The Agony And The Angst: MLM Investors Ponder Enforcement Policies At The FTC

Dec. 05, 2019 2:13 PM ETHerbalife Nutrition Ltd. (HLF)NUS13 Comments5 Likes
Robert FitzPatrick profile picture
Robert FitzPatrick
391 Followers

Summary

  • The FTC recently prosecuted three large, mainstream "multi-level marketing" - MLM - companies, members of the Direct Selling Association, triggering speculation about more crackdowns on MLM.
  • The prosecutions, along with DOJ criminal bribery charges against two Herbalife officials in China, prompt investor angst that MLM growth is in peril. YTD, MLM stocks -21%, S&P +24%.
  • Negative media on MLM losses, attrition, lack of retailing, and cultism add pressure on the FTC. Regulation has been lax, contradictory, and with many conflicts of interest.
  • For guidance, wise investors should focus on MLM Politics, not business economics, products and marketing.

The fortunes of investors in the $20 Billion "multi-level marketing" sector hang, by a thread, on current enforcement policy of the FTC regarding Deception and Pyramid Scheme Fraud. Following the unprecedented Herbalife (NYSE:HLF) prosecution in mid-2016, two more MLMs, both of which are large, mainstream and members of the Direct Selling Association, were prosecuted as pyramid scams this year. Adding to regulatory fears, the DOJ brought criminal bribery charges against two Herbalife officials in China. China is MLM's last market for expansion.

Informed observers and MLM promoters know that the violations cited by the FTC in these recent cases, including Herbalife's, are endemic to the MLM model. Cases of the same types could be brought against virtually any MLM, putting the entire sector at risk.

Investor Angst

Investors who examine FTC actions and statements on MLM from 1980 forward inevitably discover how confusing, contradictory, and strangely detached for real-world business reality they are. No general investigation has ever been done of MLM practices by the FTC. The FTC exempted MLM from a "business opportunity" rule that would have required disclosures when soliciting money from consumers. There is also an unsavory history of revolving doors between FTC officials and the lucrative MLM world.

So, what should investors in Herbalife, Avon (AVP), Usana (USNA), Nu Skin (NUS), Medifast (MED), Tupperware (TUP), among others, do for analysis of current developments?

Having spent the last two years writing the book, Ponzinomics, the first comprehensive treatment on the history and development of the MLM phenomenon, to be published in early 2020, I recommend that investors abandon Economic Analysis altogether. They should not waste time examining SEC filings, consumer markets, pricing, efficacy of MLM "health" products, or MLM marketing and consumer behavior. They would be better served, in my opinion, to focus entirely on MLM Politics. In that non-economic realm where Washington power dynamics hold sway, including over law enforcement, a rational and grounded narrative explains the last 40 years of FTC behavior and offers some investor guidance.

Futility of Conventional Analysis

  • In MLM-world, the usual approach for assessing regulatory risk of researching SEC filings is futile. Those documents don't address elements relevant to pyramid schemes, only financial outcomes. Relying on bottom lines and "growth" figures can be perilously misleading. Illegal pyramid schemes are vastly more profitable than real direct selling. Colossal deceptions and utopian promises cause mass hysterias and irrational economic behavior, which is then depicted as "growth" and "demand" in financial statements. Massive attrition rates, for example, are papered over with recruiting figures or expansions into new areas, giving an appearance of sustainable or organic growth.
  • Similarly, studying product trends is not helpful. MLMs sell the most ordinary products like cell phone service, meal replacements, life insurance and kitchenware. They don't set trends, introduce new products or pioneer technologies.
  • Market-based demand for MLM products, separate from its "unlimited" income promise, cannot be shown. Most MLM "salespeople" have barely a few personal customers or none at all. Few MLMs have recognizable brands. They do no advertising. Most "customers" and "salespeople" stop buying MLM products in less than a year. MLM goods have no price or quality advantages. They are inconvenient to acquire. MLM claims to be nothing more than a modern form of the Fuller Brush salesperson, a creature that went extinct decades ago.
  • Consumer behavior analysis is a labyrinth. How to explain - in legitimate business terms - why millions of people would sign up for an "income opportunity" in which not even 1% a year ever gain any net profit? Why would people buy "sales kits" and sign "sales" contracts only to get a modest "discount." What would account for nearly 100% attrition over a few years of time?
  • Where MLMs sell "health" products, Science is of little use. Miracle "health" pills, "anti-aging" lotions, and "brain-boosting" potions are unregulated and require no scientific evidence to be marketed. How it is that MLMs can sell products that dramatically claim to improve health but also state they are "not intended to diagnose, treat, cure or prevent any disease" is a conundrum of logic and law.
  • Finally, a classic business model analysis bears no fruit. MLM's "endless chain" structure and incentives rely on the concept of "infinity", rendering market sizes, market saturation, numbers of competitors, size of sales forces, and productivity irrelevant. On top of that, its pay plan involves so many variables (quotas, structure and size of downline, rank, points, etc.) consumer due diligence, before signing, is not possible.

