Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman. (Justice Louis Brandeis, italics mine. Note that Bill Ackman quoted this phrase in presenting his Herbalife short thesis)
After a precipitous drop following the earnings release on November 3rd, Herbalife (NYSE:HLF) has spent a month in purgatory, drifting mostly sideways, and moving up and down on the silliest pieces of non-news, including most recently the release of a sunscreen, apparently to ward off Pershing Square's attempts to let the sun shine in, followed by the heroic tale of CEO Michael O. Johnson's new vote of confidence through his stock options exercise.
The upshot was that Michael Johnson slowed down his rate of his automatic cashing-in of Herbalife shares from exercising his options, which this year he'd been lucky enough to do in May, right into the company buyback program, at over $60 a share, totaling $15 million, see here, and here. His failure to sell all of the shares from this options exercise, but just enough to cover the cost plus taxes, was explained by the spin-meisters as an act of increasing in his holdings. After all, technically they could hardly call it a purchase, but the wording was reminiscent of "advancing to the rear," and other such historical feats of double-speak. After netting it all out, Mr. Johnson is left valiantly holding the bag with an extra 292,454 shares that cost him $0, which represented the lowest amount of shares he could have gained from the transaction without putting up a penny. Apparently, he finally agrees with Bill Ackman's assessment of the prospects, fortunately not everyone reads Mr. Johnson's move as Herbalife's PR department does, see here, or here. The opportunity cost to him is arguably the $12M he passed up by not selling the remaining shares outright, but at this stage it could have hurt the stock price seriously. Clearly, it's the very misleading PR spin that made this otherwise routine transaction unnecessarily problematic.
The $64,000 question: will they or won't they?
Will the FTC shut down the company? For shareholders that seems to be the question, but it is not. Herbalife's business fundamentals are deteriorating rapidly, as discussed here by "Fear and Greed," and that could possibly be accelerated somewhat by any FTC-imposed restrictions or cut very short by a shut down, but the effect is the same, because the problem is the business model, as Kay Herbert has shown here. Matt Stewart looked under the hood of the latest financial reports, and detects the underlying deterioration in recruiting rates here. Recruiting trends are negative in all but one market, and the churn is essentially 100% for 3Q 2014, starting and ending at 3.9 million participants, with 540,000 coming in and going out. We should be reminded that the rate of change at the margin is very predictive. Meanwhile, an interesting new view comes from Jonathan Brand, and concerns the company's Internet reputation, here. In other words, Herbalife is well on its way to collapsing under its own weight, in spite of the best efforts of regulators to avoid dealing with the problem. The question is why it is self-destructing.
The answer to the why is very simple. Major defections have already happened and will happen again, as demonstrated here. For now, top people are stuck, nobody will want them, but the lower tiers have every reason to run. More generally, ninety nine percent (99%) of people lose money in pyramid schemes, simply because the decks are stacked against them, as is the case in three-card Monte. To follow the famous research that Ford Motor Company (NYSE:F) carried out in the run-up of the Taurus program, four people tell their friends about a positive product experience, and nineteen tell their friends of a negative one. Based on his method to quantify this phenomenon even better, Jonathan Brand's article, referenced above, speaks of a checkmate - MLM is hoist on its own petard, purely from blowback of its deceptive marketing. In short, while regulators and law enforcement may be ever so confused over the meaning of a pyramid scheme and the case law in this matter, and what the best legal strategies may be, on the ground the company's bad rep increasingly precedes it, and that rate is accelerating.
My neighborhood offers a perfect example. My district of the Bronx has the greatest ethnic diversity in all of NY, and is not predominantly Hispanic, even though the Bronx as a whole is, yet the Herbalife 'nutrition clubs' are completely Hispanic. No habla Engles. This makes no sense if the intention were to sell product. It only makes sense if the program were an affinity scam, and word is getting out, and slowly but surely, and people are filing complaints. That deterioration on the ground is the real payoff from an abusive business model.
Is an impairment charge against 'goodwill' called for?
