ON MARCH 26, JUST BEFORE IT OPENED THE STATE'S electricity market at midnight on the 31st, the California Public Utilities Commission announced new interim rules to protect consumers, plus this warning: "Any entity who is considering doing anything contrary to [state law] regarding electric restructuring, and [this] decision adopting such safeguards, should think twice."
Ostensibly, that advice followed from last year's passage of State S.B. 477, which told the PUC to adopt financial, technical and operational standards for electric service providers, and from reports issued by the PUC's Direct Access Working Group, which raised concerns about consumer protection.
However, it might also have had a bit to do with a certain college dropout, who rose from jewelry salesman to founder of what might have been one of California's largest electric resellers (em until the PUC suspended the business in February for "misrepresenting" services and savings to customers "through dishonesty, fraud and deceit," according to a PUC press release.
The new business, built by the 19-year-old Christopher Mee and his company, Boston-Finney Inc. of Harrisburg, Pa., allegedly sought to build profits by selling distributorships rather than electricity. Boston-Finney's activities, known as "multilevel marketing," also caught the attention of state attorneys general in California and Pennsylvania, who have filed civil complaints.
Nevertheless, Boston-Finney and other similar companies still believe that multilevel marketing has a place in power retailing, given the nature of the new electricity sales business, which promises confusion for customers and extremely tight profit margins on the product itself.
"The business opportunity for the person-to-person process of multilevel marketing works best¼ when there is a lot of confusion in the marketplace," explains Mark Talbott, a senior marketer at Amway. "And there is considerable consumer confusion about electricity."
On the other side, some consumer protection groups aren't so sure. They vow to pay careful attention to the fine line between legitimate multi-marketing and illegal pyramid schemes.
"The argument used to be that [consumer advocates] would go away once rates start to be dictated by markets rather than by regulators," says Charles Acquard, of the National Association of State Utility Consumer Advocates. "I think with Boston-Finney, we're already seeing that we'll be moving from ratepayer advocacy to a more general consumer advocacy involving pyramid schemes, as well as other fraudulent and deceptive marketing practices."
Pennsylvania Attorney General Mike Fisher echoes the need for vigilance. "Electric deregulation was created to bring competition to the energy marketplace and ultimately benefit consumers," he says. "However, it's my job to see that the host of new competing plans are legitimate."
How and Why
Under a multilevel marketing approach, an energy marketing agent earns commissions both for recruiting new distributors and on the sales those distributors bring to the business. More commissions are paid for additional distributors and/or sales in lower levels at the base of the sales "pyramid."
But pyramid schemes are illegal. According to Federal Trade Commission attorney John Singer, if more than 50 percent of the revenue is not generated by the sale of a product or service, the business is a pyramid scheme. Moreover, the product or service must be tangible to qualify as legitimate.
"Some companies say they sell something, a binder of training materials, for example, but it's just a facade for bringing in new membership," Singer explains. "With electricity, it's presumably going to be a little more clear-cut. If the company doesn't have a contract to resell from a legitimate supplier, or isn't registered with the PUC, it would be hard for a company to prove it has a genuine intention to sell electricity."
An alleged pyramid structure is what got Mee's company booted out of California. In February, the state PUC ordered Boston-Finney to cease operations as an electric service provider (it had been registered as No. 1105). The PUC told Boston-Finney to cease recruiting California residents as retail customers, or as account executives, independent distributors, or marketing agents (I. 98-04-004, Feb. 19, 1998).
Also, Boston-Finney was slapped with two state civil lawsuits seeking more than $1.5 million in penalties. Attorneys general in California and Pennsylvania alleged that Boston-Finney had set up a pyramid scheme involving 8,000 people. According to the allegations, each participant paid about $300 to become "power reps," plus $160 in annual dues. Boston-Finney also fraudulently misrepresented itself as an established utility reseller, the attorneys general claim. Authorities are seeking to force Boston-Finney and Mee to pay restitution to the hapless 8,000. (See, Case No. 717631, Calif. Superior Court, San Diego County; Docket No. 183 MD 1998, Pa. Commonwealth Court.)
Pennsylvania Commonwealth Court Senior Judge Eunice Ross granted an injunction freezing $310,000 in personal and business accounts. Mee's $90,000 Mercedes, bought with corporate funds, was impounded. Boston-Finney was banned from conducting further business. Mee, who once touted the electrifying potential for multilevel marketing during deregulation, declared personal bankruptcy and is seeking to have his assets returned.
All the same, the notion persists that an Amway-style sales force (em selling distributorships along with the product (em is the way to market low-margin commodities to retail customers.
According to Paul Clanon, California PUC energy division director, margins in electric generation will be small, between 5 and 10 percent, which may make it difficult for resellers to compete on price alone.
