Herbalife – Ethics And Pyramid Schemes In The MLM Industry: A Response To DSA President Mariano

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Herbalife – Ethics And Pyramid Schemes In The MLM Industry: A Response To DSA President Mariano by William Keep, Seeking Alpha

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.


Are we losing the meaning of words in pursuit of a business opportunity?

Churning recruits; low probability, opaque paths to success; and “consumers of the opportunity”.

Trade associations as business ethics enforcers and other fantasies.

Direct Selling Association (DSA) President Mariano’s press release regarding my last Seeking Alpha claims that I have shown a “blatant disregard for the facts about DSA and direct selling with little to no accountability for his mis-statements.” Descriptors such as “irresponsible mud-slinging” and an attempt to “destroy a retail sales channel” pepper the language. Why should investors care?

With a wet finger in the wind, investors look for clues to future behaviors. For example, should Mariano’s comments correctly identify weaknesses in my arguments, DSA assurances regarding its members, such as Herbalife and others, might be given more weight. Alternatively, evidence showing Mariano’s complaints prove spurious and inaccurate may raise serious questions about DSA’s ability to speak to the behaviors of its members. Recent news regarding GM ignition switches and VW exhaust tests serve as a clear warning to investors regarding overly friendly relationships between industries, politicians, and regulators.

Rather than destroy a retail channel, or redefine the meaning of retailing, I argue for positive change. Here I respond to Mariano’s comments with detailed support:

1) According to Mariano, I was incorrect in implying that ethics played a role in awarding the 2013 ETHOS Award to Vemma, “no such accolade was ever bestowed…to members for ethics.” Actually, this 2013 press release contains the full quote, a portion of which I referenced: “‘Receiving a DSA ETHOS Award is a testament to the commitment a company has made to being a model for the highest standards in business practices and ethics,” said DSA President Joseph Mariano. ‘I congratulate this year’s winners on their achievement.’ A complete list of 2013 ETHOS Award winners and more information on judging criteria can be found at here.”

Notice that: a) the linkage between “the highest standards in business practices and ethics” and the ETHOS Award was created by Mariano himself and b) when you clicked on the link provided you likely get “Error 404.” Apparently, something is broken at the DSA. Fortunately, this archived version further describes the DSA view of the Award: “The term ETHOS describes the guiding beliefs or ideals that characterize a community, culture or ideology. Likewise, DSA’s slate of awards is designed to identify and promote programs that serve as examples of direct selling done right.” And, “Designed to identify and promote programs that serve as examples of direct selling at its best, DSA’s slate of awards recognizes programs that help define direct selling as a business that helps people live better lives.”

I can see why Mariano would be embarrassed by me sharing more broadly his own and DSA language that explicitly links “ethics” and “direct selling at its best” to the 2013 ETHOS Award given to Vemma. Imagine the joy within Vemma at receiving the award and, according to the FTC, the harm to many thousands of its victims.

2) According to Mariano, I was incorrect in stating the DSA tried to distance itself from FHTM and BurnLounge. He writes: “DSA did not need to do so, because neither company was ever a DSA member,” FHTM “did not meet DSA’s high standards for membership” (unlike Vemma). And, “DSA embraces the U.S. Appellate Court’s decision in the BurnLounge case because it provides useful guidance on what constitutes a pyramid scheme: an emphasis on rewarding salespeople for recruiting additional salespeople instead of for selling products.”

As I never said FHTM or BurnLounge were DSA members, I will go directly to why the DSA needs to continually distance itself from any MLM accused of operating a pyramid scheme. Here too Mariano is helpful. The day after the FTC action, Mariano clearly distanced the DSA from FHTM: “Following the Jan. 28 announcement that an enforcement action against Fortune Hi-Tech Marketing (FHTM) is being initiated by the Federal Trade Commission (FTC) and several attorneys general for allegedly operating a pyramid scheme, the Direct Selling Association has received numerous inquiries regarding whether FHTM is a member of the Association. ‘FHTM is not a member of DSA,’ confirmed President Joe Mariano.”

