as a rule regarding reassigned numbers. It is now up to the FCC to establish a new definition that takes inro accout the Court’s concerns.

The rule providing opt-out parameters was upheld.

Judge Neil Gorsuch

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Although I am not quite familiar with Judge Gorsuch’s scholarship or opinions, I have combed the opinions of the academics whom I trust to get a sense of his reputation.  The opinion is unanimous among both liberal and conservative professors – Judge Gorsuch is an intelligent, distinguished jurist of integrity who will perform an admirable job as a Supreme Court Justice.

However, there is one element of his record which gives me pause, and that is his opinion on Chevron deference.  Each opinion in itself is reasonable.  And he does make a compelling argument for allowing judicial precedent take priority over agency procedures.  However, it does deviate from the overal tradition of the court to give deference to settled SCOTUS precedent.  Chevron has been settled law for decades now.  It is one of the bedrocks of administrative law.  Overturning this case will inevitably also overturn legions of its progeny.

And, of course, that will also affect the Federal Trade Commission and the Consumer Finance Protection Bureau.  As it would all agencies.

Of course, first he has to be confirmed.  If and when he is, he would need the support of four other justices, and the right case, to actually make headway on narrowing or even reversing Chvron (the latter being something I see the other Justices being reluctant to do).  At the very least, Robert’s penchant for narrow holdings may control, and we could see the Court chip away at agency deference rather than make sweeping changes.

I should also mention here that there are rumors that President Trump would like to reverse the Board of Labor’s rule that financial advisors must act as fiduciaries to their clients, also known as the Fiduciary Rule.  At this point it is only a rumor, but it is something those of us interested in consumer protection and finance will be watching quite closely.  The Rule just went into effect January 1, so it will be a shame if it is not given the time to be field-tested and see how it affects consumers.

Arbitration Ageement Challenged in Wells Fargo Case

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Recently, Wells Fargo opened up to 2 million deposit and credit-card accounts in customers’ names without their permission. Often, customers learned of these accounts only after they began accumulating fees.

The CPFB issued a $100 million penalty against the bank, and a class action suit is pending.  It has also agreed to refund the charged fees.  However, it filed a motion in District Court to dismiss the case as per an arbitration agreement.

The CFPB is considering rules that would prohibit some financial institutions from forcing consumers into arbitration, and contracts which require customers to waive their right to class action lawsuits.  However, as discussed earlier this week, changes in agency leadership that result from the new legislation may prevent such a rule from being enacted.

California Bag Ban Upheld

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Passed in 2014, Senate Bill 270 is a California law that limited the types of stores that could give customers single-use plastic bags.  In the recent election, a referendum attempted to challenge 270, which was suspended pending the outcome.  The referendum was defeated, which means Senate Bill 270 is law in California once again.

Grocery stores, liquor stores, convenience stores, and most types of retailers save clothing-only shops will be required to sell reusable bags to customers.

Court holding on CFPB

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A Federal Circuit Court held last week that the structure of the Consumer Financial Protection Bureau is unconstitutional.  It held that the director was improperly granted too much power, and suggested a fix of granting the President the right to terminate the agency’s director.  The decision comes at a key time, as Republican victories in Congress and the White House could enable them to curtail the agency’s power, part of the party’s platform.  However, Richard Cordray, the currect director, cannot currently be removed while the agency’s petition for appeal is pending.

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