"I don't look to make more than 50 cents a customer a month, if that, from selling electricity," says Eric Borgos, an inactive Boston-Finney sales rep. "Recruiting other distributors is the only way I'm going to make money."
Kevin Tran of ITT Powercom, a California ESP, points out that multilevel marketing is the least costly way to get customers. "Until we know what the actual supplier charges to us are going to be," Tran complains, "I don't know if we'll be able to make a profit on electricity."
"The problem with telemarketing is that today people are afraid they might be getting slammed," says Tran, referring to the practice in the long-distance phone industry of customers automatically being switched to a new provider. "Advertising is expensive, and you can't be sure of its effectiveness. Multilevel marketing gets people actively involved to sign up new people."
"Who are you more likely to buy from, some salesperson or someone you know personally?" asks Alan J. Setlin, chairman of the Future Group, which includes FutureNet Inc. and Future Electric Networks, both targets of a pyramid scheme investigation.
"When you develop a personal relationship with people, they're more likely to take a look at what you have to offer," Setlin notes.
"[Conventional wisdom says] you can't sell green power, for example, because it's going to be more expensive¼ California is the land of conservation. And when you tie that into the one-on-one relationships our distributors develop, I think a lot of people are going to be surprised about the choices consumers will make."
Telecom Sales: Lessons for Energy?
The multilevel marketing strategy is seen frequently in telecommunications, where the Federal Trade Commission has been active of late.
In March, the FTC announced that it had (File No. 972 3230) charged FutureNet, Inc., of Valencia, Calif., with violating federal law by allegedly promoting a pyramid scheme disguised as a legitimate business marketing Internet access devices ("Web TVS," or set-top boxes that provide Internet connections and health and beauty aids). In February, attorneys for the FTC had filed a complaint against FutureNet Inc., FutureNet Online Inc., in U.S. District Court for the Central District of California (Western Division) seeking an injunction, restitution, and appointment of a receiver for an alleged pyramid scheme that involved selling two types of distributorships for Internet consulting. The FTC reported that the court had issued a temporary restraining order on Feb. 23, freezing assets and appointing a receiver for the corporate defendants.
Though FutureNet had also formed a business called Future Electric Networks to market electricity, the FTC action against FutureNet concerned only the company's Internet access services. Spokeswoman Claudia Bourne-Farrel said the FTC's action stemmed from the fact that distributor income didn't depend on sales, but on recruitment (em the typical profile of an illegal pyramid scheme. (See sidebar, "Guilty by Association?")
Pennsylvania's attorney general thinks this profile also fits NuSkin International, of Provo, Utah, a multilevel marketer of beauty products endorsed by celebrity Christie Brinkley, which, along with its affiliate Big Planet, has been linked by some to marketing activity in energy sales.
In a previous settlement, NuSkin paid $20,000 and signed an "Assurance of Voluntary Compliance" order to end pyramid operations. But the latest complaint (Docket No. 147 MD 1998, Pa. Commonwealth Court) accuses NuSkin Utah of violating this agreement by recruiting distributors to sell nonexistent electric and high-tech products.
Mark Calkins, Big Planet's marketing vice president, attributes the company's missteps to the "over enthusiasm" of independent NuSkin distributors who recruited before the program was operational. Calkins points out that while Big Planet may offer electricity services in the future, it doesn't now. And it has explicitly warned distributors not to make any claims otherwise. Big Planet also maintains that commissions are paid for product sales only (em not recruitment.
Of course, the energy business is different from telecommunications. A national telecom reseller might deal with only one or two long-distance companies, but electricity marketing can involve many power producers. "With electricity I may have to sign fifty to a hundred contracts," says Mark Calkins, marketing vice president for Big Planet, explaining why his company has decided to go slow on plans to enter the electric market.
That said, however, Calkins admits that electricity is still attractive to marketers because it can compliment other offerings as such long distance, mobile telephone, and Internet access. "One-stop" billing is the goal. Consumers might not care if they pay more for electricity, so long as they can write one check for all their technology services.
Despite his experience at Boston-Finney, Eric Borgos still sees opportunities in energy: "The problem right now is that there isn't a product to sell. Once deregulation is more widespread, I think more multilevel marketing companies are going to be interested."
Jim Leize of Eastern Pacific Energy, a California ESP that has a relationship with Future Electric Networks, adds that the multilevel marketer's interest in electricity is to gain a gateway to customers and sell additional services. He confirms that role in energy markets for multilevel marketing: "Almost a day doesn't go by when I don't get a phone call from some multilevel marketing company wanting to represent us. Multilevel marketers are not going to go away."
Setlin, at Future Electric Networks, for one, intends to be in the thick of the new business, just as soon as other utility services and commodities are deregulated (em and, of course, after the FTC case against him is settled.
"The whole world is going to deregulate," Setlin says. "Electricity is just the start. In 1999, billing and metering in California are going to be opened up, and then there's water and other utilities. I'm getting into electricity as a way to get a jump into all these other markets."
