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Are Two-Tier Affiliate Programs Multi-Level Marketing?

Jan 11, 2008
The title begs two questions we must address first. What is a two-tier affiliate program? And - How does it differ from a one-tier program? And, of course, what is MLM? Let us start the definition process.

Affiliate programs are a product of e-commerce. An on-line seller offers a commission to another for referring a customer to an on-line site. An offer to a person to compensate them in some fashion for bringing in business, WITHOUT any additional incentive to locate (find, recommend, recruit, sponsor) more business finders, is a one-tier program, (at least for the purposes of this article.) I have personally had two, two-tier programs explained to me in excruciating detail. What I write next is based on that experience, and not on any universal examination of all the programs that are titled "two-tier." When a program contains TWO sources of income, namely compensation for bringing in business, AND compensation when you locate (find, recommend, recruit, sponsor) more business finders, WHO THEN BRING IN BUSINESS, it is a "two-tier" program.

The "program" involves selling something, and paying commissions for sales. Look at the money flow, and the REASON for the money flow:

Someone buys something. Money flows from the buyer TO the program. This is a customer sale.

The program pays a commission to the "customer finder." Money flows AWAY from the program TO an income opportunity seeker, to reward the person for bringing business volume to the program. This money flow evidences the existence of a single-level income opportunity. (To use affiliate program words, "one-tier") Note that there exists NO incentive for the income opportunity seeker to find more "income opportunity seekers," only to find customers.

If, in addition to the above, the program pays a commission to an income opportunity seeker, BASED UPON the business volume of another income opportunity seeker introduced by the first income opportunity seeker, a two fold incentive exists. The income opportunity seeker has a financial incentive to get customers for the program, AND a financial incentive to find more income opportunity seekers. In this second case, the second type of money flows AWAY from the program TO an income opportunity seeker, BUT to reward the person for business volume not directly generated, but generated by the income opportunity seeker "found" by the first one. This second type of money flow evidences the existence of a "two-tier" program.

There are two other characteristics to the money flow away from the program (both one-tier and two-tier) that should be noted. It is gross income, taxable to the recipient, to the extent income exceeds allowable business deductions, and it is reportable by the payer under the 1099 rules to the extent it exceeds $600 in a year to an individual recipient.

"Is a two-tier affiliate program MLM?" - takes us to an attempt to define MLM. The Direct Selling Association defines MLM (my paraphrasing) as a form of compensation that creates the incentive and reward for income opportunity seekers to "sell" to consumers, AND find more "sellers." Clearly two-tier programs fit the definition. This is not LAW, and not even all DSA member companies accept this definition. There is MUCH law affecting direct sellers, but LITTLE law specifically defining MLM. Only five states and Puerto Rico attempt a definition. It follows:

"Any person, firm, corporation, or other business entity which sells, distributes, or supplies for valuable consideration, goods, or services through independent agents, contractors, or distributors, at different levels wherein participants in the marketing program may recruit other participants, and wherein commissions, cross-commissions, bonuses, refunds, discounts, dividends, or other considerations in the program are or may be paid as a result of the sale of such goods and services or the recruitment, actions, or performances of additional participants."

Although there is an argument that the first part of the definition excludes from MLM direct fulfillment (not different level) distribution systems, the rest of the definition talks to recruiting and compensation that would include two-tier affiliate programs. The way out of the dilemma is judicial interpretation. Unfortunately there is none. The real practical answer is - it does not matter. All the laws affecting direct sellers apply to everyone, whether or not this or any definition is met. The summarized laws of Prohibited Activity in the first four states in an alphabetical list will show what we are up against:

ALABAMA - Prohibited Activity
... any plan ... wherein a person for consideration ... acquires the opportunity to receive a pecuniary benefit, which is based primarily upon the inducement of additional persons ... to participate in the same plan ... and is not primarily contingent on the volume ... of goods, services or other property sold or distributed. "Consideration" Exclusion ...sales demonstration equipment and materials furnished on a nonprofit basis ... less than $100

ALASKA - Prohibited Activity
... a sales devise whereby a person, upon condition that he make an investment, is granted a ... right to ... recruit ... additional persons "Investment" Exclusion ... sales demonstration equipment and materials furnished at cost

ARIZONA - Prohibited Activity
... any plan ... by which a participant gives consideration for the opportunity to receive compensation ... derived primarily from any person's introduction of other persons into participation in the plan ... rather than from the sales of goods ... by the participant ... introduced into the plan ...
"Consideration" Exclusion ... goods or services furnished at cost ...

ARKANSAS - Prohibited Activity
... any scheme whereby a participant pays valuable consideration for the chance to receive compensation primarily from introducing one or more additional persons into participation in the scheme ...
"Consideration" Exclusion ... payments based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

No one can charge for, or require a product purchase for, entry into an income opportunity that includes the right to recruit other income opportunity seekers. This statement is based on LAWS of a vast majority of states (samples above) and is NOT dependent on any MLM definition. What does it all mean? Well, if you offer, or participate in, a one-tier affiliate program, think vacuum cleaner or encyclopedia company representatives of years ago. The laws applying to those types of arrangements will apply to your arrangement. Pyramiding and endless chain concerns are generally not present. A quality general practice law firm should have the answers to virtually all questions that may come up. But if you offer, or participate in a two-tier affiliate program, a line has been crossed. The unique skills of an MLM Legal Specialist, either in-house, or from one of the approximately ten such specialty firms in the United States, are highly recommended. Two-tier affiliate programs, while not structured in a traditional MLM way, must be as carefully structured as a full featured stair-step breakaway or uni-level to which they are closely related (in a legal sense.)
About the Author
Gerald P. Nehra is an MLM-specialist, private practice attorney. He is one of only a few attorneys nationwide whose practice is devoted exclusively to direct selling and multilevel marketing issues. His 33 years of legal experience includes nine years at Amway Corporation, where he was Director of the Legal Division. He can be reached at 1710 Beach Street, Muskegon, Michigan 49441-1008, 231-755-3800, 231-755-4700 fax. His e-mail address is GNehra@mlmatty.com.
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