BEFORE THE
FEDERAL TRADE COMMISSION

Comments of the Direct Selling Association On

Federal Trade Commission Trade Regulation Rule on Disclosure Requirements and Prohibitions Concerning

Franchising and Business Opportunity Ventures

16 C.F.R. Part 436-Comment

62 Fed. Reg. 9115 (February 28, 1997)

Joseph N. Mariano
Senior Vice President & Legal Counsel
DIRECT SELLING ASSOCIATION
Suite 1010
1666 K Street, N.W.
Washington, DC 20006
(202) 293-5760

Dated: April 30, 1997

TABLE OF CONTENTS

I. INTRODUCTION 1

II. BUSINESS OPPORTUNITY FRAUD (Questions 8-10) 2

A. General Information (Questions 8-9) 2

B. Distinguishing Between Fraudulent and Legitimate Businesses (Question 10) 2

III. DEFINING A BUSINESS OPPORTUNITY (Questions 11, 12,14-15) 2

A. Creating a Definition of a Business Opportunity (Questions 14-15) 2

B. A Business Opportunity Definition Should Specify that Payments are Requiired 3

C. A Business Opportunity Definition Should Include a $1,000 Threshold (Question 11) 3

D. A Business Opportunity Rule Should Contain an Exemption for the Purchase of Sales Kits and Certain Inventory 4

IV. ESTABLISHMENT OF AN EXCLUSION FOR THOSE COMPANIES THAT PROVIDE FOR AN INVENTORY REPURCHASE GUARANTEE 5

V. PRE-SALE DISCLOSURES (Questions 16-17) 6

VII. CONCLUSION 6

INDEX OF APPENDICES

Appendix I "Promises. Check 'em out! Business Opportunity Fraud."
Appendix II Sample Business Opportunity Definitions
(Florida) Fla. Stat. Ann. § 559.80 - 559.815
(Illinois) Ill.. Rev. Stat. Chapter 815, Act 5 § 5-5.10
(Virginia) Va. Code Ann. § 59. 1-262 et seq
Appendix III Buyback Information
(Oklahoma) Okla. Stat. Ann. Title 21 §1071-1075
(Texas) Tex. Bus. & Com. § 17.461
Appendix IV DSA Code of Ethics

I. INTRODUCTION

This Comment of the Direct Selling Association (DSA) is in response to the Advance Notice of Proposed Rulemaking on the Trade Regulation Rule on Disclosure Requirements and Prohibitions Conceming Franchising and Business Opportunity Ventures issued on February 28, 1997. ⁽¹⁾

DSA is the national trade association representing 180 companies which sell their products and services by personal presentation and demonstration. primarily in the home. The direct selling industry attracts individuals who seek job flexibility, with low start-up costs and miminal work experience. Many direct sellers are women, minorities and the elderly who work on a part-time basis to supplement their income. In 1995 there were approximately 7.2 million direct sellers in the United States. Our association represents 95% of all direct sales and salespeople in the United States and includes some of the nation's most well-known commercial names. The home party and person-to-person sales methods used by our companies and their independent contractor salesforces have become an integral part of the American landscape. The direct seller, as a microentrepreneur, is the quintessential small business person.

DSA welcomes the Commission's consideration of separating franchises and business opportunities for rulemaking purposes and appreciates the chance to offer our industry's perspective on business opportunities. DSA and several of its member companies including Amway Corporation. Avon Products and Mary Kay Cosmetics commented during the rulemaking process of the Franchise Rule in 1978 and during periodic reviews of the rule. We are happy to participate in the further development of a business opportunity rule.

Our industry is committed, as a public service, to reducing business opportunity fraud. To that end, through the Direct Selling Education Foundation, our public education foundation. DSA developed a consumer brochure in cooperation with the National District Attorney's Association Economic Crime Project. This brochure is reprinted in Appendix 1. DSA takes an interest in rules concerning such matters because of possible confusion between our direct selling activities and the business opportunities which involve significant financial risk. We wish to avoid any mistaken characterization of direct selling as analogous to "franchises" or "business opportunities" which require large cost outlays.

In the direct selling industry, sellers enter into a contract with a direct selling company giving the seller the right to sell that company"s products or services. Over 99.8% of direct sellers are independent contractors.⁽²⁾ Upon signing the distributor agreement. some direct selling companies require the seller to purchase a start-up kit, w,hile other companies make purchase of the kit an option. These start-up kits typically contain some product samples, promotional literature, and training and sales aids. DSA member sales kit range in price from less than $100 to near $500. It is not unusual for these sales kits to be sold at a not-for-profit basis by the company.

We urge that the Federal Trade Conunission take great care in regulating business opportunities activities to ensure that its rules do not impose unnecessary and inappropriate regulations on direct selling companies and their salespeople.

