Nu Skin Fined in China for Improper Direct Sales Activities

by Davis Wright Tremaine LLP
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Facts
The investigation was launched as a direct result of a series of news reports by the People’s Daily, China’s official newspaper released in January 2014, alleging that Nu Skin China had organized “brainwashing” gatherings, and exaggerated its product influence and creditworthiness among its customers.

SAIC then stepped in and, on March 24, 2014, made an official statement on its website regarding its investigation and the penalties imposed on Nu Skin China. It stated that Nu Skin China was found to have sold products that were not registered for direct sale, which resulted in a fine of RMB 150,000 and confiscation of all the illegal sales revenue of RMB 3,114,000 by the Shanghai AIC. Nu Skin China was also found to have overstated the effectiveness of its products and, as a result, was fined RMB 100,000 by the Shanghai AIC. Additionally, the officials at the Beijing AIC imposed a fine of RMB 130,000 on each of six sales representatives of Nu Skin China for their unauthorized promotional direct sales activities and confiscated illegal gains of RMB 1,368,000. The Beijing AIC also ordered Nu Skin to enhance the education and supervision of its sales staff and to shut down all its “working studios”, which are the small offices that were accused of engaging in illegal activities. SAIC also announced in the same statement that, as a next step, it will work with other authorities to enhance the level of regulation of the direct sales market, and harshly crack down on and prosecute any illegal behaviors.

On the same afternoon as SAIC’s statement, Nu Skin China responded that it was taking steps to correct the issues raised in the investigation, and will remain committed to working cooperatively with the government. Nu Skin China also mentioned that, effective Jan. 21, 2014, it had already suspended promotional gatherings since, and ceased the recruitment of any new sales people.

Analysis
Direct sales market is reported to be a grey regulatory area in China. Chinese law permits direct sales activities under limited conditions but, expressly prohibit pyramid selling activities. The term “pyramid selling” as defined in the Regulations on the Prohibition of Pyramid Selling refers to any actions by which an organizer or operator:

  1. Recruits members;
  2. Calculates remuneration of and pays those members based on the number sales performance of the people that the members directly or indirectly recruit; or
  3. Requires members to pay an entry fee for participation, which results in their obtaining unlawful interests, disturbs economic order, and affects social stability.

Even though Nu Skin China obtains the required license to engage in direct sales activities in China, government officials have long been skeptical about the multi-level marketing business model used by Nu Skin and its business competitors in the direct sales market. Based on this model, the multi-level marketers make money by selling products to distributors, who in turn sell them to other local sales people rather than to the actual end users. This model has shares some similarity to the legal definition of pyramid selling, and it is currently unclear where to draw the line between any legal multi-level marketing and illegal pyramid selling activities. SAIC’s intent to increase the regulatory level of the direct sales market would certainly pose a signal of red flag for all the multi-level marketers in the direct sales market.

Interestingly, news reports show that after SAIC’s announcement, the stock price of Nu Skin Enterprise, Inc. rose nearly 20 percent trading in the New York Stock Exchange. Between the People’s Daily’s release on Jan. 16, 2014, and the SAIC announcement, Nu Skin share had lost more than a third of their value. SAIC’s penalty was imposed pursuant to the Regulations on the Administration of Direct Selling. Apparently, the penalty was much smaller than the expectation of the investors in the U.S. market. This market reaction raises the possibility that the Chinese government might amend the regulations to increase the penalty levels in its future actions.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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