What Role for Regulators?
In California, Boston-Finney became a registered energy service provider by filling out a form and paying a $100 license fee. It didn't participate in the initial pilot program on electric customer choice in its home state of Pennsylvania. There, it may have been deterred by the much more intensive review of its business capabilities required under Pennsylvania law, including a mandatory a $250,000 bond, says Irwin A. "Sonny" Popowsky, Pennsylvania consumer advocate.
Now, however, things have changed in California.
In Decision 98-03-072, the California PUC adopted new interim standards affecting registration of and technical qualification for energy service providers. Moreover, it also approved a redesigned ESP registration application form, requiring ESPs to submit additional information regarding financial, technical and operational abilities. Each ESP must have executed a service agreement with each utility distribution company in whose service territory it (the ESP) expects to offer services. ESPs must also: (1) post a $25,000 security deposit for financial guarantee bond; (2) submit a copy of all agreements with scheduling coordinators (unless the California Independent System Operator names the ESP as an SC itself); (3) name key personnel involved in technical and operations aspects of the business, and describe their working experience; and (4) supply customers with a uniform notice of price, terms and conditions of service, and employ a standard billing format.
The question remains, however: Will these new requirements affect multilevel marketers, or make it more difficult to conduct a pyramid scheme in retail electricity markets?
In asking that question, remember California state law allows the PUC to require registration by ESPs but not much else: "Registration with the commission is an exercise of the licensing function of the commission, and does not constitute regulation of the rates or terms of conditions of service offered by registered entities. Nothing in this part authorizes the commission to regulate the rates or terms and conditions of service offered by registered entities." (Calif. Public Utilities Code sec. 394(e), as added by Senate Bill 477, Stats. 1997, ch. 275.)
The PUC enjoys surprisingly little authority to control how ESPs engage in marketing activities (em whether directly or through Amway-style, multilevel marketing arrangements. The PUC acknowledged the problem: "We are aware that some ESPs will undertake marketing activities 'in-house' with their own employees, while others may contract thus function out or establish agency-type relationships." (See, Decision 98-03-072, March 26, 1998, p. 11.)
The PUC has added, however, that while these types of multilevel marketing entities "need not register as an ESP," any ESP using them must give notice of that fact to any customer, explaining that the sales agent acts on behalf of the ESP. That its registration process for ESP's might give it at least some leverage over sales agents was a fact not lost on the commission: "Should any of these marketing entities violate any of these provisions, we will hold the ESP accountable."
Will the Boston-Finney experience elicit further commission rules to supervise multilevel marketers?
"Certainly that will be something to look at," says Richard Bilas, California PUC president, contacted while the PUC deliberated its new rules. "However, it is important to keep in mind that multilevel marketing is a perfectly legitimate business. Amway is a classic example of a totally aboveboard operation." (See sidebar, "A Major Endorsement.")
Utilities as Police Officer?
In Washington state where complaints were received against Future Electric Networks, but where electric deregulation isn't expected for at least another two years, spokeswoman Janice March reports that the state attorney general is deferring to the FTC, rather than taking action on complaints filed by consumers.
"As deregulation becomes a reality and products can be sold in Washington state, we will be carefully evaluating aggressive marketing tactics that cross the line," she says. "However, to define what will be sold and how can it be sold at this point would be premature."
Meanwhile, the FTC disavows any big plans for preemptive strikes against potential pyramid schemes. "We're a small office, " notes the FTC's Bourne-Farrell. "Any future action we take will be on a case-by-case basis."
Should the electric industry itself do some policing of its own?
In its recent decision, the California PUC proposed UDCs (electric utilities) track and provide reports of calls from consumers regarding complaints against registered or unregistered ESPs. The PUC asked for comment on the idea. It proposes to require UDCs to maintain a database or record of "complaint" calls to their customer service centers, categorizing the complaints by type of conduct alleged, and recording name, address and telephone number. The PUC's Consumer Services Division would have access to the database. (See, Decision 98-03-072, March 26, 1988, pp. 99-100.)
Tom Boyd of Southern California Edison questions the idea of utilities policing ESP behavior.
"We provide advice about ESPs to our customers," he says. "In dealing with any third-party provider, we caution looking at the fine print, but as far as multilevel marketing companies go, we leave it to the PUC to determine if they are operating legally."
Pacific Gas and Electric spokesman Cory Warren agrees: "As long as they follow state requirements and those of the Power Exchange and the Independent System Operators, we'll enter into a service agreement."
Boyd doesn't consider ESPs, much less whether they are multilevel marketers, much of an issue. No one is jumping on the bandwagon of new providers. "Out of 1.2 million customers, we've only had 2,500 requests to switch," he says.
ESPs may not be able to keep a hands-off approach to the multilevel marketing business, however.