II. BUSINESS OPPORTUNITY FRAUD (Questions 8-10)

A. General Information (Questions 8-9)

DSA members do not require substantial investments, large sales kit purchases, or inventory purchases, of individuals who wish to sell for them. Historicallv, direct selling activities have not been treated as business opportunities within the context of the Commission's jurisdiction and regulation nor within state laws which regulate this area. ⁽³⁾ DSA is not aware of any trade associations that represent business opportunities per se.

We understand that the Commission is interested in distinguishing betnveen loss-prone businesses and profitable ones: however failure of a person to make profit in a business should not be a touchstone for regulation. There are millions of legitimate businesses which fail for financial reasons but which do not deserve special regulation. The basis for any consumer statute or regulation should be the propensity for fraud, not mere potential failure of the business.

B. Distinguishing Between Fraudulent and Legitimate Businesses (Question 10)

There are certain characteristics which distinguish fraudulent business opportunities from legitimate businesses. Some of these are:

-A large up-front payment.

-The absence of an effective inventory and sales aids repurchase policy.

-Pressure to participate, and

-Promises or guarantees of large returns in short periods of time with minimal effort.

DSA has a Code of Ethics. the provisions of which are useful in combating the evils of business opportunity fraud. DSA requires its members to adhere to an inventory repurchase program, and it prohibits undocumented and outrageous eamings claims and any other misrepresentation in the recruiting process. DSA believes these policies, which it encourages the Commission to consider, are features which distinguish the legitimate opportunities offered by, DSA members from those which involve significant financial risk, a propensity for fraud, or blatant illegallity.⁽⁴⁾

III. DEFINING A BUSINESS OPPORTUNITY (Questions 11, 12,14-15)

A. Creating a Definition of a Business Opportunity (Questions 14-15)

DSA encourages the Commission to adopt a definition of "business opportunity" which is consistent with existing state laws. Such a definition, unlike that put forth in the proposed rulemaking, would provide consistency, and uniformity for direct selling and other businesses seeking to deternine converage or non-coverage by the law. Unlike the state laws, the proposed definition is too broad and could include direct selling within its coverage. This would be unprecedented.

At least twenty-two states have business opportunity laws⁽⁵⁾, and many of these states have developed definitions of a business opportunity which can be looked for guidance. Direct selling exists in all fifty states. and would benefit if a federal definition of a business opportunity was consistent with state statutes in this area. For the convenience of the Comrru'ssion and staff, DSA has offered as Appendix II the business opportunity definitions from Florida. Illinois, and Virginia. We believe that any one of these definitions would be appropriate for adoption by the Commission as they meet both the Commission's needs and would ameliorate our industry 's concerns about potential confusion between direct selling activities and the "business opportunities" which are covered under existing state laws.

B. A Business Opportunity Definition Should Specifv that Payments are Required

Where there is no required payment to participate in a marketing plan and where payments which are made are subject to bona fide refund there is no need for the disclosures and other protections of the proposed rule. The FTC's proposed definition would apply to payments without any mention as to whether those payments are required. We suggest that the proposed rule, like the FTC existing rule. should recognize that coverage under the rule should be triggered only when certain minimum payments (as described below) are required in order to participate.⁽⁶⁾

C. A Business Opportunity Definition Should Include a $1,000 Threshold (Question II)

The business opportunity threshold should not be lowered. In fact. lowering the threshold would complicate compliance for direct sellers without imparting any significant protections for to those individuals. There are 7.2 million direct sellers nationwide and the industry has a very high attrition rate due to the temporary and part-time nature of 90% of our salesforce. In fact. our industry is recruiting, on the average, over 70,000 new people per week. Additionally, 6% of U.S. households currently, have an active direct seller living there. and 13% of U.S. households have a person who has been a direct seller in the past living in that household. These individuals are paying little or nothing to engage in direct selling. However, if the business opportunity regulations were applied to direct sellers, these individuals who have made a low-cost commitment to the protected by the low costs for participating and a bona ,fide repurchase policy, these lengthy documents would not serve to provide the individuals with greater protection.

By lowering the threshold. the business opportunity requirements could impose significant costs on the direct selling industry. Marketing plans would have to be revised, information and documents reprinted. and documents disseminated and explained to the individual sellers and those they recruit. This flurry of information would not provide additional benefits to a potential participant, but it could raise the initial amount in costs for the company---and ultimately, the participant--to engage in direct selling.

Not only should the threshold not be lowered, but the threshold should be raised. Numerous business opportunity actions cite frauds in amounts well above the suggested $ 1,000 threshold.⁽⁷⁾ These cases suggest that individuals are being defrauded for significant amounts of money bevond their initial required investment. Also, a bona fide repurchase provision protects consumers from being defrauded even through a minimal investment. That minimal investment. when subject to a bona fide repurchase policy, should not be a per se trigger of a business opportunity law.