The Politics of Enforcement

Until recently, Washington power dynamics toward MLM were so settled they were hardly mentioned. From 1980 to 1996, there were virtually no FTC or SEC prosecutions of MLM. In subsequent years, only smaller and marginal MLMs were dispatched. As some MLMs made public stock offerings, smart money saw the obvious: MLMs were politically safe. MLM's K Street lobby and some of its largest companies, chiefly Amway, were on the inside of Washington's power elites.

It also didn't take a marketing genius to see "M-L-M" meant Miracle-Lucre-Machine. Gross profits over 80%, no advertising or mass marketing needed to produce "demand." Price didn't matter. No brand maintenance required. No significant debt, as the "distributors" pre-order and finance upfront. No R&D needed. Almost any sort of product worked in MLM, though non-FDA approved, "alternative health" products were best. What wouldn't sell like hotcakes that included the promise that buyers could become millionaires, without experience, capital or knowledge? Then, add in possible miracle cures and fountains of youth!

Also add in a growing MLM market for recruits - students with debt, military spouses with multiple deployments, de-industrialized cities, downsized or outsourced white-collar workers, undocumented immigrants, minimum wage workers with two jobs, Baby Boomers with little retirement savings, even seemingly affluent households facing perpetual job insecurity and heavy debt - and then also those tens of millions in countries begging for a slice of capitalism's mythical bounty.

MLMs were confidently declared "growth stocks" with "buy" recommendations. As long as new territories were opening, "growth" and "beating expectations" could be counted on. And when they rarely didn't, MLM's "pop and drop" phases offered profit opportunities for short-sellers. The one small proviso was that pyramid fraud thing raised occasionally online, in class action lawsuits or by short-sellers, but they had no lobby.

Conflicted FTC

Then, about seven years ago, the picture began to change. At first, new events only seemed to verify conventional thinking. Speculators laughed all the way to the bank as short-selling hedge fund manager William Ackman disastrously challenged Wall Street's Informed Opinion on MLM. The FTC, which Ackman had banked on, ruined the short-sellers by refusing to prosecute Herbalife as a pyramid scheme while confirming the illicit behavior characteristic of pyramids.

The facts uncovered during that lost cause - and confirmed by FTC investigators - have inconveniently lingered. For example, Ackman and other short sellers gave evidence that MLM is at risk of unpredictable prosecutions by Chinese regulators. On paper, the MLM recruiting model is banned in China. Yet, MLM "growth" in China was inexplicable without classic, and prohibited, MLM income promises based on outlawed "endless chain" recruiting. Ackman sent investigators to China who reported violations of China's anti-MLM law that authorities there mysteriously ignored. Recently, two Herbalife officials were charged with bribery in China.

Coincidentally, the factor of global saturation also emerged with Amway's revenue, which skyrocketed from China operations, losing in a few years almost 30% of the volume built up over 50 years. It was the first global pop-and-drop cycle.

One other question lingered from the Herbalife episode. Are the standards the FTC used in the prosecution and terms of settlement for Herbalife applied consistently to all other MLMs? When Politics resides over rule-of-law, the door is not opened only to regulatory inaction but also arbitrary action. In the eyes of the FTC, are all MLMs equal but some more equal than others?

In explaining historically lax oversight and regulatory contradictions, I direct investors to the lucrative revolving-door for FTC officials into MLM-related jobs and the massive political contributions from certain MLM owners and promoters to presidential, congressional and state-level office-holders. This was grandly demonstrated with Amway-Betsy Devos' appointment to the President's Cabinet. And then, there is the elephant in the room, President Donald Trump's personal history in the MLM business over a 10-year period. The current president of the United States is the most famous of all MLM-endorsers. (Others have included O. J. Simpson, Bob Hope, Madeleine Albright, Hulk Hogan, Chuck Norris and Carl Icahn.) The FTC is part of the executive branch.

