Herbalife – Supernova of RICO Predicate Acts; Mafia Boss Michael Johnson and his Made Guys

In 1979 then 4-year Federal Trade Commission (FTC) Administrative Law Judge James P. Timony made a decision to accept virtually all the deceptive and fraudulent business practices of the Amway Corporation, Inc.  The founders of Amway, Richard DeVos and Jay Van Andel, using their Christian faith as part of their sales pitch to new recruits, said “Trust us…” and the FTC agreed.  The FTC had success prosecuting straight “headhunting” pyramid schemes, but product-based pyramid schemes were rapidly emerging in new and creative ways and the FTC didn’t have the intellectual or legislative tools to nail them. Or they just missed it. Or they just bought Amway’s lie.

(Today, product-based pyramid schemes are well understood by the FTC.  But in the case of Herbalife, the Perpetrators have evolved yet again with a conscipted “daily consumption” Nutrition Club model.  It is so clever, well concealed and new, that management has actually advertised it (hiding in plain sight) as evidence of many millions of legitimate consumers and with what they believe is less risk of going to jail.  It is perhaps the reason Herbalife and its top recruiters started moving away from the old pyramid scheme and Internet lead generation model and toward Nutrition Clubs as their primary source of revenue and profit.  That is, until they were found out.)

A 5 member Commission, headed by Robert Pitofsky, who would go on to become the Dean of Georgetown University Law Center and then Chairman of the FTC, and including Commission member Elizabeth Dole, wife of Senator Robert Dole, adopted Timony’s Amway findings as Fact in their Final Order and the “1979 In re: Amway” decision became the basis for a Standard of Practice within the industry. What a tragedy that was for tens of millions of people worldwide, who have since been defrauded out of tens of billions of dollars. It isn’t just the pyramid schemes, it is the ancillary business builder Tool scams that go along with them. The scope of fraud is staggering, yet there remains a surreal debate about whether this is all illegal or not.

The modern MLM Mafia was born in 1979, immediately on the heels of Amway, and it has grown up to be strong and sophisticated. People like Mark Hughes at Herbalife knew exactly what that Amway decision meant. It was open season! Over the next 30 years the Direct Selling industry was run over by pyramid schemes, an avalanche of lobbying dollars and a cottage industry of morally pliable lawyers willing to deflect, disguise and deceive to protect the shaky foundation and thin veneer of legitimacy created by Amway. The Utah valley, in particular, became ground zero, as scams popped up like mushrooms amid a corrupt system of political protection (Two former Utah Attorneys General Arrested). Nevada was right behind them.

The FTC Commissioners had no clue the sinister nature of what they had before them in 1979. I’ve written about how Herbalife uses its Foundation as a tool to perpetrate its fraud here.  DeVos and Van Andel used their Christian faith in much the same way.  (Read the Memoir by DeVos.)  The FTC needed people like Andrew Maloney and John Gleeson, the US Attorney and chief of its organized crime bureau, respectively, who stayed on the John Gotti case after he was let off several times in the 1980’s. The government has a decidedly different posture toward the Mafia. I believe the tide has turned for Herbalife and the MLM Mafia.

What is coming to light (literally coming into the light), and is difficult for many to fully comprehend and accept, is the MLM equivalent of the 1957 “Apalachin Meeting”, when prosecutors and America first saw the Mafia through a new pair of glasses – not as disparate individuals or small crews, but as a well organized, financed and inter-connected conspiracy to perpetuate and replicate large scale illegal rackets for the primary benefit of organized leadership.

I’m not talking about Herbalife and MLMs, I’m talking about criminals.

Joe Valachi testified before Congress and gave America the phrase “La Cosa Nostra” and memorably said, “I’m not talking about Italians, I’m talking about criminals.”  In the 1960’s the government estimated the 20 Families in the American Mafia raked in $7 Billion annually, equal to the combined earning of the ten largest industrial companies in the country at the time.  In 2013 Herbalife alone had nearly $5 Billion in revenue.

