Vemma: Caught in the Cross Hairs

On Dec. 4, 2014, Matthew Thacker logged onto a computer in Dallas and signed up as an Affiliate for Arizona-based Vemma Nutrition Co. Seven days later, three boxes arrived containing his starter kit, which consisted of a variety of products and materials for launching his business. Over the course of the next few months, he spoke with his up-line enroller for guidance on establishing his business, attended two training events, received regular product shipments and spent considerable time studying online Vemma training materials.

But Thacker was far from being a new, engaged company recruit.

As Vemma learned in late August, Thacker is an investigator with the Federal Trade Commission. He signed up for Vemma using an undercover name, contact information and credit card account, documenting each step along the way with screen recording software, and he continued to use his undercover identity as he …

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Vemma Regains Partial Control of Business; Judge Appoints Federal Monitor

A federal judge has returned partial control of Arizona-based Vemma Nutrition Co. back to the company’s management team, by granting only part of the preliminary injunction sought by the Federal Trade Commission.

The 10-year-old company essentially had been shut down since Aug. 24, when the FTC served Vemma with a temporary restraining order that it obtained on an ex parte basis. That TRO had come with the appointment of a temporary receiver to run the business and a freeze on the assets of the company as well as the other named defendants: CEO B.K. Boreyko and top distributors Tom and Bethany Alkazin. U.S. District Court Judge John J. Tuchi heard arguments related to the FTC’s request for a preliminary injunction on Sept. 15. He issued his ruling approximately one hour before the temporary restraining order was set to expire on Sept. 18.

Under the preliminary injunction, the judge is permitting Vemma to…

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Vemma Battles FTC to Restart Operations

Arizona-based Vemma Nutrition Co. had its day in court Sept. 15, making its case and asking Judge John J. Tuchi to lift or modify the terms of the court order that has put a halt to the company’s business.

In August, the Federal Trade Commission sued Vemma, accusing the company of being a pyramid scheme, making false and misleading income claims, and failing to provide appropriate income disclosures. The FTC requested and received an ex parte temporary restraining order with asset freeze and the appointment of a receiver, which meant Vemma executives did not have an opportunity to offer a defense prior to the order being issued. The FTC has asked the judge to extend the government’s control of the company with a preliminary injunction. It is the first significant FTC action in the direct selling space since the Ninth Circuit of the U.S. Court of Appeals’ 2014 ruling that BurnLounge Inc. was an illegal pyramid scheme. The court’s final decision will join existing case law in shaping the legal standards that govern direct selling in the United States and may provide new insight into how federal regulators view the distribution channel.

The more immediate issue for Vemma, however, is that the temporary receiver appointed in the case has shut down all company operations, including its international business units and retail sales. “There is no doubt that if this injunction is left in place we are never going back,” Vemma’s counsel said in his closing summary before the judge. The temporary restraining order expires at 2 p.m. local time on Friday, Sept. 18, and Judge Tuchi said he will issue his ruling before that deadline.

The courtroom was packed for the all-day hearing, which included cross examination of witnesses on both sides of the case: FTC investigator Matthew Thacker; professor Stacie Bosley, who provided an analysis of Vemma’s compensation plan for the FTC; Truth in Advertising Executive Director Bonnie Patten; Kenton Johnson, Executive Vice President of Robb Evans & Associates, the temporary receiver currently running the company; professor Emre Carr, Vemma’s compensation analysis expert; Allison Tengan, Vemma’s Vice President of Legal Affairs; and Vemma COO Brad Wayment.

During the hearing, the FTC continued to shape a sweeping case that Vemma’s compensation plan improperly paid Affiliates for recruiting and not for product sales to end users, its marketing materials made inaccurate income claims, and its compliance efforts were ineffective. The defense offered testimony to refute those assertions, arguing that the government built its case without using actual purchasing data from the company and by cherry-picking often out-of-date marketing materials. The defense also focused much of its time before the judge on building a case for why the TRO should be lifted or modified, including establishing that the receiver spent a combined 90 minutes with company management before deciding that he could not continue any aspect of Vemma’s operations under the terms of the TRO.

The BurnLounge Court Decision Clears the Air on Many Issues

by Kevin Thompson

Editor’s Note: On the publication of the Ninth Circuit Court of Appeals’ opinion on the BurnLounge case, attorney Kevin Thompson published an article on Seeking Alpha detailing the decision and what each aspect of the Court’s opinion meant for the direct selling industry as a whole, and Herbalife in particular. This article contains excerpts of Thompson’s longer article, which you can access on SeekingAlpha.com or Thompson’s website.