Countervailing Force

Herbalife was saved by the FTC, however, a countervailing force, arguably as powerful as money, jobs and political influence, even strong enough to challenge the presidency, was beginning to take shape. It is now gathering strength and pushing the FTC into what appears to be internal conflict. This force is public awareness. For decades, millions of victims of MLM have been convinced by MLM promoters that their failures in MLM (over 99% "fail" each year) were only the result of their own bad judgment, lack of effort or "loser" mentality. The same narrators also persuaded the public-at-large that MLM is authentic "direct selling", the Yankee Peddler resurrected, and that most people in MLM really do make some profit.

MLM was depicted, without challenge from universities or government or economic pundits, as the "last best hope" for millions who face declining job opportunities, fading chances for home ownership, stagnant wages, even lowered life expectancy. This myth provided regulators a comfortable cover for silence, inaction and, for some officials and politicians, collusion.

With revelations spreading of 99% annual loss rates, attrition reaching 90%, contrived income "averages", and the virtual absence of bona fide "customers", the public is awakening. The facts of consumer harm and deception beg for explanation - from the FTC.

Adding to this pressure, the media now routinely depict MLM in negative terms, with ominous social implications. Cultism, brainwashing, social disruption and political bribery are spoken of openly. An award-winning Netflix documentary and a popular Showtime series depict MLM as predatory, harmful and cultic. The popular John Oliver Show on HBO, which generated more than 20 million views, lampooned MLM as one big pyramid scheme. Then a popular Podcast, The Dream, attracting millions of listeners, tracked MLM's murky origins and baffling escapes from law enforcement.

Perhaps a final blow against silence or inaction has been the cult scandal of the MLM, NXIVM (pronounced Nexium). The characterization of MLM as a cult movement has loomed over MLM for years, but it is now generating much more attention. Cult experts are analyzing MLM persuasion methods and classifying MLM as a "commercial cults." NXIVM was an MLM. CEO Keith Raniere had a long record in the MLM business. He was a former Amway distributor and the founder of two other MLMs. One of his company's, Consumers' Buyline, is frequently cited in legal discussions of MLM. It had over 250,000 distributors and was eventually shut down by regulators. For the relevance of NXIVM to the MLM enforcement controversy, see the Albany Times Union's 4-minute YouTube on NXIVM: MLM.

Under this onslaught of facts, media attention, revelations, and growing consumer awareness, the FTC itself appears to have entered into its own agony. Remaining silent is no longer an option. The FTC's contradictory history with MLM has come back to haunt the agency.

Legal "in Theory"

In a nutshell, the FTC, from 1979 forward, has been publicly and consistently asserting that "MLM is legitimate." Since the mid-90s, it has prosecuted about one or two MLMs a year, on average, not enough to affect practices but just enough to create an impression that the "bad apples" are being eliminated and all the other MLMs, by inference, are legitimate.

This FTC endorsement has led the public into a tragic briar patch, vainly searching for the "legitimate" MLM where people really do make money "on average." When they inevitably didn't find what the FTC's pronouncements had led them to believe was available, they were left with confusion and MLM's stigma of "loser." The most common and persistent question I receive at Pyramid Scheme Alert, is "Yes, okay, I get it about the MLM model… but (pleadingly) what about this MLM?"

As it turns out, the FTC has never named even one MLM as a model of legitimacy. Instead, it created a "theoretical" legitimacy for MLMs, which it endorsed. In that model, each and every new recruit has a viable chance of earning a sustainable income from retail selling. The recruiting element, under this theory, is for building a team of other "retailers."

Here's the thing though. No one has encountered one of these theoretical MLMs. It is unlikely anyone ever will. Viable, profitable retail selling, and endless recruiting of more and more salespeople in every territory, as any salesperson could attest, are mutually exclusive. To that reality, must be added the real-world question of who, today, needs or wants "personal salespeople" for purchasing commodities?

Ponzinomics

In Ponzinomics, I painstakingly document a 35-year history of revolving door connections between FTC officials and the MLM industry. "Endless chain" schemes foster a delusional belief system affecting notions of work, livelihood and business, which I term "Ponzinomics." These destructive economic delusions do not endure unless supported with intentional neglect or disguised promotion from government

As one example in recent FTC history, I recommend investors to recall that Herbalife's settlement terms with the FTC - no pyramid scheme charge, time to implement "restructuring", and a modest payment to a tiny proportion of "losers" - was negotiated with the aid of the immediate past chairman of the FTC - who was working for Herbalife. The previous chairman of the FTC at that time, Jon Leibowitz, had left the FTC and gone to work to help the company that the FTC was investigating and then prosecuted.