The quantitative approach to reputational problems that the Internet makes possible is remarkable, and with that data, there should be grounds for an impairment charge against 'goodwill.' The company still carries $105 million of 'goodwill' on its books. Perhaps it should be written down to zero. The damage as reported by Jonathan Brand is nearly impossible to overcome. Arguably, in some circles the brand name may still have positive associations, so perhaps a 50% impairment could be defended, but not recognizing the damage is willful ignorance at this point.
Where are law enforcement and regulators?
The long silence from the multitude of investigations now under way has been precociously exploited by the company and the few remaining longs who do speak about it - seems like we're mostly down to just John Hempton in that camp. They keep arguing that the government will do nothing. While that does remain a possibility, the more likely case is that the government is actually working on the case very hard, but simply making sure they get it right. Unfortunately for the victims that increasingly means the money will be gone. The corporate jet may have already filed flight plans for the Cayman Islands. Very likely, this was also the reading of the attorneys in the Bostick case, who preferred collecting at least some fees over the possibility of the government seizing the company's remaining assets first. However, hope springs eternal for the preliminary court approval still needs to be ratified in May, and lots could happen between now and then.
The issue of regulatory capture of the FTC, facilitated mostly by the DSA (Direct Selling Association), has been all over this situation, not unlike the SEC was completely snowed by Madoff's seeming respectability until it was too late. The situation is not unlike the Keating five fighting off regulators in the S&L scandal. We already have Madeleine Albright and Jennifer Cunningham as cheerleaders. One way or another, regulators and politicians tend to get blinded by the industries they need to regulate, and the historical fact is that lobbying, donations and outright bribes always go up in direct proportion to the amount of malfeasance. Legally dubious situations always require 'fixing,' and the fixers cost money. It is always when regulations are unclear that 'favors,' are needed. The level of Charles Keating's spending on lobbyists and attorneys in the S&L crisis was staggering. We are seeing it again today with Herbalife, and most recently in the lobbying attempts with New York's AG Schneiderman by his ex-wife, Jennifer Cunningham, which garnered some unwelcome press attention. Another prominent issue of an AG in the hot seat is that of Kamala Harris, the California AG, who has failed to ever enforce the 1986 injunction against Herbalife, and in her case the undue influence could well be coming from her husband, whose law firm has represented Herbalife as reported here, and here.
In other words, if the agencies are changing course after thirty-five years of haphazard enforcement in this area, they need to overcome the inertia of undue influence of MLM during that period. The grounds exist, and the legal foundations can still be found. The Amway '79 case was so clearly flawed, it must be eventually overturned. The burglar could not possibly argue with the court over how many burglaries it would take before he could be convicted of burglary, 5 or 10. In Amway '79 the court allowed itself to get drawn into that sort of an argument.
The reason the FTC is becoming superfluous to the Herbalife case in particular is two fold. One is that Herbalife is perfectly capable of shooting itself in the foot without the regulators, as they are busily doing - it just takes longer and causes more damage, which seems unnecessary and avoidable. The second is that the FTC possibly remains as confused about the whole issue of pyramid schemes as ever, as is evident on its website, where it continues to confuse the reader with the non-existent distinction between a 'legitimate MLM' and illegal pyramids.
The FTC confusion is beautifully demonstrated by this marvelous video of a former FTC general counsel, now industry shill, Robert Paul. This man seems to seriously think that MLM is a form of distribution, and he is completely bamboozled by the fact that MLMs merely appear to 'distribute' real products, when those are overwhelmingly conscripted sales needed to hide the pyramid scheme from view, and without which the pyramid would collapse. It seems he does not know prior court decisions either. For the courts have seen through the pretend legitimacy of products as a foil - what matters is how the scheme operates, and how the money flows, not what the accountants call it.