On June 2, 2014, the Ninth Circuit published its long awaited BurnLounge Opinion. Within hours, both sides of the Herbalife (HLF—NYSE) battlefield issued statements claiming victory about the decision. One thing is clear: The gray space in MLM law separating legitimate direct selling companies from pyramid schemes has been minimized considerably.

BurnLounge was held by the court to be a pyramid scheme. In its opinion, the Ninth Circuit clarified a lot of contentious issues surrounding the industry. The factors assessed in reaching that determination are informative for long and short investors going forward. And of course, the factors are informative for the industry as a whole. While the people betting against Herbalife have argued that the entire industry has been propped up with bubble gum and duct tape over the years with clever interpretations of case law, this opinion clears the air considerably.

Thoughtful Analysis Regarding the Definition of “Ultimate User”

The Court dedicated an entire section to the definition of “ultimate user.” Before diving into the law, it’s important to understand the basics: The practice of paying commissions on purchases made by distributors for self-consumption and/or resale is known as “internal consumption.” The opposite is when distributors buy primarily to qualify for bonuses, i.e. buy things they would never buy at prices they would never pay without the financial opportunity. In BurnLounge, the Court held that participants in the plan can be counted as “ultimate users” provided that the participants bought the products for legitimate “internal consumption,” i.e. personal use.

The Court held, “BurnLounge is correct that when participants bought packages in part for internal consumption, the participants were the ‘ultimate users’ of the merchandise and that this internal sale alone does not make BurnLounge a pyramid scheme.”(BurnLounge Decision, p. 19). The Court went on to say, “Whether the rewards are related to the sale of products depends on how BurnLounge’s bonus structure operated in practice.” Bottom line: Factors need to be weighed when assessing whether commissions are driven by “ultimate users.”

What Is an “Ultimate User”?

In this regard, the Court looked to the FTC’s 2004 Staff Advisory Opinion for guidance. The section quoted by the court reads, “In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme. The critical question for the FTC is whether the revenues (that support the commissions) are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in the money-making venture,” (emphasis mine).

BurnLounge was held to be a pyramid scheme because “the rewards BurnLounge paid were primarily for recruitment, and (distributors) were clearly motivated by the opportunity to earn cash rewards from recruitment.” (BurnLounge Decision, p. 3-4). The Court weighed several factors in reaching its conclusion that the majority of the rewards were tied to recruitment, not legitimate product sales to “ultimate users.”

Retail vs. Non-Retail

It’s now a moot point. Up until this case, critics argued that the majority of a company’s revenue must come from retail sales, i.e. sales to customers outside of the network. Their rationale: Rewards via internal consumption were “recruitment rewards,” thus, the majority of revenue must come from customers instead of participants. While external sales remain a strong indicator of product value, it’s not a bright-line, determining factor. More importantly, it’s not a requirement.

In its opinion, the Court made itself clear that purchases made by the participants can be counted as legitimate sales PROVIDED… and this is key… there’s legitimate consumer demand for the products. In other words, the Ninth Circuit affirms the idea that there are essentially two categories of purchases: (1) those by ultimate users inside or outside the network, and (2) those derived via opportunity driven demand, i.e. people inside the network buying to qualify for commissions, otherwise known as “channel stuffing,” “garage qualifying,” “inventory loading,” etc.

Factors the Court Used in Finding that BurnLounge Lacked Sufficient “Ultimate Users”

It’s now reality beyond debate: Revenue from participants inside the network must be carefully considered when assessing a company’s legitimacy. The resulting commissions from internal consumption cannot be blindly treated as “recruitment rewards” as critics would prefer.

What are the factors that the Ninth Circuit used?

  • Purchasing patterns
  • Lack of value
  • Requirements to buy to qualify
  • Lack of consumer safeguards
  • Emphasis of the marketing

While these factors were not centrally located, they were referenced in various locations throughout the opinion. They’re discussed more fully below.

Purchasing patterns: The Court was disturbed by the fact that 95 percent of distributors bought the premium products while only 35 percent of non-distributors (customers) bought the same. (BL Decision, p. 14). The Court said, “If package purchases were driven by the value of the merchandise included in the packages rather than by the opportunity to earn cash rewards, one would expect to see comparable numbers of (distributors) and (non-distributors) buying the same packages.”

