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January 1999



FTC, AG, SEC: Why They're All Involved? - Paul Greenberg

Mr. Greenberg, we hear about actions taken against Network Marketing companies by the Federal Trade Commission, State Attorneys General, the Securities and Exchange Commission, as in the recent International Heritage case... how should we understand their relationships with this industry and with each other?

These agencies are independent of each other, but all have in common the role of protecting American consumers. If a marketing program has a defect, it may very well violate various different laws of one or more states, and federal laws as well. No matter which or how many apply, to some extent it's the same conduct they're all talking about.

Think of it this way: If you and I have an argument in a shopping mall and you sue me, your lawyer will have five different causes of action for the same set of facts. I slandered you, I intentionally caused you emotional harm, I battered you . . . it's really just different ways of saying the same thing so that under one theory or another they prevail. With most of these laws, whether they are federal or state, the starting off point is asking whether someone is paying for something other than product, and what they're getting in exchange. Most illegal programs can be attacked under any of these things and found to be illegal.

The FTC has been the most active in Network Marketing, viewing everything through the filter of "unfair and deceptive trade practices;" a "pyramid scheme" is deemed to constitute such a practice. The SEC has been less, but consistently, involved. They have three basic requirements: first, in order to sell a security to the public, the transaction must be registered with the SEC, and a fully descriptive "prospectus" delivered to each "purchaser;" second, if the security remains publicly held, annual and quarterly statements must be filed with the SEC; and third, all of these disclosure documents must be truthful, accurate, complete and fulfill specific informational requirements.

The SEC charged that IHI's compensation program involved the sale of a security to its distributors, that the sale was not registered with the SEC, and that no prospectus was given to the prospective purchasers-- an SEC violation. What was alleged to be a security? The field positions themselves. A sale of a security is when somebody pays money in exchange for a promise that they'll get their money back and make a profit based substantially on the efforts of others. In Network Marketing companies, this could be the corporation or the downline. In a non-mlm context, if you buy 100 shares of General Motors, you're also going to make money depending on how well others-- the management-- perform. Federal securities law says if you are making an investment that depends on others then you should be told in the form of a prospectus all you need to know to assess whether they'll make money for you or not.

So the second alleged violation was fraud in connection with the sale of a security, specifically non-disclosure. The government said it was a pyramid and that distributors weren't advised of that they before they signed up. Of course, IHI didn't consider itself to be a pyramid, but the SEC argued that, "This is a pyramid under FTC law, that wasn't disclosed, and therefore it's a violation of the securities law." The FTC could easily have followed the same pattern in reverse.

Most cases have historically started with one or more complaints to a particular regulator, so it comes down to what's in their arsenal. If Attorneys General get a complaint, they'll use state laws concerning securities, pyramids, chain referrals or business opportunities-- whatever laws they administer. The postal service would use the lottery statute. The best defense of all against such cases is that people are getting product value for their money.

Paul Greenberg practices law, with a specialty in Network Marketing, at 1875 Century Park East, Ste. 700, Los Angeles, CA 90067; 310-277-6109.

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Reprinted with permission from Upline, Upline Legal - January 1999, 888-UPLINE-1,