American Mafia leaders were once among the wealthiest in the United States (Meyer Lansky was on the Forbes 400 in 1982.  But they hide their wealth as well as they hide their crimes.)  Today, some of the MLM Mafia are among the wealthiest in America, with enormous political power and perceived legitimacy. People you have never heard off make tens of millions per year from MLM rackets, preying on the hopeful, poor and unsophisticated. Converting illegal wealth into social legitimacy is not a new story line.  The unfortunate sideshow with Herbalife is the already wealthy people jumping on (or in and out of) the bandwagon to increase their personal wealth without the slightest concern for those it harms.

Providing secondary market capital (debt and/or equity) in support of a pyramid scheme is akin to aiding and abetting a fraud. In my view, that applies to every shareholder and lender, including Wells Fargo. The proper function of a secondary market is to provide liquidity and access/allocate capital to productive enterprise. It therefore follows that if a given enterprise is not productive (if it allocates capital to illegal enterprise), then market participants should not ignore it, but should dis-allocate and frustrate the enterprise desiring liquidity and capital, so capital will flow to alternative enterprise.  When Sam Zell comments or Barry Rosenstein comments or any other similarly situated individual chimes in with a lame comment of no weight or substance, and knowing they can/will influence many reporters or lazy thinkers simply because they are rich, it is exceedingly ignorant and detrimental to the proper function of markets. They become part of the problem. It is the rare billionaire who is humble enough to say, “I simply don’t know enough to comment intelligently.  I don’t want to weigh in on something I don’t know well.  I shouldn’t share my opinion broadly because I didn’t study the facts, I’ve just read the headlines.  You may find this surprising or shocking (Mr. or Mrs. Interviewer), but I don’t have all the answers.”  What a shocker that would be.

Those who brought the Mafia to light were called quacks, conspiracy theorists and racists. It took about the same 30 years from the time the Fascists chased the Mafia from Italy to America to the sunlight of Congressional hearings. Thereafter, the government was no longer fooled by high priced lawyers and lobbyists and did not negotiate, accept modest fines or business model changes. They started throwing people in prison for a very long time. I trust and hope they do the same, beginning today.

The government made the Mafia leadership appear in the sunlight and asked them startlingly simple questions, which they refused to answer. The American public saw the Mafia for what they were. Now we watch movies about those same Mafia characters and it seems so obvious in hindsight. Herbalife and the MLM Mafia refuse to answer similarly simple questions for the same obvious reasons.  “Downline: an intolerable potential to deceive” should be a Box Office Hit movie.  It is glaringly obvious.

Do You Hear What I Hear?

A bell was rung recently. Some Herbalife investors may not have heard it or are tone deaf, but the FTC rang it, then the Department of Justice and FBI, too. Then several States Attorneys General decided to make it a full Christmas Carol. It signals a changing tide of political and regulatory will. Politicians and regulators, who for three decades allowed all but the most egregious pyramid schemes to pop up like mushrooms, turned on the Untouchables, in particular Herbalife. The Direct Selling Association (DSA), in conjunction with individual distributors and companies, has spent tens of millions of dollars lining the pockets of lobbyists and buying Federal and State elected officials for decades. To suggest that Pershing Square bought an investigation in so short a time and for so few relative dollars is intellectually lazy and/or dishonest. Whatever Pershing Square spent to draw government attention to this fraud is a tiny fraction of the DSA largesse that has been “buying protection” for decades. The DSA owned the government.

MLMs sell a “business opportunity” in addition to products. Several years ago the DSA successfully lobbied the FTC to exclude MLMs from the Business Opportunity Rule. Do I need to say that again for effect, or did you get the ridiculous irony the first time? That’s like saying the Dental Association got the FTC to exclude the Dentists from the Dental Opportunity Rule.  (Maybe Sam Zell or Barry Rosenstein have something to add on that tiny point?)  In my opinion, we all need to accept one of two things: either the MLM world is upside down, or someone should go to jail for that.  The Business Opportunity Rule included a “7-Day Wait Period” and anyone who knows anything about this scam knows that there cannot be a wait period.  Period.