The reason MLM is not a sales method, but a recruiting method, is very simple. If you create maximal incentives for recruiting, not sales, people will recruit. If you were launching a new product, and you had no distribution, but you spent $10 million on advertising, you just wasted $10 million. It's called a mis-allocation of resources. Or, in more mathematical terms, optimizing a secondary variable. Assuming sales were the purpose, the unrestricted recruiting of distributors undermines their profitability, so they will fail, and increasingly they will either do nothing or figure out that recruiting is the only way to make money. The point is that sales is never the purpose in MLM, that's just for public consumption, so it appears like a direct sales business. Recruiting and a money transfer scheme was always the real objective. As a side effect, the expenses associated with promotion are largely moved off balance sheet, to the "distributors," which explains the industry typical 99% loss rate amongst participants. Amazingly, even some company owners do not really understand this much of simple economics. Again, if sales were the objective, you would incentivize sales, not recruiting. If recruiting is the objective, you would create maximum incentives for recruiting. That is the case in MLM, and that is why it is simply a pyramid scheme parading as a direct sales business.
Fortunately, there still is some jurisprudence that is a tad more insightful than the clueless Robert Paul, who gets completely wrapped around the axle by the industry's favorite lawyerly dialectics, proving once again that Gore Vidal was right: we're a country not of laws, but of lawyers. Then again, the DSA probably pays him better than the FTC did. After all is said and done the root cause of the problem is the fallacy of unrestricted recruitment of recruiters, with minimal sales guaranteed by conscripted consumption and otherwise as merely an optional extra, and literally "for show."
Bruce Craig, former Assistant AG from Wisconsin and a contributor on this site, suggests the following as a minimalist definition of the building blocks of a pyramid scheme (from private correspondence):
- The sponsoring company is the 'promoter'.
- There is a dollar requirement (products, or fees, or both), in order to recruit others, this is your 'investment'.
- There is a right granted non-exclusively to recruit others who also make that 'investment,' and profit from those subsequent 'investments.'
- There is an endless continuation of 2 & 3.
The bottom line is that we need any regulation of MLM to deal with the cause, and not the effects, as Amway '79 did. (Attempting to prevent inventory loading, and lack of retail sales, without dealing with the pyramid scheme itself.) In that nonsensical ruling, the court erred by stipulating what amounts to an MLM not being a pyramid scheme if it meets certain conditions to mitigate the effects that results from it being a pyramid scheme. The problem was that an MLM is a pyramid scheme because of its economic design. The effects of incentivizing unbounded recruiting include inventory loading and lack of retail sales, but fiddling with the effects does not change the fact that the design is a pyramid scheme. In other words, if MLM wants to be legal it should follow a direct sales model in fact, not just hide behind the name of the Direct Selling Association, which they have now usurped.
The 'industry' has been attempting to move beyond the Amway '79 quagmire, enabled by the Internet: all distributors buy direct in newer plans, they no longer resell inventory to one another, etc. In 2003, Joe Barton of Texas tried to do an end run with his HR1220 proposal, which was an underhanded way to legalize MLM, inspired by the DSA - but, mercifully, that attempt failed. Going back to the Koscot ruling we find that it provides clarity on the issues, providing among others, commissions only on consummated sales to people outside the network:
"The Commission has previously condemned so-called 'entrepreneurial chains' as possessing an intolerable capacity to mislead. Holiday Magic, Inc., Docket No. 8834, slip op. pp. 11-14 [84 F.T.C. 748 at pp. 1036-1039] (Oct 15, 1974); Ger-Ro-Mar, Inc., Docket No. 8872, slip op. pp. 8-12 [84 F.T.C. 95, at pp. 145-149] (July 23, 1974), rev'd in part 518 F.2d 33 (2d Cir. 1975). Such schemes are characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users. In general such recruitment is facilitated by promising all participants the same 'lucrative' rights to recruit.