The threshold should be raised to reflect inflation over the past twenty years. Based upon the Consumer Price Index ["CPI"], $500 in 1978 would be the equivalent of over $1,200 in 1997 dollars. ⁽⁸⁾ Similarly, what would have the buying power of $500 In 1978 would have a buying power of less than $200 in 1997.⁽⁹⁾ If the Conunission establishes a business opportunity rule as a result of this rulemaking process, it is unclear when the next review process would occur. The direct selling industry would encourage a threshold that adequately anticipates and reflects the inflationary costs of the current threshold.

D. A Business Opportunity Rule Should Contain an Exemption for the Purchase of Sales Kits and Certain Inventory

When there is a bona fide repurchase policy, the business opportunity rule should specifically exclude from a definition of payments which trigger a threshold, those payments which are made at a bona.fide wholesale price for a reasonable amount of inventory. ⁽¹⁰⁾ DSA suggests that a definition of a business opportunity also specifically exclude payments for sales demonstration material fumished at cost for use in making sales, if provided on a not-for-profit basis, and if not for resale. This exclusion is specifically stated in nearly all of the business opportunity state laws and implied in the Interpretive Guides.⁽¹¹⁾ Adoption of such a provision would provide consistency for the business community. The North American Security Adminstrators Assocation (NASAA) Model Business Opportunity Sales Act also contains an exemption for "the not-for-profit sale of sales demonstration, material, or samples or ...inventory sold to the purchases as a bona fide wholesale price. ⁽¹²⁾

IV. ESTABLISHMENT OF AN EXCLUSION FOR THOSE COMPANIES THAT PROVIDE AN INVENTORY REPURCHASE GUARANTEE

The Commission should adopt an exclusion from any business opportunity disclosures or regulation for those companies that offer an inventory repurchase plan, or buyback. The DSA Code requires all direct selling companies to repurchase at 90%, all inventory on hand from a terminating direct seller if that inventory was purchased within one year prior to termination.⁽¹³⁾ The repurchase obligation also requires companies to repurchase sales kits, demonstration and other promotional materials. A copy of the DSA Code of Ethics reprinted in Appendix IV. In effect for four years, the buyback policy has been widely praised by law enforcement officials and consumer advocates. The NASAA Model Business Opportunltv Act contains a comment suggesting that states might consider enacting a buyback policy. ⁽¹⁴⁾ DSA suggests that the buyback policy must be real, demonstrable, and in line with existing industry and legal standards in order to qualify for such an exclusion.

The most recent legislative examples of a buyback policy are in the new state anti-pyramid laws of Oklahoma⁽¹⁵⁾ and Texas⁽¹⁶⁾ which are attached as Appendix III. T'he buyback policy provides a valuable assurance to direct sellers that the risks of entering and exiting their direct selling activities are minimal.⁽¹⁷⁾ We suggest that the FTC adopt an exclusion from the definition of business opportunity for all companies that provide for a buyback policy consistent with the DSA Code and the state laws.

In summary, bona fide repurchase provisions protect individuals and should be encouraged by the Commission. ⁽¹⁸⁾ Legitimate business should not be penalized for creating standards to protect participants. Businesses which falsely promise to repurchase inventory should be prosecuted as frauds.

V. PRE-SALE DISCLOSURES (Questions 16-17)

DSA has explained in this submission that coverage of direct sellers under this rule is inappropriate and unnecessary. Correspondingly, DSA asserts that "pre-sale disclosures" are unnecessary in the context of direct selling activities where the risks of financial loss are low by virtue of small costs to participate and the existence of a legitimate repurchase policy.

VI. CONCLUSION

DSA is pleased to have the opportuniy to participate in the creation of a new rule to better guide consumers, legitimate businesses. and law enforcement agencies as to business opportunities. DSA supports within the definition of a business opportunity, a $ 1,000 threshold which would provide ample consumer protection withhout placing undue burdens on direct selling activities. Also, DSA supports an exclusion from the definition of a business opportunity the not-for-profit sale of sales demonstration, material or samples or inventory sold to the purchaser at a bona-fide wholesale price. Finally, a business opportunity rule should also include an exclusion for those companies that have a real, workable buyback policy for goods returned in the marketable condition. The direct selling industry looks forward to the Notice of Proposed Rulemaking and appreciates the Commission's attention to our concems.

Joseph N. Mariano
Senior Vice President & Legal Counsel
DIRECT SELLING ASSOCIATION
1666 K Street, NW Suite 1010
Washington. DC 20006 phone: (202) 293-5760 Dated April 30, 1997

1. 62 CFR Reg. 9115 (February 28, 1997)

2. 26 U.S.C. Sec. 3508 (1986).