Lack of value: The Court held that the BurnLounge products had limited value, thus, the primary motivation leading to the purchases was NOT for legitimate product consumption. (BL Decision, pages 10, 19). Instead, the BurnLounge distributor was motivated to enhance earning potential. The Court held, “In practice, the rewards BurnLounge paid for package sales were not tied to consumer demand for the merchandise in the packages; they were paid to (distributors) for recruiting new participants. BurnLounge, through its recruitment efforts, created its own synthetic market.”

Requirements to buy to qualify: In BurnLounge, participants were REQUIRED to buy the premium packages to qualify for deeper commissions. Since the motivation driving distributor consumption is crucial in pyramid scheme analysis, BurnLounge was immediately dead in the water when it required distributors to buy. The Court held, “The district court found that because purchasing a package was required for participation as a Retailer or Mogul, and because Moguls earned cash for selling packages, (distributors) by default received compensation for recruiting others into the program.” (BurnLounge Decision, p. 10). Plus, distributors had to recruit several additional participants to qualify for the basic bonuses (“concentric retail bonuses”). Without question, the plan forced people to focus on recruitment and buy items they never would have bought at prices they never would have paid but for the income opportunity.

Lack of consumer safeguards: This is a point that’s more nuanced. While the Court did not reference the “Amway Safeguards” specifically, they did note that Amway was found to be legitimate due to its policies. As a recap, the FTC held Amway to be a legitimate enterprise largely because of its consumer safeguards. Specifically, Amway had a 70 percent rule (where 70 percent of all purchases needed to move to other people), the 10 customer rule (where distributors had to certify that products went to at least 10 customers each month) and the buyback rule (where distributors had 12 months to return sellable inventory). These safeguards were not specifically referenced in the opinion. However, in response to BurnLounge’s argument that it was just like Amway, the Court said, “Though Amway created incentives for recruitment by requiring participants to purchase inventory… it had rules it effectively enforced that discouraged recruiters from ‘pushing unrealistically large amounts of inventory onto’ recruits.”

In my opinion, the 70 percent rule and the 10 customer rule are no longer relevant. Those rules are vestiges from an era that pre-dates direct fulfillment. In those days, the “directs” had to purchase inventory on behalf of their entire organizations and fulfill the orders; thus, warranting rules that ensured the inventory was moving to “ultimate users.” Today, unique orders can be shipped to individual homes. The risk of inventory loading is greatly reduced provided that there’s a robust, easy-to-understand and clearly communicated buyback policy.

The Court held that BurnLounge had zero policies to prevent bonus buying. Once bought, the products were non-refundable.

Emphasis of the marketing: The Court held that BurnLounge participants focused primarily on recruitment over product value. The Court wrote, “The district court also found that BurnLounge’s marketing focus was on recruiting new participants through the sale of packages.” (BurnLounge Decision, p. 10). In BurnLounge, the pay plan literally required participants to recruit several people to achieve the basic levels in the plan. Plus, the products had minimal value, leaving distributors with little choice but to focus on the financial opportunity.

What Does This Mean Going Forward?

Network marketing companies will get more intelligent in delineating between “ultimate users” and everyone else. The market is already moving toward preferred customer programs where people can receive product discounts as preferred customers WITHOUT joining the business. Since we know these are metrics the courts want, it’s important to show clean data. Absent clear delineation, we have the factors provided in the BurnLounge case to help. Currently, when people join to save money on product (as my friend recently did with an essential oils company), short sellers treat them as “victims” or “failures” for purposes of beefing up the failure rate and finding a pyramid scheme. As the BurnLounge opinion makes clear, it’s not proper to make such distinctions without carefully considering the motivation driving the sales.


KevinKevin Thompson is an MLM attorney specializing in working with direct selling companies, large and small. He is a founding member of Thompson Burton PLLC and a Supplier Member of the Direct Selling Association.

A New Champion in Direct Selling Education

by Lauren Lawley Head

Click here to order the July 2014 issue in which this article appeared or click here to download it to your mobile device.

Gary Huggins

Education: Texas Christian University, bachelor of arts in political science and communication

Personal: A Dallas, Texas, native, Huggins now resides in Laurel, Maryland, with his wife and four children, ages 15, 13, 10 and 7

Point of interest: served on George H. W. Bush’s 1988 presidential campaign and Inaugural Committee


After an extensive search, the Direct Selling Education Foundation has chosen its next Executive Director, Gary Huggins.

Huggins comes to the Foundation with deep experience in education reform, innovation, policy and advocacy. He most recently served as CEO of the National Summer Learning Association, an organization that serves as a network hub for thousands of summer learning program providers and stakeholders.

