Seeking Alpha

An Academic Speaks, But For Whom?

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Includes: HLF
by: William Keep
Summary

Investors love the MLM positive cash flow but what about protecting consumers.

Academics and politicians, who knew how little homework they would do.

HR 3409 and the Moolenaar amendment, bad policy to protect bad businesses.

It is not uncommon for legislation to carry a label that belies its true intent. It seems, however, less common to have an academic defend the approach. An article by Professor Coughlan claims that HR 3409 protects consumers from pyramid schemes while preserving the entrepreneurial “business opportunity” offered by multilevel marketing (MLM). However, even an academic messenger cannot offset the overwhelming evidence that House Bill 3409 will harm consumers and make it easier to perpetrate pyramid schemes that prey on working people.

Since the 1970s, Federal Trade Commission (FTC) has developed a fact-specific inquiry to determine whether or not a business constitutes a pyramid scheme. The courts accepted this approach, shuttering or penalizing numerous MLM pyramid schemes. In fact, since the mid-90s, the FTC has earned a perfect record in over two dozen major pyramid scheme prosecutions across multiple jurisdictions.

In 2011, a court found that BurnLounge, a relatively small MLM, was a pyramid scheme. An appellate court affirmed the lower court decision in 2014, noting: 1) purchases made by BurnLounge’s distributors could not, in and of themselves, establish that there was “consumer demand” for its products, and 2) the FTC’s fact-specific inquiry and arguments of law were proper and “helpful to the trier of fact (here the court).”

The following year, the FTC charged Vemma, an award-winning member of the Direct Selling Association (DSA), with operating a pyramid scheme. A federal court concluded,

“The evidence before the Court leaves little doubt that the FTC will ultimately succeed on the merits in demonstrating that Vemma is operating a pyramid scheme…the Court will enjoin those features of Defendant’s Marketing Program and bonus structure that tie bonuses primarily to recruiting and to the purchase of product principally to stay eligible for those bonuses.”

In 2016, after a two and one-half year investigation the FTC settled with Herbalife (NYSE:HLF), requiring the company to reconfigure its compensation plan, collect, and report on sales data never before collected and undergo seven years of monitoring. FTC Chairwoman Ramirez - twice - gave the DSA guidelines to follow to avoid operating pyramid schemes. To warn MLM companies away from behaviors engaged in by Herbalife and others, the Chairwoman famously noted, that Herbalife was “not determined not to be a pyramid.”

The BurnLounge and Vemma decisions reinforced decades of pyramid scheme case law. The courts required that MLM companies provide evidence of customer demand beyond purchases made by their distributors for their own use and chided MLM operators for deceiving consumers. With Herbalife, the FTC demonstrated a willingness to impose reporting requirements on a company in a notoriously opaque industry. The DSA and leading MLM companies were stunned. Now comes HR 3409, a bill apparently drafted by lobbyists, designed not to protect consumers or distributors but, rather, to replace the FTC’s decades-old proven fact-specific approach and prevent future FTC enforcement.

In an essay that offers no support, Professor Coughlan’s defense of HR 3409 fails to mention that the bill nullifies decades of legal precedents by allowing MLM company to pay its distributors solely on the basis of purchases made by those they recruit, ad infinitum, with no sales to non-participants - the textbook example of a product-based pyramid scheme. Under HR 3409, MLM companies previously found to be pyramid schemes would be un-prosecutable.

Professor Coughlan also neglected (probably just forgot) to mention her non-academic (i.e., not peer-reviewed) industry work. Her 2012 “white paper” defending Herbalife claims, “Consumption by Non-Distributor versus by Distributor End-Users is Not a Relevant Criterion, a statement contrary to case law at that time and further refuted by BurnLounge, Vemma, and the Herbalife settlement. In a separate paper that year, Professor Coughlan claimed, with academic confidence that apparently requires no support, “The MLM firm also creates, monitors, and enforces important rules of conduct that protect all distributors as well as the MLM firm itself.” This view is inconsistent with the many class action law suits brought by former distributors and prior MLM pyramid scheme cases.

In a departure from logic and in a failed attempt to support HR 3409, Professor Coughlan concludes by referencing the FTC decision on Amway (1979). An objective review of that decision would show (but not to Prof. Coughlan apparently) that neither the FTC nor Amway ever proposed that the company’s 70% rule and/or retail sales rule could be satisfied by the distributors’ own purchases. Clearly, Amway would have had no need to defend itself with these safeguards had that been the case.

Congresswoman Blackburn (R-Tennessee), sponsor of HR 3409 and now made even more famous by the recent piece in 60 Minutes (scroll down to: “The bill, introduced in the House by Pennsylvania Congressman Tom Marino and Congresswoman Marsha Blackburn…”), cites her own positive experience in direct selling in the early 1970s as justification for the bill. But times have changed. In the decades since, according to DSA data, the predominantly single-level direct selling industry morphed into the MLM industry. The interests of MLM companies and their distributors do not align as they do in the single level direct selling model, where the company makes money when the distributor sells to non-participant customers. In the MLM model, the vast majority of participants purchase products, mostly lose money and eventually leave, only to be replaced by new recruits, creating the type of endless cash flow favored by financial investors. Too often this “business model” resembles a game of chance.

The MLM industry is peppered with misleading product claims and deceptive income earnings statements. A recent study by TruthInAdvertising.org (TINA) shows that “97 percent of DSA member companies selling nutritional supplements have distributors marketing their products with illegal health claims.” My own analysis has shown that MLM distributor earnings statements used when recruiting new distributors were not only unhelpful but risky as they fail to disclose the extent to which the same top distributors reap the vast majority of rewards year in and year out.

The euphemistic “anti-pyramid” scheme label of HR 3409 (and the similarly worded amendment offered by Congressman Moolenaar, R-Michigan) has not fooled consumer advocacy groups or the FTC. Consumer groups, including the National Consumer League, Consumer Action, Consumer Federation of America, Consumer Watchdog, League of United Latin American Citizens, National Association of Consumer Advocates, National Consumer Law Center, Public Citizen, U.S. PIRG, and Consumers Union, have roundly condemned the Moolenaar amendment and/or HR 3409, as has a current FTC Commissioner and a bipartisan group of former FTC senior officials.

None of this material information - whether readily available MLM pyramid scheme case law, a correct understanding of the 1979 Amway decision, the ongoing evidence of product and income claim misrepresentations, the significant changes emphasizing sales to non-distributors conspicuously required of Vemma and Herbalife, the opposition of consumer groups, or the denunciation from current and former FTC officials across political parties - was allowed to have any corrective impact on Professor Coughlan’s clean, industry-like language in support of HR 3409. Nor does she make apparent her connection to that industry. Shame on Forbes where, according to their own opinion website, “Prospective authors are required to disclose any actual or potential conflict of interest, including but not limited to any financial interest in any product, firm, or commercial venture relevant to their submission. Failure to do so will result in prominently placed corrections.” I challenge them to print this rebuttal as part of a properly placed correction.

William Keep, Professor of Marketing and Dean of the School of Business at The College of New Jersey, co-authored with Dr. Peter Vander Nat (FTC, retired) the first academic article proposing a model for discerning a legal MLM from a pyramid scheme and has served as an expert witness in the prosecution of pyramid schemes.

Disclosure: I/we 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.