As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed. Cf. Twentieth Century Co. v. Quilling, 130 Wis. 318, 110 N.W. 173, 176 (1907). Indeed, even where rewards are based upon sales to consumers, a scheme which represents indiscriminately to all comers that they can recoup their investments by virtue of the product sales of their recruits must end up disappointing those at the bottom who can find no recruits capable of making retail sales. [FN3]
Complaint counsel argue, in a keen analysis, that the right to sell product in an entrepreneurial chain is also likely to prove worthless for many participants, by virtue of the very nature of the plan as opposed to any particular dishonest machinations of its perpetrators. That is so, argue counsel, because the mere presence of a lucrative right to sell franchises will encourage both a company and its distributors to pursue that side of the business, to the neglect or exclusion of retail selling. The short-term result may be high recruiting profits for the company and select distributors, but the ultimate outcome will be neglect of market development, earnings misrepresentations, and insufficient sales for the insupportably large number of distributors whose recruitment the system encourages. Certainly the facts of this case and of Holiday Magic, supra, as well as expert testimony in the record (Tr. 1195 ff 1691 ff), bear out complaint counsel's contentions. At the very least we would conclude that a company which offers its distributors substantial rewards for recruiting other distributors, and charges them substantial amounts for this right, creates overwhelming barriers to the development of a sound retail distribution network and resultant meaningful retail sales opportunities for participants.
What compels the categorical condemnation of entrepreneurial chains under Section 5 is, however, the inevitably deceptive representation (conveyed by their mere existence) that any individual can recoup his or her investment by means of inducing others to invest. That these schemes so often do not allow recovery of investments by means of retail sales either merely points up that there is very little positive value to be lost by not allowing such schemes to get started in the first place.
A discussion of 'inherent' illegality and capacity to deceive may seem pointless given the more than 4000 pages of transcript detailing the actual deception and injury in which the Koscot plan resulted. Nothing could be further from the truth. It is regrettably clear that responsible authorities, including this Commission, have acted far too slowly to protect consumers from the manipulations of respondents and others like them. As this is written the corporate respondent, Koscot, is in Chapter XI reorganization proceedings, while the individual respondents plead poverty. The administrative law judge estimated that $44 million was taken from consumers (I.D. p. 59 [p. 1163, herein]), and no more than a fraction of that is presently accounted for. Whether more than a small fraction of the consumer loss will ever be recovered is open to serious doubt. These particular individual respondents may not, under the watchful eyes of federal authorities, repeat their misdeeds, but once has clearly been too much.
We think that failure to act more promptly can be traced to the previous inability of relevant authorities to obtain summary relief against the practices involved. The necessity to prove that a marketing plan, manifestly deceptive on its face, has in fact resulted in injury to numerous consumers, is a lengthy process. Only where the law condemns the mere institution of such a plan, without the necessity to demonstrate its consequences, is meaningful relief likely to be obtained. In the years since Koscot's heyday, many States have enacted laws which categorically proscribe entrepreneurial chain methods of selling. Similarly, the Commission has held that the Federal Trade Commission Act forbids such tactics, and has announced that it will henceforth not hesitate to seek recently-authorized injunctive relief should it seem warranted, Holiday Magic, Inc., supra, page 14 [84 F.T.C. 748, at 1038]. The viability of a Federal remedy, however, will depend, if not upon congressional enactment, then upon the willingness of courts to recognize the serious potential hazards of entrepreneurial chains and to permit summary excision of their inherently deceptive elements, without the time-consuming necessity to show occurrence of the very injury which justice should prevent. To require too large an evidentiary burden to condemn these schemes can only ensure that future generations of self-made commercial messiahs will dare to be great and dare anyone to stop them." (Note: Italics added)
On the positive side, since the underlying economic dynamics of pyramid schemes are always the same, faulty analysis in some cases can not stop the truth from coming out eventually. The overwhelming research shows clearly that 99% of people lose money, in the same way Koscot described. So even if Herbalife just continues with little or no FTC interference, or the FTC arrives late to the party, as the SEC did with Madoff, the eventual post mortem might highlight the need for better regulation. Some have already called for changes in law that would make it clear MLM is just a pyramid scheme and can be shut down, as Koscot suggested, based on a simple definition such as the suggestion by Bruce Craig, above.
When did you stop beating your wife?
