As I’m writing this article, the Federal Trade Commission (FTC), together with three state attorneys general, just came out with a temporary injunction against a network marketing company, forcing them to temporarily shut down.

It is important to note that the company in question did not necessarily do anything wrong or illegal. The company’s representatives haven’t had a hearing, so no conclusion can be made until they have had a chance to tell their side of the story and the court has made a determination.

Interestingly, much of what this company was doing seems to apply to many network marketing companies. It would thus be instructive to all companies and distributors to understand what the FTC was complaining about in their filing so that these items can be corrected, hopefully avoiding any future conflict with either the state attorneys general or the FTC.

Never pay commissions on initial startup kits. Although further discussed below, the FTC demands that no commission be payable on recruiting or startup kits. Commissions can only be payable on sales of products—period. Thus, any monies received for startup kits or for the right to be a distributor should not be part of the compensation plan.

Commissions must be payable solely on retail sales and not for recruiting. According to the FTC, commissions can only be paid on product sales. Thus, it wouldn’t be advisable to have a compensation plan giving bonuses based on the number of recruits in a downline. If a company wants to pay based on achieving certain levels of recruits, it must insist that there be a certain volume associated with each recruit and the commission should be paid only on the volume generated, not on each recruit. It may result in the same amount of money, but the wording in the pay plan seems to be essential.

Compensation plans should encourage retailing to outside, non-distributor customers. Many pay plans are geared to encourage recruiting more than retailing. This should probably be somewhat changed. I would encourage a larger percentage of payout for those who retail the product, with a better markup for them. Encouraging retailing in the comp plan seems to be a very important factor to the FTC.

Be careful about showing checks and earnings of top distributors. The FTC doesn’t like the way companies parade their top distributors on stage, showing their earnings or bonus checks. They feel this implies that everyone can achieve this easily. If a company is going to do this, it is essential that a written disclaimer be made stating that these results may not be indicative of what will be achieved by the distributor. Also, if a company wants to note that prospective distributors could become financially independent, I would suggest using the word “potentially” whenever possible. This would make the statements more accurate.

Watch out for startup costs. The FTC doesn’t like high startup costs. I would suggest limiting any startup cost for becoming a distributor and/or for training kits to no more than $100 and preferably less. In addition, as noted above, no part of this money can be paid out to distributors.

Have at least an 80 to 90 percent buy-back policy with no restocking fee. The FTC wants a substantial buy-back of products without a restocking fee if a distributor quits. Ninety percent seems to be what they consider ideal. A company can probably include a time limit in the guarantee, such as all product purchases made within ninety days.

Make distributors aware that most people don’t earn large incomes as the top leaders do. The FTC doesn’t like it when companies claim that people can make significant incomes selling their products, which isn’t the case for most distributors. I think some statement in the distributor’s contract should show that only a small percentage of distributors earn significant incomes.

It is vital to censure and sanction distributors who don’t adhere to rules. If there are distributors who do not follow the rules, it would be wise for companies to send warning notes and/or actually terminate distributors for clear wrongdoing. Showing that the company does in fact enforce their rules seems to be important.

Do not provide false and misleading materials to prospects. The FTC rightly objects to any material that provides false earning claims or provides false and misleading product claims.

Allow distributors more freedom to retail products. Many companies provide prohibitions on retailing products unless all advertising is approved by the company. The FTC feels that this is restrictive toward encouraging retailing. To be safe, a company policy should note that “distributors are encouraged to retail products anywhere as long as any advertising or marketing brochures are approved by the company for legal compliance.” This should make the FTC happier.

Don’t state that suppliers are “partners.” The FTC objects to companies’ use of the word “partner” when mentioning the name of their suppliers, because this implies an endorsement of the company by that supplier. It is much better to refer to suppliers as affiliates or vendors.  

Reduce the number of unhappy distributors. In the injunction mentioned at the beginning of this article, the FTC cited all the complaints by the company’s distributors, which probably started their investigation. It is essential to try to limit unhappy distributors. This means honoring all guarantees and promises, not requiring too much product to be purchased each month, allowing a buy-back of product without a restocking fee, and so on. The FTC’s actions don’t result from happy distributors.

Since there wasn’t a formal hearing or judgment on these factors, it is hard to tell which will be crucial and which aren’t required. However, if you want to be safe, adhering to these factors should lesson any possible problem with the FTC and state attorneys general.

SANDY BOTKIN is a CPA and attorney. He is the president of the Tax Reduction Institute of Washington, D.C., and lectures all over North America. Sandy is a former IRS attorney and has trained many IRS attorneys for the IRS’s Corporate Tax Division. Sandy is the author of Lower Your Taxes—Big Time!