According to the Direct Selling Association, in 2011 alone some 92 million multi-level marketing (MLM) plan operators, or direct selling businesses, grossed over $154 billion world-wide. While MLM plans can be a profitable business model, caution is warranted for prospective market entrants as they must comply with many provincial requirements and ensure that their proposed business model is not deemed to be an illegal pyramid scheme under the Competition Act (Act).
Under the Act, a “multi-level marketing plan” is defined as a plan that promotes the supply of a product, where participants in the plan receive compensation for supplying such product to other participants.
While MLM plans are not deemed illegal under the Act, they may become a criminal offence where misleading representations are made by MLM plan operators or participants with respect to (i) compensation actually received by ‘typical participants” in the plan; or (ii) compensation likely to be received by typical participants in the plan.
In addition, in order to avoid falling under the definition of a pyramid scheme, MLM operators should be careful when requiring participants to purchase merchandise as a condition of adherence to the plan. Indeed, such purchase can only be required where the products are sold at the operator’s cost and for the purpose of facilitating future sales, as in the case of “start-up kits” or product samples.
An MLM plan may also become illegal when it requires selling unreasonable quantities of products to participants (inventory loading) and it does not allow the return of products on reasonable commercial terms.
Therefore, in contrast to an illegal pyramid scheme, a legitimate MLM has a real, marketable product or service to sell – one that is sold to the general public without requiring consumers to pay an additional fee to join the MLM program. In addition, while MLM Plans may pay commissions to a long string of distributors, such commissions should primarily be earned in relation to actual retail sales, and not for recruiting new participants.
MLM operators must be careful so as to not give a misleading impression about how easy it will be to gain revenue as a participant in the MLM plan. Indeed, the Act prohibits the making of representations relating to compensation without fair, reasonable and timely disclosure of the amount of compensation received or likely to be received by ‘typical’ participants in the plan. Pursuant to the Competition Bureau’s Multi-level Marketing Plans and Schemes of Pyramid Selling Enforcement Guidelines (the “MLM Guidelines”), a ‘typical’ participant is a participant in the MLM plan who earns an income similar to that of the majority of participants under the MLM plan.
Operators of MLM plans must also remember that pictures of luxury cars, profiles of unusually successful participants, and testimonials about the life changing effects of the plan are all considered to be representations under the Act, and are therefore subject to the same rules.
Ultimately, operators are responsible not only for the information they communicate to participants and potential participants, but also for the representations participants make to individuals wanting to adhere to the plan. As such, MLM operators should implement policies as to the type of information participants can impart about compensation. Only operators who implement effective sanctions and who demonstrate that sufficient efforts were made to communicate such policies to participants will be able to invoke the due diligence defense under the Act.
Operators should bear in mind that they are legally responsible for the policies, procedures and overall operations of the plan. Running an MLM business based on prohibited practices may lead operators to incur criminal charges under the Act, including a fine in the discretion of the court and/or imprisonment for a maximum term of five years on conviction or, on summary conviction, a fine not exceeding $200,000 and/or to imprisonment for a term not exceeding one year.