By way of another look at the absurdity of the Amway '79 case, the following could be helpful: the question about wife beating is a famous example of a trick question, a statement masquerading as a question, and Judge Timony in the Amway '79 case was tricked in just this way. The case was a turning point, and it was directly responsible for the growth of MLM. By avoiding dealing with the charge of being a pyramid scheme, Amway's lawyers crafted simply the conditions that would ensure the court would not find it so. This resulted in the now infamous 10 customers a month and, 70% inventory sell-down rule, inventory buybacks, etc., which became part of MLM agreements ever since, until quite recently. The rule is absurd on its face in the MLM context, for if it were enforced, and all participants would have 10 retail customers a month, the whole country would be using Herbalife (let alone Amway) products. Since then, MLM attorneys and the DSA are attempting to argue the rules are no longer applicable, and are attempting to design around the issue in other ways.
In short, the court was tricked into never making the pyramid scheme determination, but sidestepping the core issue and instead discussing the conditions that would establish that it was not a pyramid scheme. Once Amway's lawyers engaged the court in the discussion of those conditions, they must have sighed a collective sigh of relief, for they had effectively led the judge by the nose, right past the danger zone. Just as much as if someone were to answer the question about beating your wife as asked.
To use yet another little parable, from an imaginary traffic court, the following compares to what judge Timony did:
Judge: Sir, you were clocked at 85 MPH in a 35 MPH zone.
Defendant: But your honor, I drive this $250,000 Maserati, and I agree it's designed to go 207 MPH, but it's factory limited to just 150 MPH, so I already made a sacrifice of 57 MPH to road safety.
Judge: Ok, your sacrifice suffices for this court, ticket dismissed.
In setting those conditions, the court furthermore confused cause and effect. The effect of a pyramid scheme is that the marginal value of a new prospect is as a potential distributor, not as a retail customer, so the retail offer is only a lure to get new people interested, and no serious retail sales will occur if the money is in the recruiting. Since there are always too many distributors, the retail margins tend to disappear, and eventually even the wholesale cost becomes a cost of doing business, as the product tends to be given away as a free sample. The result is too few retail sales. However, since companies, like Herbalife has recently stated "don't have visibility at that level," what really happens is that companies pass the risk of compliance to distributors, who can't realistically make those kinds of retail sales. But by obligating distributors to sign for the fact that they do, they in effect force the distributors to commit fraud, and if push comes to shove, they can fire them for not having the required documentation, and washing their hands off another "bad apple."
If it quacks like a duck...
To repeat: a recruiting program is not a sales program and from a pure economic standpoint, if a program, or a compensation plan as the MLM 'industry' calls it, is designed to promote unrestricted recruiting, this means automatically that retailers will be thrown to the wolves, because under perfect competition margins go to zero, and eventually even the wholesale cost of the product itself also becomes a mere business expense, as the product increasingly becomes a 'free sample,' for prospects, simply because the marginal value of a new customer is highest as a prospective distributor, not as a retail customer. In other words both behaviorally, and from a little bit of forensic accounting, it should be readily evident that sales of the products is not the purpose, pyramid recruiting and money transfer, euphemistically called 'networking' is. The only way to guarantee the cash flows required to reward recruiting is by the conscripted consumption that is typical of all network marketing.
The way it works in practice is that, for public consumption, the narrative always starts with a notional retail opportunity of a product. However, the upshot is that a pyramid scheme by any other name is still a pyramid scheme, and any good forensic accountant could show you that every MLM is a pyramid scheme, with the recruiting compensation being laundered through the product margins to avoid detection by regulators. If there is no intervention, in the end what will happen is that retail margins increasingly do go to zero, and eventually the higher earners can afford to give away the product as free samples, causing the retailing of product to dwindle to insignificance, leaving just a naked pyramid scheme that survives only by reason of the cash flows from conscripted consumption. This economic situation is the reason why Herbalife's nutrition clubs are such a stroke of brilliance - they break the bribery of future earnings potential down to the lowest possible level and instill the habit of conscripted consumption from day one, training the hamsters to like the mill.
