Herbalife is one of Wall Street’s favorite controversies, and now it seems like there could be another problem on the company’s plate. Although it isn’t directly impacting Herbalife right now, it could at some point in the future, as the company has admitted to being under investigation by the Federal Trade Commission.

Herbalife Ltd. HLF

FTC moves against Vemma Nutrition

The FTC is now seeking an injunction against Vemma Nutrition, another multi-level marketing company which sells some products that are similar to those sold by Herbalife. Unfortunately for Herbalife, its business practices (some past and some present) seem to be in some ways similar to Vemma’s practices. ValueWalk contacted a pyramid scheme expert who found three areas of concern for Herbalife in the case filed against Vemma.

Court documents reviewed by ValueWalk (Hat tip to Quoth the Raven) reveal that the FTC has some problems with Vemma’s “advertising, marketing, promotion, and sale of opportunities to sell health and wellness drinks.” The agency seeks an injunction and restitution for alleged violations of rules pertaining to MLM companies. The FTC also named the company’s CEO, secretary, and director, Benson K. Boreyko, in the lawsuit, which was filed on Aug. 17.

Also named are Tom Alkazin, who is described as “a promoter of the business opportunities offered by Vemma Nutrition Company and Vemma International Holdings,” and his wife Bethany Alkazin, who is accused of receiving “funds that can be traced directly to Defendants’ deceptive acts or practices alleged below” and having “no legitimate claim to those funds.

Potential problems for Herbalife

ValueWalk contacted pyramid scheme expert Bill Keep, Dean of the School of Business at The College of New Jersey, and he thinks Herbalife could potentially have a problem, just based on this case against Vemma:

“First, would be the issue of distributors regularly misrepresenting the products and/or the ease with which a recruit can achieve positive income (i.e., after expenses). Critics of Herbalife and the media have produced some evidence of Herbalife distributors’ misrepresentations.

“We know that monitoring complaint behavior is not in and of itself enough as pyramid scheme victims are less likely to complain than victims of other types of consumer fraud. If VEMMA and Herbalife are operating pyramids schemes, complaint behavior takes too long to develop.

“Second would be that lack of what the Ninth Circuit Appellate Court called ‘consumer demand.’ In the BurnLounge case that court found that simply selling to recruits, the vast majority of whom quickly become inactive is not a defense against a pyramid scheme charge. VEMMA made little pretense of selling outside the distribution network and Herbalife seems inclined to blur the distinction.

“Finally, the anti-pyramid scheme policies that Amway used successful to defend itself in 1979 are either absent or of little use as presented by both VEMMA and Herbalife.”

The reference to Amway’s anti-pyramid scheme policies relates to a 1970s court case the FTC brought against Amway. The court ruled that Amway was not a pyramid scheme, partially because the MLM company had a rule that distributors had to sell 70% of their products to people outside the Amway network. They also had to sell to 10 customers per month.

We have reached out to Herbalife to request a comment on this story.

Vemma’s business practices

A scan of the court documents filed against Vemma reveals what looks like a standard MLM business model. According to the documents, the company’s business model “depends upon” its “Affiliates” (a.k.a. individual distributors) “recruiting individuals to participate in Vemma as Affiliates and encouraging them to purchase Vemma Products in connection with such participation, rather than selling products to ultimate-user consumers.”

The documents also state that the sales and marketing activities and the compensation scheme “place little emphasis” on selling to consumers outside of the Vemma network. In 2013 and 2014, Vemma reportedly earned over $200 million in annual revenues.

Misrepresentation?

As part of the marketing of Vemma’s products and “business opportunity,” the defendants allegedly used websites, videos, testimonials, print materials, social media, and live presentations called “opportunity events” or “home events.” The materials typically feature “young, seemingly affluent individuals surrounded by conspicuous displays of wealth, such as luxury vehicles, jets, and yachts.”

The FTC alleges that the defendants misrepresented the “nature and income potential” of signing up to be a Vemma Affiliate.  The court documents include a list of claims allegedly made by the defendants in the case, and some sound eerily similar to claims allegedly made by some Herbalife distributors in the past. It seems Vemma also marched the few top earners with big checks in front of potential Affiliates to talk about how much money they made by selling Vemma products.

However, annual disclosure statements made by Vemma indicate that more than  93% of Affiliates made less than $6,169 a year in 2013, while more than 87% earned less than $3,674, more than 40% earned less than $939, and less than 0.62% earned at least $92,181. The court documents also indicate that Vemma includes only “‘active’ Affiliates who have met certain minimum purchase thresholds and omit participants who fared worse.”

The FTC also alleges that Vemma appears to have been targeting college students. Herbalife, on the other hand, has been accused of targeting Hispanic communities, although while some Hispanic groups speak out against the company, others support it.

Differences between Herbalife and Vemma

It should be noted that there are some key differences as well, like the FTC describes Vemma as using an “auto-delivery” system in which new affiliates sign up for automatic orders of product amounts that are enough to keep them eligible for bonuses. Herbalife doesn’t appear to use any such system.

The court documents also indicate that while encouraging Vemma Affiliates to recruit others as Affiliates, they also encourage new recruits to give away the products they buy as free samples and instead focus just on recruiting new Affiliates.

As of this writing at precisely 2:02 p.m. Eastern, shares of Herbalife were down 1.74% at $53.02 per share.