After “numerous inquiries” the DSA quite reasonably wanted to set the record straight. However, the real problem the DSA has is described by Mariano: “‘Pyramids are bad guys,’ Mariano said. ‘Their mere existence confuses the marketplace and makes it more difficult for legitimate direct-selling companies to do business and to be understood.'” According to Mariano, pyramid schemes are so similar to some of his members as to cause likely confusion. Or, as he stated in 2013 “there are a lot of pyramid schemes that like to disguise themselves as legitimate direct-selling companies. That creates an environment where there can be confusion.” Until we get much better regulatory clarity and required reporting the DSA will necessarily continue to make similar statements.

[I address the issue of the DSA embracing the BurnLounge court decision below.]

3) According to Mariano, my claim that a former DSA Associate General Council helped defend FHTM and BurnLounge was “entirely false” an “Unfounded accusation,” yet he does not refute my evidence, instead providing boilerplate language regarding the DSA and ethics. My piece clearly states that organizations cannot control the action of their former employees. But, as illustrated by sponsors who drop ill-behaved athletes, responsible organizations disavow certain behaviors.

There is no doubt that Mr. Luce assisted BurnLounge (his deposition is available) and no doubt that FHTM tried to use his role as advisor in their defense, presumably with his permission. What makes his defense of these two pyramid schemes interesting is, (per his deposition, given under oath) his ongoing roles, first in a legal capacity “promoting the passage of certain types of consumer protection legislation,” and later in shaping DSA policy, serving “on the board of directors,” helping draft “amendments to the code of ethics,” and chairing a committee “charged with the purpose of amending the code of ethics at that time to include consumers of the opportunity, as well as consumers of the product.” Mariano seems disinclined to recognize the connection between the DSA and the attempt to defend the BurnLounge pyramid scheme by one of its long-time members who held numerous leadership roles.

Now about that BurnLounge decision. I take issue with Mariano’s use of the word “embrace” to describe the DSA’s attitude toward that decision. Specifically, Mariano likes the decision “because it provides useful guidance on what constitutes a pyramid scheme: an emphasis on rewarding salespeople for recruiting additional salespeople instead of for selling products.” Notice that he does not say who is buying the products.

For approximately one hundred years direct selling offered an alternative retail channel through which independent representatives retailed products to household consumers. Is the DSA’s position that “consumers of a business opportunity” constitute retailing? If so, then: a) imagine all the “consumers” that we now typically call franchisees, and b) these “consumers” are not actually retailers. When distributors buy products for their own consumption the parent MLM is the retailer. In the extreme, MLM distributors operate as agents selling a business opportunity to new agents (who buy some product), who then sell the business opportunity to yet more new agents (who buy some product), in a chain-letter like set of behaviors (e.g., Vemma). Though an MLM company may adopt the language of selling “through” its distributors, the evidence suggests that at least some MLM companies have the goal of simply selling “to” their distributors. By conflating participants of a business opportunity with consumers of a product, the language undercuts the meaning of direct selling, shifts attention away from who is then the actual retailer (i.e., the MLM company) and creates the very real possibility for fraud. Most worrisome here is the DSA’s desire “to include consumers of the opportunity,” which reveals a lack of explicit concern for distributors actually retailing products to non-distributors, and the willingness of Luce to supply a report and deposition in defense of BurnLounge, ruled by two courts to be a pyramid scheme.

Mariano fails to mention other aspects important to the BurnLounge court. Specifically, the Court agreed with the FTC, “…that BurnLounge’s focus was recruitment and that the rewards it paid, in the form of cash bonuses, were primarily for recruitment rather than for sales of merchandise.” The court warns against rewards reliant “primarily” on recruitment throughout the document. The court goes on to distinguishes between rewards based on purchases by distributors for their own consumption and sales to non-distributors, concluding, “But it is incorrect to conclude that all rewards paid on these sales were related to the sale of products to ultimate users.” Ultimately, the court concluded, “rewards BurnLounge paid for package sales were not tied to the consumer demand for the merchandise.” Is the DSA willing to embrace that language as well? Or, does the DSA prefer to redefine retailing as something different, something related to and dependent upon “consumers of the opportunity”?

Rather than repeat here my concerns regarding behaviors in this industry and some firms specifically, investors should carefully consider whether the DSA has authentic capacity to offer any reasonable assurance of the type Mr. Mariano delivers in his press release.

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.

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