The ruling by the United States Court of Appeals for the Ninth Circuit in the Omnitrition case (Webster vs. OMNITRITION INTERNATIONAL, INC.) is one of the most important lawsuits affecting the future of multi-level marketing. The Federal Court reversed a district court and cleared the way for the case to go to trial as a class action suit. It was later settled out of court, but the Federal Court ruling stands as the leading legal precedent in MLM cases involving pyramid scheme allegations. Recognizing the extraordinary potential of the case to change MLM as practiced today, the Direct Selling Association (the MLM industrity's trade association) filed a "friend of the court" brief in defense of Omnitrition.
The people bringing the suit were former Omnitrition distributors. They alleged that Omnitrition's marketing program was actually a fraudulent pyramid scheme violating federal securities laws, state unfair sales practice and fraud laws and the Racketeer Influenced and Corrupt Organizations Act.
Omnitrition claimed that it was not a pyramid scheme largely because its program was similar to Amway's. The case became extremely important because the court established clearer, more explicit ground rules for what constitutes a pyramid scheme. The Ninth Court's Ruling, many observers believe, makes the entire MLM industry vulnerable to more suits and the imposition of stricter regulations. The old "we are like Amway" defense will no longer hold. Amway's own legal position could be jeopardized and MLM's era of operating without regulation may be coming to an end.
Omnitrition was a "multi level marketing" program, selling nutritional supplements, vitamins and skin care products, the typical products of so many other MLM companies. Members of Omnitrition's retail sales force were known as "Independent Marketing Associates" ("IMAs"). An Omnitrition distributor had the right to buy products at a discount from Omnitrition for use or resale and to recruit others into the program. A distributor could qualify to become a "Bronze Supervisor" by ordering a minimum amount (several thousand dollars) in products. In order to remain a supervisor, an IMA must continue to meet the minimum order requirements each month. Bronze Supervisors were entitled to receive a "Royalty Override Bonus" on up to three generations of "downline" supervisors, i.e. people the supervisor recruits who themselves also meet the minimum monthly order requirements to be supervisors. The "Royalty Override Bonus" gave the Bronze Supervisor a 1 to 4% commission on orders placed by downline supervisors. Supervisors and those they recruit must continue to purchase a minimum amount of products each month from Omnitrition to qualify the supervisor for commissions. Beyond the Bronze Supervisor level were Silver, Gold, and Diamond supervisors, who could recruit more supervisors into the program and earn the right to royalties on up to six levels of downline supervisors.
A key point of the case was whether Omnitrition really sold products to consumers based on their demand for the products, or, the company induced people to buy the products in order to gain or maintain a position on the sales chain. The court found that the amount of focus a company places on retailing versus recruiting is a key determinant of whether or not it is a pyramid scheme. See "70% Rule" in the index.
The Federal Court stated, "The mere structure of the scheme suggests that Omnitrition's focus was in promoting the program rather than selling the products... The promise of lucrative rewards for recruiting others tends to induce participants to focus on the recruitment side of the business at the expense of their retail marketing efforts, making it unlikely that meaningful opportunities for retail sales will occur."
Omnitrition argued that it was not a pyramid scheme because it required its distributors to sell 70% of their previous purchases before ordering more goods. Further, Omnitrition said distributors may get a 90% refund on the goods they have purchased but not sold if they choose to drop out.
The court challenged these defenses. "On its face, Omnitrition's program appears to be a pyramid scheme. Omnitrition cannot save itself simply by pointing to the fact that it makes some retail sales," the court ruled. It went on to note that the 70% rule included goods sold wholesale to other distributors, not just to retail (non-distributors) consumers.
Regarding the Amway defense, the court said, "Omnitrition misreads (the Amway case in 1979) Amway as holding that any "multi level marketing" program employing policies like Amway's is not a pyramid scheme as a matter of law. That was not the FTC's holding.
Because there is a triable issue of fact as to whether Omnitrition was operating an inherently fraudulent pyramid scheme, there also is a triable issue of fact as to whether Omnitrition's promotion of the scheme and use of the mails and wires in furthering the scheme constituted securities fraud, mail fraud and wire fraud respectively."