3. See 62 Fed. Reg. 9117.

4. See Appendix 4.

5. Cal. Civ. Code § 1812 et seq.- Conn. 36-503 et seq.-. Fla. Stat. Ann. § 559.80 (West 1995 Supp.) et seq.-.

Ga. Code Ann. § 10-1-410 et seq.-. 111. ReN,. Stat. ch. 815 § 511 et seq.- Ind. Code Ann. § 24-5-8 et seq.loin,a Code Ann. § 523B (West 1995 Supp.)-. Ky. Rev. Stat. Ann. § 367.801 (Baldwin 1994 Supp.) et seq.-.

La. 51:1821 et seq.: Maine Rev,. Stat. Ann. 32 § 4691 et seq; Md. Business Reg. 14-101 et seq.-, Nficli.

Coinp. Laws Ann. § 445.902 et scq.-. Minn. Stat. Ann. § 80C.01 et seq.: Neb. Re\,. Stat. § 59 et seq.: N.C.

66-94 et seq: Ohio Rev. Code Ann. § 133 1.01 et seq.. 71 Okla. 801 et scq. -. S.C. 39-57-10 et scq.: S.D. Codified Laws Ann. Sec. 37-25A et seq.; Tex. Rev. Civ. Stat. Ann. art. 5069-16 et seq. ; Utah Code Ann. Sec. 13-15 et seq.; Va.Code Ann. Sec. 59.1-262. et seq;Wash. Rev. Code Ann. Sec. 19.110 (West 1995) et seq.

6. Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures: Promulgation of Final Interpretive Guides, 44 Fed. Reg. 49,967 ["Interpretive Guides"].

7. A 1980 study of the Iowa Attorney General's office showed that the average Iowa business Opportunity fraud victim lost $5,400 and the money lost ranged from $2,000 to $4,000. "Examples of Public Education Techniques in a Campaign Against Business Opportunity Fraud", Iowa Attorney General's Office. See also, "Undercover Blitz Targets Business Opportunity Scams" Wall Street Journal, July 19, 1995 (nothing that two consumers were defrauded of between $1,500 and $6,000). See, e.g. In Re Marquette, FTC File No. X950076 (opportunity sold for nearly $5,000); Florida v. Unique Gems Int'l. Corp., No. 97-4977 (Fla. Cir. Ct. 11th Jud. Cir., Dade Co.) (opportunity cost $3,000).

8. U.S. Dept. of Labor, Bureau of Labor Statistics. (CPI-U) 1982-1986=100. The calculation was derived assuming that $500 in 1978 was invested at a rate equal to the CPI in every year since 1978.

9. Id.

10. Ill. Rev. Stat. ch. 815 Sec. 5/1 et seq. ; Interpretive Guides, at Sec. I.A. 1.c.; 49,967.

11. Conn. 36-504(6); Fla. 559.801(1)(d); 1995 Ill. Laws Chapter 815, Act 5 (to be codified Sec. 5-5.10(b)(7); Ind. 24-5-8-1; Ky. 367.807(1)(d)(1994 Supp.); La. 51:1821:Maine 4691.3B: Md. Business Reg. 14-104(2); N.C. 66-94; Ohio 1331.01(G); 71 Okla. 803.7; S.C. 39-57-20(4); S.D. 37-25-A-3(7); Tex. 5069-16.04(1); Utah 13-15-2(1)(b)(ii); Va. 59.1-263.A; Wash. 19.110.040(6).

12. 1 NASAA Rep. (CCH) Paragraph 4222 (Model Code Sec. 200 G).

13. DSA Code Section A.7. The Code allows for some minor exclusions, i.e. if the company clearly discloses to salespeople prior to purchase that the products are seasonal, discounted, or special promotion products.

14. 1 NASAA Rep. (CCH) Paragraph 4221.

15. Okla. Stat. Ann. tit. 21 Sec. 1071 et seq. (1997 Supp.)

16. Tex. Bus. & Com. Sec. 17.461 (1997 Supp.)

17. Five states and Puerto Rico have mandatory buyback requirements for multilevel companies. Ga. Code Ann. Sec. 10-1-415(d)(1); La. Admin. Code tit. 17, Sec. III.501; Mass. Ann. Laws ch. 93, Sec. 69 (c) (Law Co-op.); Md. Code Ann. Bus. Reg. Sec. 14-302; Wyo. Stat. sec. 40-3-105; P.R. Laws Ann. tit. 10, sec. 997b.a.

18. Some state laws actually include the promise to repurchase inventory as a term within the definition of a "business opportunity". A bona fide repurchase policy should not be a trigger for business opportunity coverage, however. Instead, a bona fide policy should be seen as minimizing the need for coverage under business opportunity regulations.