Herbalife’s Millions of RICO Predicates…Annually

I’ve identified Michael Johnson, the CEO of Herbalife as the Boss (the Capo di Tutti Capi) of an Organized Crime Family called Herbalife, with 50 or so Underbosses (Founder’s and Chairman’s level mega recruiters) and 1,000 or so Capos (President’s Team top recruiters) – all of whom are Made Guys, ostensibly “independent” distributors. It is absolutely clear that civil and criminal RICO applies to Herbalife. It is glaringly obvious.  The Department of Justice prosecuted the Pharmaceutical industry in an analogous manner, they paid tens of billions in civil and criminal fines, including for RICO violations – I’ve written about that here.  Big Pharma survived, where Herbalife will fail, because they had a stable of other products people wanted and needed.

Herbalife is a Supernova of RICO predicate acts.  In order to establish a RICO pattern, prosecutors need 3 predicate acts.  Herbalife creates several million predicates each year… as it constantly recruits new victims like a slow moving stellar explosion around the globe, except this one never seems to end.  MLM is far more economically destructive than mafia racketeering.  Mafiosi skim profits or add an extra layer to an existing demand.  When the government removes the Mafia from the garbage industry, for instance, prices come down and the garbage collection industry remains.  When the government removes and MLM, the whole thing disappears, as if it never existed.  MLM is completely fabricated and wealth transferring.  Here’s how it works in practice:

Herbalife and top recruiters are not independent of each other. They are one unit – a well-organized, criminal enterprise, designed and structured to systematically run rackets, just like the Mafia. Michael Johnson and John Tartol (or any other top recruiter) are as independent of each other as John Gotti and Sammy “the Bull” Gravano.

In this post (about 2/3rd of the way down) I explain that 90% or $5.4 Billion of Herbalife’s enterprise value is attributed to the 1,050 or so Founder’s, Chairman’s and President’s Team members recruiting prowess.

  • Herbalife exists for the PRIMARY BENEFIT of enriching the 1,050 Top Recruiters and Management.
  • The other 2.75+ million participants are the business opportunity that Recruiters and Management exploit.  When an anomaly participant does the miraculous and breaks the “pay plan barrier” (which it is actually not designed to do) they parade them around on stage like a Rock Star.
  • The public market for Herbalife stock is also a money transfer scheme, a mechanism for Insiders to monetize additional profit through stock options without the risk of long-term ownership. It is a stock fraud perpetrated on the public.   Herbalife systematically loots the balance sheet each and every year of any and all cash flow through buybacks and dividends, into which Insiders sell. They are hoping to walk away with their fortunes intact if/when the scam ends – leaving the “the boobs in the public” holding the bag.

Just in case you missed it: Nutrition Clubs are small hub and spoke pyramid schemes, owned by a parent company that is a pyramid scheme, that is a publicly traded stock market fraud.

Top recruiters work together, own businesses together and coordinate their Herbalife activities with each other and the company.  Prosecutors call that conspiracy. Herbalife has not disclosed this criminal conduct (1) because it is criminal, and (2) they claim these distributors are “independent” and therefore they can keep it off the books.  (In general, companies don’t like to disclose criminal conduct.)

Individual top recruiters make millions from Herbalife, but they make tens of millions per year from the rackets they run “off the books”. e.g. John Tartol is one of the highest ranking recruiters – a 31 year 1982 vintage Chairman’s level– he signed up right under Mark Hughes, the founder. In 2013, Herbalife paid Tartol $3.3M. That is a great amount of money for anyone, but don’t be fooled into thinking that’s all John Tartol is gaining from the Herbalife scam.

In part because of the attention Bill Ackman recently shined on the business builder Internet Lead Generation Tool scams, Herbalife had to abruptly shut them down. Herbalife may have been phasing Internet Lead Generation Tool scams out anyway, as Nutrition Clubs were on the rise as the new Golden Goose, but the abrupt shut down nonetheless hurts top recruiters when their cash flow gets cut off. Nutrition Clubs are now also in the spotlight for their dubious practices. These are the real cash cows for top recruiters.