The public is starting to get it
How come the regulators cannot get it, but the public does? Refer again to the piece on Internet reputation issues, above. For a more pedestrian assessment, see this funny video on pyramid schemes and remember that you've seen Bill Ackman make the same presentation about Herbalife. Then catch these four young guys from Toronto with a spoof of Vemma and WakeUpNow (warning spicy language!), or a more serious presentation on Herbalife by Ethan Vanderbuilt. In other words, at some level the population gets it. Why don't the regulators and law enforcement get it?
Apparently one of the problems is that in court cases, and in the public dialog, there is a frequent confusion of cause and effect, and the nomenclature of "pyramid scheme" is part of the problem, for the pyramid shape is merely the result of the recruiting scam, if it develops more or less regularly. The pyramid shape is not the cause of the problem, endless chain recruiting is.
The central problem in a pyramid scheme is a simple economic concept that you build a program to recruit people for a business that either does not exist or is not viable, but you create an organization based on recruiting rewards, that is like a chain letter, and the originators of the scam, both the founders of the company and the top recruiters, are the co-conspirators, who stand to make a lot of money (or as per Anthony Powell: "get filthy rich") and they will be nowhere to be found when the scheme collapses due to saturation, when people cannot find new victims easily.
The argument for outlawing such schemes, and for law enforcement intervention is simply prevention of greater harm, because it is entirely predictable. The case is simple for Ponzi schemes, and chain letters because hard money is involved and little else. A Ponzi is an investment scheme (passive) that produces a clear claim on principal plus interest, and it collapses when redemption exceed new investment, as it did with Madoff.
The MLM proposition is different because is pretends to be a business opportunity, an "active" investment, and there is a "soft" quality to the damages it causes. It should be noted that, the investment includes not only any initial fees, but all subsequent product sales, and expenditures of time, money, and reputation, invested in this non-business, where the victim has 99:1 odds of succeeding, and these ongoing investments are fraudulently induced by indoctrination and various misrepresentations.
Therefore again, eventual damage claims by the victims should definitely include all ancillary expenditures, including on lead generation, trainings, meetings, swag, and other support services and tools. Again: all of these consequential expenditures are fraudulently induced. The way it usually works is that the official line talks only about earnings potential (revenue), and then people find out for themselves the other expenses involved or they learn from the "leaders" (co-conspirators), how they generate leads, etc. These secrets are passed out not from the official communications, but in back alleys, at conventions, trainings, and various meetings. People spend many times what they spend on their membership, and products, on training and ancillary services, and this is why they are usually deep in the hole by the time they find out it's not working and they quit. This is how we see people lose $10K, or $100K, and sometimes more in MLM. And people sometimes end up deeply in debt - just this week I learned of another complaint being filed against Herbalife of a proud nutrition club owner, who lost $150K on her involvement.
We are fortunate that there is a legal framework in place that still supports a vigorous response to pyramid schemes. The only problem is to first understand the economics properly. The legalese must follow from the actual (economic) happenings "on the ground:"
- A pyramid scheme is a form of a Ponzi scheme, in which the product is not a phony financial "investment" (passive), but a "business opportunity," (active), and therefore the "investment" is all of the time, effort, expenses, and reputation that the victims invest in such frauds.
- An MLM is merely a form of a pyramid scheme, that is dressed up as a legitimate direct sales program. The real purpose is readily discernible. Usually the promotional materials will focus on a 'business opportunity,' preferably an 'unlimited income potential,' and endless recruiting. If direct sales were the objective, you would manage the sales channel to avoid conflict and restrict the competition among reps, if making money on recruiting is the objective, you would allow unrestricted recruiting, and use the retail proposition as a lure for the unwary, and as a foil for law enforcement. Also, if recruiting is the real (unstated) objective, the program must have some form of conscripted consumption to guarantee the cash flows that keep the scam going, which is what makes it so lucrative for the co-conspirators at the top. This is the essence of the MLM model. The sales narrative is a fig leaf, not the purpose of the business.
