In Defense Of MLM: More Politics And Less 'Real' Business

Includes: HLF
by: William Keep

Politicians surely think our students should know some US history; the time to read more business history is clearly overdue.

Turning to industry for advice on how best to protect consumers is more (i.e., worse) than wishful thinking.

Moolenaar amendment and HR 3409 combine to turn the FTC away from protecting consumers.

About two weeks ago I noted here how a marketing professor at a well-known business school published unsupported nonsense in defense of HR 3409, the bill introduced by Congresswoman Blackburn to hamstring the Federal Trade Commission (NASDAQ:FTC) in its efforts to protect consumers against multilevel marketing (NYSE:MLM) style pyramid schemes. Now we get similar nonsense from the political arena in a letter from Congressman Huizenga and Congresswoman Eddie Bernice Johnson supporting the Moolenaar Amendment (similar to HR 3409 but faster-acting).

How does the Moolenaar amendment and HR 3409 tie the hands of the FTC? Both are designed to specifically carve out from FTC oversight product-based MLM pyramid schemes that fail to establish consumer demand beyond selling products to an ever churning, endless-chain of recruits, who maintain purchase behavior in pursuit of an ever-elusive reward. Successfully prosecuted in a number of cases, these types of schemes have harmed tens of thousands of consumers. The individual amounts lost can be small (hundreds to thousands of dollars) but the total amount funneled to a miniscule number of scheme leaders can be very large.

Before I get to the data in the Huizenga/Johnson letter let's focus on the stated need to "give legitimate direct selling companies more guidance on what constitutes ethical business practices." Twice in a little over a year the Federal Trade Commission (FTC) provided such guidance to the Direct Selling Association (DSA) - here and here. The guidance directly links established case law created over decades to actual practices. The consistency of case law can be shown in the recent Vemma (an award-winning DSA member) and BurnLounge cases. It appears that the DSA and some in the MLM industry simply do not like the guidance given. Why? What are they afraid of? Why run to their favorite politician?

When referencing state laws Representatives Huizenga and Johnson fail to note the years-long industry campaign (e.g., Louisiana) to change or prevent state laws forbidding endless-chain selling schemes that have baked-in failure for the vast majority of participants. Not all fail because a small number must succeed to sustain the fraud. The fear among industry members appears to be that some among them do in fact operate illegal pyramid schemes. Rather than reinforce the FTC message and clean up the MLM industry, the DSA has chosen to support legislation that dramatically limits FTC prosecutions and rolls back consumer protection.

Representatives Huizenga and Johnson also erroneously note that the language of the Moolenaar Amendment is "consistent with case law." For that statement to be true the "case law" must be parsed in such a way as to disregard significant portions of specific decisions. For example, the DSA liked to say that the BurnLounge court "affirmed that compensation in a multilevel marketing business must be primarily based on the sale of products and services to the ultimate consumer, whether or not that consumer is also a seller of the products." In fact, of course, in finding BurnLounge to be a pyramid scheme the appellate court wrote: "In practice, the rewards BurnLounge paid for package sales were not tied to the consumer demand for the merchandise in the packages" (emphasis added). In other words, recruits purchased packages (i.e., product) but those purchases alone DID NOT constitute consumer demand as only those pursuing rewards by recruiting others purchased the product. The BurnLounge court provides plenty of references to case law and reaffirms the approach taken by the FTC. Whether Representatives Huizenga and Johnson know this or not, the Moolenaar Amendment would effectively reverse this decision and tie the hands of the FTC in terms of prosecuting product-based pyramid schemes.

Now for the numbers. According to the Huizenga/Johnson letter "More than 20 million Americans run small, legitimate direct selling businesses across the country. Together, these men and women contribute more than $35 billion to the American economy each year and help form the backbone of many local communities. 90% of direct sellers operate their small business part-time and make a medium income of $3,400 a year." To cut to the chase - having followed this industry for years, it is my opinion that these three sentences cannot be supported and constitute a bunch of hog wash (whatever that looks like). [Oh, and don’t start a sentence with a numeral unless you spell it out.]

Here is why. First, every major MLM company that reports the data shows a high turnover of distributors. So the real number of Americans running successful MLM companies (virtually all "direct selling" in the US uses an MLM structure) surely is not 20 million. Second, according to the DSA, 15.2 million of the 20 million are "discount customers," purchasing product for their own consumption and not operating a "business." Third, if the $35B is correct, it constitutes less than 1% of total US retail sales, and that percentage has been declining. Point to where in the US that level of sales constitutes the “backbone” of any community. Fourth, if taken literally a reader might be inclined to calculate the overall number of direct sellers times the percent earning income times the average amount earned, sort of like this: 20,000,000 x .90 x $3,400 = $61.2B. I know that I am just an academic and not a wiz bang financier or politician but even I know that $35B in sales is not generating $61.2B in income. What's missing? A lot, and that is, has been, and continues to be the real problem.

Representatives Huizenga and Johnson, without any apparent recognition of business history, have apparently concluded that major consumer groups, a sitting FTC Commissioner, and a bipartisan group of former FTC seniors officials have misunderstood this whole MLM, direct selling, pyramid scheme issue. They have not. And, indeed, this is not a partisan issue but, rather, one concerned with protecting consumers from deceptive scams and endless-chains destined to have the vast majority of participants lose money. As I previously wrote, it appears the DSA and parts of the MLM industry seek political help because they fear an honest conversation. Since I don't have powerful Congressional letterhead please feel free to distribute this as you like.

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.