Huggins also served as Director of the Aspen Institute’s Commission on No Child Left Behind, a bipartisan, independent effort dedicated to improving the No Child Left Behind Act, as well as Executive Director of the Education Leaders Council, Education Leaders Action Council, and CSCV, a coalition of corporations, small businesses, and consumer and environmental groups that promoted market-based environmental solutions.

“I am so pleased we were able to introduce Gary Huggins as DSEF’s Executive Director at DSA’s Annual Meeting,” said Amway Chief Sales Officer and DSEF Board Chairman John Parker. “Gary brings a wealth of knowledge and experience that will equip him well in leading DSEF.  If you did not have a chance to meet Gary in person in Orlando, I hope you do soon.”

Though he officially begins the role July 7, Huggins attended the Direct Selling Association’s Annual Meeting in Orlando in June and spent some time talking with Direct Selling News.

Industry voices

On June 5, the 9th Circuit Court of Appeals issued its long-awaited opinion in the case of the Federal Trade Commission vs. the multi-level music marketing company BurnLounge. The Direct Selling Association had filed an amicus brief in the case, asserting that internal consumption qualifies as a legitimate sale. The 9th Circuit affirmed the U.S. District Court’s decision that BurnLounge was an illegal pyramid scheme, but it also affirmed the principle that compensation to direct sellers based on their consumption is legitimate—excellent news for the direct selling community.

The opinion was issued while the DSA Annual Meeting was in progress, so it naturally got some attention. Here are some snapshots of what was said:

“The preliminary reading is actually quite good,” DSA President Joe Mariano told meeting attendees that afternoon. “…I think we can be positive and say that some of the work that we have been doing over the last year, two years and indeed for generations, has had an impact and effect on at least partially educating the 9th Circuit Court of Appeals.”

“I don’t think BurnLounge today is going to be the catalyst to change the short position on Herbalife,” Canaccord Genuity Managing Director Scott Van Winkle said during the question-and-answer portion of a workshop entitled The Wall Street View.  “I think it helps. I think it is one more building block.”

“I’m excited to be here and excited about this industry,” he said.

Huggins says he will be identifying and developing his priorities in the coming months but knows supporting the Foundation’s academic initiatives will be key. Having university professors and others understand the direct selling business model is important, he says, so that they include discussion of the channel when they teach students about entrepreneurship and entrepreneurial opportunities.

“My work in education has always been very supportive of entrepreneurship in education,” he said. “We (direct selling) ought to be part of Main Street conversations about entrepreneurship.”


It might be the middle of summer, but in many ways it feels like the start of a new year. The Direct Selling News Global 100 celebration and the Direct Selling Association’s 2014 Annual Meeting are behind us, and it’s now time to dig into the work ahead. These are critical times for the direct selling community. Let’s approach the opportunities—and tackle the challenges—head on.

Lauren Lawley Head

Lauren Lawley Head
General Manager
lawleyhead@directsellingnews.com

 

BurnLounge Roundup: Unpacking the Ninth Circuit Decision

Click here to view this article on our web page

This month the United States Court of Appeals for the Ninth Circuit passed down a long-awaited decision in the case of FTC v. BurnLounge Inc. The Federal Trade Commission brought a pyramid complaint against the New York City-based company in 2007.

Digital music seller BurnLounge positioned itself as a breed of network marketing company that enabled independent retailers to sell music through online “BurnPages.” The company’s labyrinthine compensation plan included multiple income opportunities, with extra incentives based upon the sale of premium packages rather than actual merchandise.

The recent ruling upholds a 2012 judgment barring the defendants from operating a pyramid scheme and ordering the payment of $17 million in damages. The opinion provoked a flurry of related opinions on its implications, for Herbalife in particular and direct selling in general. We’ve rounded up commentary from industry legal experts and other interested parties to provide a better understanding of the precedent established in BurnLounge.

 

 

 

  • Pershing Square Responds to Recent Ruling in ‘FTC v. BurnLounge Inc.’ “The notion that the Ninth Circuit’s decision is a vindication of Herbalife is absurd. The case certainly does not support Herbalife’s position that sales of products to distributors who tried—but failed—to succeed in their pursuit of the Herbalife business should be regarded as true retail sales.”

 

  • BurnLounge Appeal Decision by MLM attorney Jeffrey Babener “[TheBurnLounge decision] will dramatically impact the landscape of direct selling to provide guidance on two fundamental legal issues: (1) What activity constitutes a pyramid scheme? (2) What is the role of ‘personal use’ (by distributors) in pyramid case analysis?”