Top recruiters are the engine that propels Herbalife. Their primary job is to sign up Supervisors (marks) each year at Extravaganzas, who in turn head home very enthusiastic to recruit new member participants for either their traditional pyramid program or Nutrition Clubs conscripted “training” program. Through this multiplier effect Herbalife replaces 2.5 million members who churn every year. The enormous value of the top recruiters (the 50 Founder’s/Chairman’s and 1,000 President’s Team) is that they recruit 250,000 Supervisors (an average of 250 new Supervisors each), who in turn recruit 10 new Members each, which results in the roughly 2.75 million new members every year.

A decent or average Supervisor can sign up 10 members in a year. But closing 250 new Supervisors requires a special talent – a Mega-Recruiter!

That’s just the tip of the iceberg.  Those 250,000 Supervisors are big believers and stay in the program an average of 1-2 years, investing far more than the $3,000 to become a Supervisor, sometimes tens of thousands or more, and not just buying shake mix.  For instance, If top recruiters sold 30% of these new Supervisors (75,000 of them) just 2 Internet Leads per week @ $100 each that is $750 Million per year! That Internet Lead scam was as big as the Herbalife pyramid scheme. Mark Hughes got to sell shake mix stapled to a pyramid scheme and the top recruiters who push it for him got to fleece them for just as much or more.  Thirty-five years ago Amway top recruiters sold motivational cassette tapes. Today it’s Internet leads. But it’s the same scam. (Why hasn’t anyone called this “inventory loading”? It’s the same concept – you’re loading the Target/Mark with a pile of stuff that has no value, they don’t need or can’t sell. I’m surprised more victims haven’t gone postal on these mega recruiters.)

In order to better understand this, think about Herbalife not as a publicly traded corporation, but as Mark Hughes individually, because he used to own 100% and Herbalife is distributor #1.  It is the top of the pyramid.   When Carl Icahn buys stock in Herbalife he is fully aware that he is bypassing the entire hierarchy of the pay plan and jumping right into a fractional ownership in distributor #1.   Herbalife should tell recruits to forget working their way up the pay plan – just buy stock in HLF.   Of course, if you told all the recruits that the fastest way to the top of the pay plan is to buy stock, you’d have no recruits or customers, you’d have a stock scam, which is what we have anyway. (As Michael Johnson goes around the world telling distributors that their “way of life is under attack” by a reckless billionaire stock speculator, how many are encouraged to buy stock alongside the company buyback – while Michael Johnson dumps $15 million of his?  The stock chat boards are loaded with distributors taking up the cause for the company.  It is a fraud.)

The people who Mark Hughes recruited to sell the scam between 1980 and 1985 – the mega recruiters – knew they were going to make him (meaning Herbalife) disproportionately rich by the mechanics of pyramid pay plans; much the way the Underbosses know they are going to enrich the Boss in the Mafia. So the Mafia Boss is constantly giving away free vacations, but more importantly, other lucrative rackets to balance power and greed.

In 2013, those top 50 or so Founder’s and Chairman’s (after nearly 30 years) averaged compensation from the Herbalife pay plan of maybe $3M (using Tartol and several other publicly disclosed as a benchmark) and the 1,000 or so President’s Team (after 15-20 years) averaged say $250K, which totals about $400M Pretax Income for 1,050 people. Herbalife (aka 100% Mark Hughes alone) had Pretax Income of 735M!   Here is an observation: There is no way the Underbosses and Capos in the Mafia Family are standing for that income disparity! They will whack that Boss in 2 seconds and take his money. So, the Boss has a solution for the Made Guys (I mean the Founder’s and Chairman’s level): the Boss gives them other lucrative side rackets, like the $750M+ Internet Tools scam.