- Note: the pyramid shape of an MLM organization may result from the economic drivers that are the foundation of the business model, other ancillary effects are: inventory loading resulting from conscripted consumption, lack of retail sales outside the network (prices are usually prohibitive), wire fraud and mail fraud, and often a wide variety of dubious claims, because the fundamental business proposition must of necessity misrepresent the facts, because it is entirely counter-factual itself.
- The upshot is this: if you promote a lie (and MLM is an economic lie), you must of necessity use lies to cover up the original lie. As a result, fraud, and therefore violations of section 5 of the FTC-act are endemic to all of MLM.
- The only viable answer in the long term is stopping these schemes when they start, not waiting for damages to accumulate.
The realistic legal foundations for remediation
A lot of useful information has been published here on SA in the course of this debate. The presentations and the two websites by Pershing Square, here, and here, were the beginning, not the end, but the body of work that has been produced during this period by various contributors, which include:
- Douglas Brooks, Esq. on the legal aspects of the pyramid scheme industry.
- Bruce Craig, Esq. and former AAG from Wisconsin, on the need for clarity in FTC policy positions, and a comprehensive, not case by case approach.
- William Keep, Dean of the College of New Jersey, and frequent expert witness on MLM, on the meaning of the BurnLounge ruling.
- Robert L. FitzPatrick, consumer advocate and frequent expert witness on MLM, on why the Herbalife case must be the foundation to a comprehensive approach.
Some other relevant legal/criminological information is the following, in particular pertaining to the RICO approach:
- Juth-Gavasso, Organizational deviance in the direct selling industry: a case study of the Amway Corporation. Ann Arbor, Michigan, University of Michigan 1985 (University Microfilms International, 1986). This study is focused mostly on the criminogenic business culture of Amway, but clearly applies to all of MLM.
- Prof. Robert Blakey, here. This material was developed pursuant to the Procter and Gamble lawsuit with Amway.
- Thomas J. Salvatore, an investor has a very comprehensive and humorous analysis of all things Herbalife on his blog, here, where he mostly focuses on the criminal conspiracy aspect of the business and the importance of the RICO statute to the case.
From the S&L crisis to Albania
Thankfully MLM is less than 1% of retail, so we are not at risk of becoming Albania, where pyramid schemes took over the economy, but the lessons are clear. In this country, it was YTB (Your Travel Biz) which set the precedent when the travel industry focused on its illegal marketing methods as a basis for a pyramid complaint, and successfully so. Likewise, the mis-allocation of capital to unproductive, illegal enterprises should concern the SEC, for it undermines legitimate business, and it puts investors, including pension funds at risk. There is no reasonable case for permitting anything that looks like a pyramid scheme to be publicly listed. Public companies should be forced to disclose any dealings they have with MLM companies.
The economic principles are exquisitely simple. If you want sales, you build a system around sales incentives, and you rationally manage your sales channels. If you want recruiting, you build your system around recruiting incentives, but since people will do what makes the most money, you then have to require them to buy product, so as to guarantee the cash flow that supports your recruiting system. It is a very elegant concept, if it works, but it happens to be illegal, and for good reason. One thing is clear, if you read William K. Black's book The best way to rob a bank is to own one, and that is the simple fact that if fraud becomes too successful, the damages mount quickly and it must be dealt with, before it overwhelms the legitimate economy. Lack of enforcement is a serious threat to the economy.
Never mind the short term vagaries of the HLF stock movement, which for now is taking its guidance from the management outlook, the internal forces of destruction are at work. Thus the company and the MLM industry seem to be finding out that the Internet has a way of letting news get around faster, and it becomes harder to spin the facts.
The long-term outlook is $0, sooner or later. Sooner with FTC action, later without it, but thanks to the management determination that some would call intransigence, the course remains set at $0, for even if the company wanted to make a serious change it has run out of time, and maneuvering room, because of the mounting debt pressures.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.