The MLM Business Model: Maybe Lies Matter

Includes: HLF, NUS
by: William Keep


Investors know deception (i.e., lying) can be profitable.

The Direct Selling Association ethics Code: "prohibits statements or promises that mislead consumers or prospective salespeople." says DSA: "IS HONORING ETHICS CODE VIOLATORS" and pervasive "false and unsubstantiated income claims to promote the companies’ business opportunities."

US Congresswoman says: "It [direct selling] provides millions with a means to earn a steady income."

Research using available data shows distributor earnings opaque and probability of success unknowable.

The time has come for state and federal regulators to ask two important questions:

  1. Can the MLM business model succeed without deceptive marketing?
  2. What prosecutorial tools will protect consumers and investors from any company that profits from a network of agents they cannot or will not control?

Last year a investigation documented pervasive illegal health claims made by MLM companies and distributors selling nutritional supplements. Data on members of the Direct Selling Association (DSA) was particularly telling. Of the 158 company members of the DSA in 2016, 62 (i.e., 39%) sold nutritional supplements. Of those, 60 (i.e., 97%) were found to “have distributors who are making (or have made) claims that their product can diagnose, treat, cure, prevent, alleviate the symptoms of, and/or reduce the risk of developing a multitude of diseases, which means they are making illegal disease-treatment claims.”

It isn’t just that approximately 38 percent of DSA companies had distributors making illegal claims, many well-known, long-established companies made the list (e.g., AdvoCare, Amway, Arbonne, Herbalife (NYSE:HLF), Melaleuca, Nu Skin (NYSE:NUS), Young Living, etc.).

That was a year ago. This year “ investigated every company on the November 29, 2017 Direct Selling Association membership list and found that more than 97 percent have made or are making – either directly or through their distributors – false and unsubstantiated income claims to promote the companies’ business opportunities.” Now we are not talking about a third of DSA member companies but, rather, nearly the entire DSA membership.

No need to list the offenders, just throw a dart at the DSA membership list. So much for DSA claims that “Consumers can be confident that DSA and its members will not tolerate unethical behavior, and the DSA Code backs up that assurance.”

Accusations of misrepresentations and misleading claims within the (MLM) industry date back at least 60 years. As a fun exercise, conduct a quick Internet search on a few of your favorite MLM companies using: “MLM company” + “misleading” or “deceptive.” While some links will lead to industry critics, other will show run-ins with regulators in the US and elsewhere.

For a more serious look try researching regional and nation newspaper archives. The prevalence of complaints over decades may surprise you. They may also surprise members of Congress and others who support the industry (here and here). Consistent with this history, nine months after published data on illegal health claims half or more of the illegal claims were still publicly available.

Deception, lies, misrepresentations, and fabrications are certainly nothing new to investors who have long known that wealth can be transferred by misleading others, even if the deception is accepted for only a short period of time. In the case of the MLM industry, however, the more serious question is: To what extent is deceptive marketing vital in the business model?

From the DSA we read pronouncements about industry ethics. Yet, the previous cited investigation showed that, over a five-year period, 15 of 27 companies receiving DSA awards had distributors making inappropriate health claims. Perhaps if DSA members would be less self-congratulatory and work more with regulators they would foster what appears to be a chronic failure of self-regulation.

Lying can work because most people are terrible at detecting a lie and some people are better liars than others. One study showed subjects, “willing to lie to someone they know even over a small price discrepancy.” So much for the trust of affiliate marketing. Since big lies can cause big problems (e.g., Enron), legions of journalists, analysts, consultants, accountants, regulators conduct research to detect major lies that can impact a business, industry, or investors.

In some instances, a company or trade association will publically call out a firm misrepresenting its product or service, sometimes triggering regulator interest. In other cases, a non-profit like highlights such mischief (e.g., Wal-Mart (NYSE:WMT)).

Then there is the MLM industry - a miniscule industry (less than 1% of US retail trade based on DSA data) that claims to engage as much as eight percent of the US adult population. Recently stung by a series of successful pyramid scheme prosecutions, industry members and the DSA enlisted Congressional friends to support legislation that negates 40 years of successful FTC prosecutions and associated case law.

Presented as pro-small business and pro-consumer the legislation would make legal endless-chain recruitment schemes regularly prosecuted as illegal pyramid schemes. Defense for the legislation ranges from 40-year-old views of direct selling that, ironically, the bill does not support, to the DSA redefining the traditional meaning of direct selling.

The accumulation of investigative reporting, class action cases (e.g., LulaRoe, Stream Energy, Nu Skin, and Jeunesse), and the Herbalife Settlement bring continued scrutiny and fresh stories. Not without irony, it was Herbalife that pronounced an inability to control the marketing message of its distributors: "As a result, there can be no assurance that our distributors will participate in our marketing strategies or plans, accept our introduction of new products, or comply with our distributor policies and procedures" (2011 Annual Report, p. 28).

The FTC Complaint certainly agreed. Similarly, in the report on false and unsubstantiated income claims, the President of the DSA is shown on stage pronouncing (or pleading, not sure which) for industry representatives to more accurately describe what typically happens. Yet, year after year MLM companies repeatedly “disclose” distributor earnings in such a way as to make ascertaining the probability of success virtually impossible.

In 2018, we can expect the DSA and its political friends to try to deny virtually the entire history of successful MLM-style product-based pyramid scheme prosecutions. But will members of Congress get behind an industry repeatedly tagged with deceptive practices?

Happy New Year and let’s hope for a more honest 2018!

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.