Eastern Pacific Energy, for instance, markets via independent sales affiliates. When its Pacific Advantage affiliate contracted with Future Electric Networks to sell residential and small commercial services, the company found itself thrust into a controversial arrangement it would just as soon have avoided.
Publicity about Boston-Finney's collapsed pyramid scheme and its false claims regarding energy savings prompted Eastern Pacific Energy to "sit Future Electric Networks down with the PUC to discuss what they could or could not represent to customers," Leize says.
"I think the problem with the multilevel marketing industry as a whole is that it tends to overly engage in hyperbole. That's a rascal we've got to work to keep in its cage if anyone in the electric business is ever to effectively partner with them." F
David Soyka is a freelance writer in Alexandria, N.J.
Guilty by Association?
Future Electric Networks Fights for Respect
IT REALLY IRKS ME that the press is lumping Future Electric Networks
and me in with Boston-Finney, " says Alan J. Setlin, chairman of the Future Group, formerly FutureNet Inc.
"I started this company in November 1997 with $2 million of my own money," says the self-described former insurance broker. "I've got 200 people directly on payroll and 40,000 square feet of office space, and 50,000 distributors nationwide. Anyone who comes down here to look at my facility can see I'm running a legitimate business."
The Federal Trade Commission claims that one aspect of Setlin's business (em a multilevel marketing program to sell Internet access devices (em is a pyramid scheme. (The FTC charged FutureNet with recruiting third-party distributors as Internet "consultants," who would then bring on more "downstream" paying members, so that the income from the plan would not depend on sales of Internet devices, but on recruitment.) Under a modified restraining order, however, the Future Group can now do business under a court-appointed monitor (em as long as it doesn't recruit distributors and sells products only to end users.
Setlin scoffs at the FTC's allegations, noting that in the week following the modified order, "we generated more than $400,000 in sales. I think that proves we're a legitimate retail business."
Whether the Future Group is a lawful electric reseller is harder to pin down. Although Setlin says a contract to sell energy services proves he is not using electricity simply as an enticement to lure people to pay $99 or more for distributorships, the actual energy services provider (em Eastern Pacific Energy (em doubts whether Future Electric Networks will be able to deliver any significant customer sales.
The multilevel marketer insists it's a legitimate reseller, yet it hasn't sold anything yet and its contract depends on resolving the FTC charges.
Future Electric Networks hopes to market to California retail and small business customers electric and green power services through Pacific Advantage, a sales affiliate of Eastern Pacific Energy. Setlin claims to have 10,000 customer letters of approval to switch service to Eastern Pacific Energy once deregulation becomes effective.
"Unlike Boston-Finney, I didn't spend $100 for a license so that I could claim to be an ESP," Setlin says. "I don't want to be in the electric business. I want to market it, so I signed a half million-dollar contract [with Pacific Advantage to act as its sales agent]. All my promotional materials will clearly state, in accordance with PUC requirements, that we're not in the electric business, that we are licensed to represent a company that has that expertise."
Jim Leize, CFO of Eastern Pacific Energy, stresses that his company's contract with Future Electric Networks is subject to how the FTC complaint is settled.
"Any violation of state or federal law automatically results in termination," he says. Even if Future Electric Networks wins a clean bill of health, Leize suspects Setlin is in for a severe reality check about how many customers he actually can get because costs savings for small businesses and residences will be minimal.
If Future Electric Networks should end up selling nothing, that's OK, the CFO says. His company wasn't going to target the residential market anyway. "Residential is a niche market for us, and if we do go ahead with them I think they've got a tough sale ahead."
A Major Endorsement?
Amway and Enron Link Up, Downplay Their Venture
TWO CORPORATE POWERHOUSES (em Enron Power Marketing and Amway (em appear to have joined forces to pursue power retailing activities, but are keeping a low profile for now, until the market heats up.
Neither, for example, mentions the relationship on its corporate web site. And both are silent on their sales activities to date, saying that although prospective customers have signed up in California, specific figures won't be released until customers finally switch.
Mark Talbott, an Amway senior marketer, shrugs off his company's reticence: "Electricity is just one small addition to the more than 4,000 products the company already offers." Enron spokesman Gary Foster adds: "Right now we're just in the process to see how selling in this market will work."
Despite the bad publicity generated by Boston-Finney, Foster doesn't feel any discomfort in working with a multilevel marketer, particularly Amway, in business since the early 1950s.
Although Amway initiated the relationship, Enron was impressed by its track record representing MCI at the start of long-distance phone service deregulation. "Amway helped make MCI the success it is today," says Foster.
"Three or four years from now, when the rules are better defined, the fact that we are reselling electricity through a multilevel marketer may not even be an issue," he says. "When you consider that a $24-billion company like Enron is working with a long-established company like Amway, I don't think there's any reason for the consumer (em or regulators (em to be concerned."
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