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Vemma: College Cheer Followed By Herbalife Ltd. (HLF) Investor Worry

Vemma: College Cheer Followed By Investor Worry by William Keep

Summary

  • Vemma, the DSA, Herbalife, and investor concern for potential MLM fraud.
  • Clarifying the meaning of “customer.” Who knew it would take this long?
  • Convoluted policies, procedures and compensation plans, and the “reasonable viewer.”

No longer needed to serve up Vemma’s Verve energy drink, the ubiquitous red plastic cup can now return to its more common beer pong role on college campuses across the nation. Based on Friday’s court decision, it appears that Vemma, a 10-year-old MLM company and member of the Direct Selling Association (DSA), has left college campuses for good. What does Vemma’s demise have to do with investors long on Herbalife and other MLM stocks? Perhaps the DSA can provide an answer.

In 2013, Vemma received the DSA ETHOS Award, “a testament to the commitment a company has made to being a model for the highest standards in business practices and ethics,” says DSA President Mariano. This is the same trade association that tried (unsuccessfully) to distance itself from Fortune Hi-Tech Marketing and BurnLounge, both closed for operating pyramid schemes, and both defended by former DSA General Counsel. Of course, like any employer, the DSA cannot control the behavior of a former employee. Nor, as the Vemma case shows, can it control its members. Neither self-regulated nor subject to FTC rules or reporting requirements, the MLM industry goes its own way because, in the words of Mariano, “everybody has their own definition of multi-level marketing.” Meanwhile leading members leave the DSA because “the industry became dominate [sic] by buying clubs and what looked like pyramid schemes,” and “there is a need to enhance the DSA Code of Ethics.”

Given her familiarity with pyramid schemes, I wonder what company Ms. Pamela Jones Harbour, former FTC commissioner and senior vice president, Global Member Compliance and Privacy at Herbalife and a DSA director, would see as a front-runner for this year’s ETHOS Award? Perhaps she can gain some guidance from the Vemma court. Or, perhaps she also believes that everyone can have her/his own definition of multi-level marketing.

While yesterday’s decision dealt with a preliminary injunction, the court was unambiguous in its support for the FTC’s position: “The evidence before the Court leaves little doubt that the FTC will ultimately succeed on the merits in demonstrating that Vemma is operating a pyramid scheme.” The court also spoke on the issues highlighted recently by New York Times columnist Joe Nocera: 1) the role of anti-pyramid scheme safeguards, 2) the importance of “meaningful opportunities for retail sales” (quoting the BurnLounge decision), and 3) “whether a company’s ‘primary’ purpose involved recruiting.”

The Vemma court recognizes that all anti-pyramid scheme safeguards do not need to be the same “not one-size-fits-all”, but they must work, noting the “key to any anti-pryamiding [sic] rule… is that the rule must serve to tie recruitment bonuses to actual retail sales in some way.” In this case, “And Vemma does not even attempt to apply a rule similar to the ten customer rule that was found to be a reliable way to control inventory loading in Amway.” Simple. Have anti-pyramid scheme safeguards, and show that they tie recruitment to “actual retail sales.” I have described in detail how Herbalife’s 10 customer and 70% rules are not like those in Amway 1979. With “not one-size-fits-all,” the court indicates that this part may be okay. But I have also emphasized that Herbalife’s rules are totally ineffective. The court’s ruling strongly demonstrates that this part would not be okay.

The court is clear that attempts to blur the lines between customers and distributors will not be a defense, again supporting the BurnLounge emphasis on “consumer demand” independent of distributor purchases, finding, “Defendants’ proposed reclassification of Affiliates to customers – as urged by Defendants’ expert, Dr. Carr – is not based in fact.” The court noted, “Much of Vemma’s contention that it is not a pyramid scheme is based on its proposal to reclassify many of its Affiliates, as currently shown in its own records, to customers, which would have the effect of decreasing the amount of sales to Affiliates and increasing the amount of sales to customers.” Siding with the government, the court wrote, “In addition, as the FTC points out, the reclassification proposed by Defendants would serve to misrepresent how many failed Affiliates there likely are.”

How many times have we heard from Herbalife and other MLMs that the bulk of their churning distributors are “customers”? The Vemma court provides useful language for prosecutors looking at MLMs that, in effect, claim: “No, that’s a Customer (C), not a Distributor. No, that’s a Frequent Customer (FC) – might see autoship here – not a Distributor. We will tell you when someone is a Distributor.” Using such labels allows an MLM to harvest revenues and uplines to earn rewards on the large churning base of all C and FC, each placed on a sponsor’s “team,” or “downline,” for commission purposes. This is not “retail sales” that are external to the distributor network; this is not the form of retailing known as direct selling. The Vemma court recognizes that labels alone can purposely distort the MLM/distributor relationship and the potential for underlying fraud.

In recognizing that words – and their use – matter, the court also takes on complex and confusing language. By now, we are all aware of lengthy, convoluted MLM policies, procedures, and compensation structures. The court found Vemma “recruiting and training materials… contain misleading income statements with either no disclaimer or a disclaimer that is impossible for the reasonable viewer to notice, let alone read,” and a Roadmap to Success that is “difficult for a reasonable consumer to understand.” As defined, what is reasonable for “ordinary consumers,” varies according to the audience. Vemma recruited aggressively on college campuses, including my own, and TINA warns about other MLMs aggressively targeting youth.

So here we have yet another preventable situation where an MLM operates for years before being prosecuted for operating a pyramid scheme. As much as I appreciate writing about the problem, I look forward to a day when I will not. I wonder how many more MLMs will need their day in court before that happens. Oh, and good luck to the DSA with that ETHOS Award.

P.S.: While my call for a Federal Trade Commission (FTC) that actually regulates the MLM industry has been far from complimentary, I have consistently celebrated their enforcement successes. Hats off the FTC lawyers in Arizona and their expert (insert clapping emoticon).

Additional disclosure: I have received no compensation from any parties associated with the Herbalife controversy and have no known financial position associated with any firm mentioned.

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.

Vemma: College Cheer Followed By Herbalife Ltd. (HLF) Investor Worry