Ponzinomics also recounts the 40-year build-up of an enormous "Pyramid Lobby" and an Orwellian PR machine that makes "wholesale" become "retail", turns salespeople into "customers", buying into "selling to yourself," and redefines due diligence as "negative thinking." Any investor trying to understand whether or not the FTC is adopting a new, consistent enforcement policy should study this record.

In my study of the history of MLM and its many escapes and resolutions involving pyramid prosecutions, tax evasion, copyright violations, price fixing, false medical claims, deceptive income promises, cult persuasion, SLAPP suits, and bribery of governments, one common theme persists: Truth versus Lie. The impossible endless chain model with its also impossible promise of "unlimited" income is the Big Lie. Will it endure? Or will Truth bring on collapse?

In a New Yorker essay in 1967, entitled, "Truth and Politics," the famous writer on propaganda, Hannah Arendt, acknowledged, "Lies have always been regarded as necessary… tools not only of the politician's or the demagogue's but also of the statesman's trade." Yet, she added, "No permanence, no perseverance in existence, can even be conceived of without men willing to testify to what is." Truth, she wrote metaphorically, "is the ground on which we stand and the sky that stretches above us." This would seem to give assurance that, if not today, at some point, the Truth about MLM will prevail, putting all MLM investors in mortal risk.

Yet, the short arc of history favors continuation of current deceptions and consumer injury and no fundamental change at the FTC. Besides historical momentum, there is the force of ongoing political influence-buying, including MLM's 40+ member, bi-partisan caucus in the House of Representatives. Then, there is the weight of MLM's $20 billion in Wall Street equity - including Carl Icahn's stake in Herbalife - that would all evaporate with an enforcement shift at the FTC.

This article was written by

Robert FitzPatrick profile picture
391 Followers
Robert L. FitzPatrick is the author of the new book, Ponzinomics, the Untold Story of Multi-Level Marketing (2020),the first comprehensive history and analysis of the "MLM" phenomenon, addressing its political influence, propaganda techniques and use of cult persuasion. FitzPatrick is an expert in examining and revealing deception and fraud in Ponzi schemes, pyramid schemes and bogus home-based businesses. He served as expert or consultant in more than 30 court cases involving pyramid schemes and multi-level marketing. He is co-author of False Profits (1997), an examination of the values and beliefs that support the delusions of pyramid schemes. He was featured on NBC Dateline, ABC World News, and CBS 60 Minutes, the documentary film, Betting on Zero and the podcast, The Dream.He has been quoted in many newspapers around the world, including the New York Times and Wall Street Journal. His booklet, Pyramid Nation, has been translated to Chinese and used by government regulators in writing China's first laws on pyramid schemes. His booklet, "The 10 Big Lies of Multi-Level Marketing", has been translated into four languages and posted on numerous websites. His White Paper, "The Main Street Bubble", which details the extensive influence-buying of the direct selling industry was featured in a CNBC Documentary, Selling the American Dream. In 2005, he delivered a seminar to in Colombo, Sri Lanka to central banking representatives from that country as well as India, Bangladesh, Bhutan, Maldives and Nepal. Robert FitzPatrick has developed informational resources for consumers, journalists, academics and regulators including a multi-media PowerPoint presentation and a statistical analysis of the losses suffered by participants in pyramid selling schemes. He also published a widely read booklet on the landmark federal case brought against the Amway Corporation. He is a expert network member of GLG Research, and Coleman Research Group, as well as other networks of experts who are referred to clients for consultation, speaking and report writing. In this capacity, he has provided expert consultation to financial many analysts who sought information about multi-level marketing companies and pyramid and Ponzi schemes. Robert FitzPatrick co-founded and serves as president of Pyramid Scheme Alert, the first international organization to expose and prevent pyramid scheme fraud. He personally responds to hundreds of consumer and news media inquiries each year. He has served as consultant and expert witness for Attorney General or State Attorney offices in four states, the US Dept. of Justice, and in numerous cases involving distributor fraud and pyramid schemes. Robert FitzPatrick is not an investor in multi-level marketing companies. He has never owned and never plans to own stocks of multi-level marketing companies. He has never been compensated based on any stock's performance. He does not offer investment advice and he is not an attorney.
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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.

Additional disclosure: The information in this article addresses the overall status and fundamentals of a sector of companies called "multi-level marketing," which is a source of many investor, consumer, media and regulatory confusion.

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