Want To Know The Future Of Herbalife And Other MLMs? Look No Further Than The Facts by William Keep

Summary

Carl Icahn says being blind to the facts is not good.

Proving Icahn right, Herbalife was blind to the facts in 2012, and now faces seven years of monitor.

The MLM industry continues to change its story on the facts.

Recently, Twitter was aflutter with whether or not Carl Icahn was buying or selling Herbalife (NYSE:HLF) shares. In a silly bit of investor tit for tat, he and Bill Ackman briefly provided content for an ever-eager media. In providing Ackman some free advice, Icahn made the point that obsessions have been “the undoing of many investors because they often blind you to the facts, and it becomes impossible to see the forest for the trees.”

Herbalife

Herbalife

I have no investment in HLF stock and have previously stated that I would not have recommended the approach Ackman took toward Herbalife. But in considering what might happen next, I decided to take Icahn up on his point to look at the facts.

In July 2012, a Herbalife consultant declared in two “white papers” on the MLM model:

  • “The MLM firm also creates, monitors, and enforces important rules of conduct that protect all distributors as well as the MLM firm itself.”
  • “First, the distributor earns the difference between the retail price s/he charges and the wholesale price s/he paid to acquire product.”
  • “Second, a business-builder can earn commissions on the sales of distributors downline from him/her.”
  • “This is because there is no sensible business or economic reason to establish such a threshold level [i.e., for the proportion of MLM sales to non-distributor end-users] as a criterion of a pyramid scheme.”
  • “Key to this logic is the notion of misrepresentation of the business opportunity to later participants. If they knew that there was no mathematical possibility of making money in the scheme, they would not choose to join.”

And specific to Herbalife:

  • “In contrast, an illegal pyramid would not benefit from low enrollment fees, because they are the primary means of compensating incumbent participants in the illegal pyramid scheme.”
  • “In contrast, an illegal pyramid suffers if it offers a reasonable buy-back policy, because any products it does offer for sale have little value or marketability, and thus the pyramid scheme operators would likely face very high return rates.”

And here are more important facts (not just factual claims). Between then and now, the FTC filed a pyramid scheme charge against Fortune Hi-Tech Marketing (an MLM that operated for ten years and that quickly went into receivership), won the BurnLounge appeal (which noted a lack of “consumer demand” despite distributor purchases), filed a pyramid scheme case against Vemma (a company not likely long for this world), and entered into a settlement with Herbalife. In Vemma, the court declared that the FTC was likely to succeed, that the company misrepresented the opportunity, and that any future distributor rewards would need to be linked to a set threshold of sales to non-distributors.

The FTC settlement with HLF similarly imposes: standards against misrepresentations and “lifestyle” statements, required training, the collection of retail sales information never before collected, and a threshold for sales to non-distributors and preferred customers. I note here that using just publicly available information, a prospective Herbalife recruit would find it virtually impossible to determine how close his/her probability of success is to zero – thus rendering moot “If they knew that there was no mathematical possibility of making money…” (they simply don’t know). And the information regarding top earner persistence, readily available to Herbalife but not to the public, is important for consumer protection.

So, contrary to Herbalife’s consultant, the facts show that MLM companies have real monitoring problems when it comes to misrepresentations and “rules of conduct,” that the FTC has long used the lack of significant sales to non-distributors in its cases, that there is little or no information at the firm or industry level on income earned by selling to non-distributors, that prospective distributors cannot determine their chances of success, and that an MLM facing a pyramid scheme charge may sell viable products and operate for many years.

There is no evidence that literally “all” later participants in a pyramid scheme lose money – though certainly, the vast majority will – because sustaining the fraud would require at least a few new success stories. In terms of fees, in 2004 the FTC wrote, “Modem pyramid schemes generally do not blatantly base commissions on the outright payment of fees, but instead try to disguise these payments to appear as if they are based on the sale of goods or services.”

In 2012, the Direct Selling Association (DSA) labeled industry participants “Direct Sellers” and described the industry as a “sales channel.” In 2014, the DSA claimed 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” (but it did not say that). In 2015, the DSA issued a consultant report that claimed “[t]he key diagnostic for a pyramid scheme is whether the transactions defining the commercial enterprise yield incremental value to society,” (a claim contradicted by most eminent authority in law & economics). DSA now labels industry members as “People Involved in Direct Selling” and backs legislation that will effectively immunize the industry against pyramid scheme charges, using language completely inconsistent with pyramid scheme cases. The DSA’s public statements of concern for consumers increasingly runs contrary to FTC actions, while meantime, TINA.org lists 65 MLM companies for which they have received complaints.

Compare the claimed accuracy of industry statements across many years about the MLM business model, some specific to Herbalife, against the ongoing consistency of the FTC’s analysis and findings used successfully in pyramid scheme cases, as well as in the Herbalife settlement. Repeatedly, we find statements from the industry and its hired consultants that are fantastically inconsistent with successful pyramid scheme prosecutions and public FTC statements. In two current actions – Vemma and Herbalife – we find government-imposed restrictions fully consistent with 40 years of case law and strongly contrary to industry pattern. Had Herbalife faced up to the facts rather than listened to inconsistent stories about the facts, it might not have now been facing substantive restructuring, including what will surely be onerous and expensive monitoring for the next seven years. Maybe Icahn will still make money from all of this for a while, but that won’t change the facts.