Press reports indicate that representatives of the Latino community will be meeting with the Federal Trade Commission today in reference to recruiting efforts by Herbalife directed to this group. One representative has expressed concern about these efforts and "concluded the company is defrauding upwards of 300,000 Latinos a year."
This concern coincides with recent calculations made by MLM critic Robert Fitzpatrick, and taken from published Herbalife data, which conclude:
• 96% of "Supervisor/Leaders" averaged in gross compensation, before deducting expenses and inventory purchases, the equivalent of less than one-half the wages of a minimum-wage job. These income figures are before all product purchases, business expenses and marketing costs are deducted, taking the true average "income" to a much lower figure.
• The median (half make more and half less) income of the bottom 96% of all Supervisors is zero.
• 49% of Supervisor/Leaders received no income from Herbalife at all - zero.
• 49% of all Supervisor/Leaders drop out or lose Supervisor status each year.
• 67% of all who join each year drop out within a year.
If these calculations are correct, it is not only the Latino representatives who are entitled to be concerned. The question then, of interest to investors as well as the public in general, is what the FTC is going to do about this situation, not only as to Herbalife but other companies operating with a similar marketing plan.
Aside from data already available from public sources, a recent Seeking Alpha article has discussed the responsibility of the FTC to obtain specific and verifiable retail sales data from Herbalife, the collection of which is required of all its distributors. Comments to this article question whether Herbalife has any obligation to obtain and provide this data. While it certainly has no obligation to do so as far as the public is concerned, other than disclosures required by the SEC, providing data to the FTC in response to a formal request is another matter. In addition, the 1986 Court order obtained by the California Attorney General appears to require Herbalife to collect retail sales data.
Although I disagree with its conclusions, the 1979 FTC case against Amway made it quite clear what is required when a company is charged with operating a pyramid scheme. In that case, Amway would have been found to be a pyramid except for its providing proof to the satisfaction of the Administrative Judge, James Timony, that its rules relating to 70% retail sales, 10 customers, and buy back provisions, were in place and in fact enforced to the extent that they protected its distributors from the abuses inherent in a pyramid scheme. In other words, in order to avoid the 'pyramid scheme' ruling, it was the explicit obligation of Amway to prove that its "Amway Rules" were not only in place but actually effective in preventing consumer injury. Whether this was in fact the case, the unchallenged Amway testimony was sufficient for Judge Timony to rule that the company was not a pyramid.
It is difficult to understand why Herbalife, and others with similar marketing plans, should be held to a different standard than Amway. All involved parties have indicated that it is difficult to distinguish between a legitimate Multi-Level Marketing company and one operating a pyramid scheme. The critical factor in this process appears to be whether, in fact, internal company rules effectively result in retail sales sufficient to prevent the abuses inherent in a pyramid scheme. In other words, it is incumbent on the FTC to obtain the data necessary to make this legal distinction. Otherwise, the FTC is relegated to obtaining data after the fact, as was the case in the recent Fortune HiTech litigation, started over 11 years after the company began business and leaving 100,000 distributors in the lurch. The Fitzpatrick data documenting less than 'minimum-wage' incomes for a great predominance of active Herbalife distributors is more than enough probable cause for the Commission to pursue the matter further by formally requiring company data.
The next, and perhaps most critical question, is whether those at the Commission charged with enforcing laws concerning unfair and deceptive conduct, and the specific topic of pyramid schemes, have been effective in their efforts. An indication of the basis for this concern is the recent FTC action to exempt MLM companies from its Business Opportunity Rule and its requirement of disclosure concerning distributor earnings claims. This was a significant, and unfortunate, exemption, given that the MLM industry claims $30 billion in annual revenues and has had a history of legal problems. It would be helpful to know, in this context, whether these disclosures would have enabled these new Latino participants to have a greater understanding of the risks they were facing. The person responsible for the promulgation of this rule - and the MLM exemption - was Lois Greisman, head of the Commission's Division of Marketing Practices since 2006. It is also her responsibility to set enforcement priorities in respect to MLMs and she is the person who will be meeting with the Latino representatives today.
It is further important to understand that prior to appointment to the Division of Marketing Practices; Ms. Greisman was Chief of Staff to FTC Chairman Timothy Muris. Mr. Muris, an attorney who worked in a law firm that represented the Amway Corporation prior to appointment by President Bush in 2001, returned to private practice in 2004 and filed, in 2006, an extensive comment on behalf of Primerica Financial Services in opposition to the proposed requirement in the Business Opportunity Rule that would have included Multi-Level marketers and the related disclosure requirements.
None of this is to say that any illegal conduct was involved, but these facts have to raise concern that the official attitude of the Federal Trade Commission in respect to pyramids has been less than diligent, particularly in light of public data that suggests considerable losses on the part of well over 90% of the persons that join these plans. Any attempt to claim that this matter should be handled by private litigation ignores the economic status of most participants in these plans, and the serious legal and procedural obstacles to class actions by distributors, including the widespread use of arbitration clauses in MLM distributor agreements.
Potential participants and investors are entitled, at a minimum, to an official inquiry into the specific, and critical, element which has remained in the shadows, the retail sales requirement. It is incumbent on the Federal Trade Commission to investigate this matter if for no other reason than to know just what is going on and to fulfill its obligation to consumers such as those represented by the organization meeting with the FTC today.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.