This works fine, so long as it doesn’t bring too much heat back on the Family’s main business.  RICO lawsuits are heat.  Bill Ackman’s 50 million candlepower flashlight is heat.  Criminals do not like the spotlight.  It is not good for business.  The lights have been on Herbalife and its criminal Top Recruiters for 2 years.  People do desperate things, to themselves and for their business, when their money gets cut off.  It will be interesting to see how long the Underbosses and Capos (Founder’s, Chairman’s and President’s Team),  hold on before they have financial breakdowns, mental breakdowns, join another “Family” or even flip on their co-conspirators as the day of reckoning gets nearer.  The first Top Recruiter to flip and become a witness for the government has a very good shot at walking away with their liberty and all their money.  If I were one of them, I’d be negotiating terms with a top lawyer already.  Denial is very costly.

The Herbalife pyramid and fraud thesis has been well articulated and documented in several forums.  Among the offenses: violations of Koscot, False Claims, anti-trust violations, and myriad related frauds – importantly, mail, wire and financial frauds in support of the scheme. It is also important (for RICO) to note that Herbalife does some legitimate business, using the legitimate business as cover for non-legitimate business.

There is an obvious case to be made that Herbalife’s actions or inaction make them criminally liable for their top recruiters unlawful acts.   This may prove to be a new direction for prosecutors in what has previously not been subject to criminal prosecution. Herbalife (in fact, the whole industry) has for many years maintained that top recruiters/distributors are “independent” businesses and the company is not responsible for their often rogue and criminal pattern of behavior, notwithstanding how much Herbalife knew or benefited. It will be interesting to see if that gets passed the Department of Justice, FBI and States Attorneys General, particularly in light of recent cases they have pursued and/or prosecuted.

Herbalife and it’s affiliates (and many other leading MLMs) have been successfully pursued under civil RICO before.  The currently pending case Bostick vs. Herbalife originally included RICO claims, but they were dropped by the plaintiff. Here’s why (in layman’s terms, it’s generally correct, so don’t over analyze it): If a company or individual sues another company or individual alleging violations of RICO but has other adequate remedies, they are almost certainly forced to pursue the other remedies, not RICO. However, unlike individuals or companies, the States and/or Federal government can prosecute all violations plus RICO, both civil and criminal.

Procter & Gamble Thought Amway was a Pyramid and Hired a RICO Expert

Sticking with Amway for a minute, the industry pioneer and leading MLM company that virtually all industry lawyers and executives hold up as the standard bearer and model – was sued by Procter & Gamble (not a disgruntled distributor, which is more typically the case) in July 1997 in Texas and this is what P&G had to say about the MLM industry standard bearer:

“The Amway enterprise is in reality an elaborate, illegal pyramid scheme.” “Of those who invest the time, money, and personal sacrifice to become distributors, only a select few even break even. Even fewer realize the profits touted by Amway in its sales pitch – and they do so by siphoning money from the victims at the bottom.”

Here’s what P&G had to say about Amway’s distribution and marketing model (for anyone, including Bill Stiritz, that believes MLM may be the marketing Holy Grail):

“… no legitimate distribution network contains so many layers of middlemen, selling and reselling the same goods a dozen or more times, encouraging those below to keep the base of the pyramid expanding with new victims. And, the pressure to keep Amway’s pyramid going with new recruits is enormous, because the Amway Pyramid is in a constant state of collapse and renew.”

P&G went on in the original suit to allege that Amway was not really in the business of selling products to the public because 80+% was sold inside the network, hence it was a closed system and the profits come not from outside the network but from redistribution of wealth among the layers within the pyramid. In addition it spawned a second line of business, “selling motivational tapes” to new recruits.  (It was 1997, but this sounds like selling Internet leads to new Herbalife Supervisors. It’s the same scam, in a different package.)

It seems a leading global consumer products company – not Bill Stiritz and Post Holdings, of course – are not as enthusiastic about MLM. Maybe this is why: From 1974 to 2012, US GDP grew approximately 3x while the direct selling industry increased by approximately 1.7x. As the number of people engaged in direct selling tripled from 1991 to 2011, direct sales as a percent of total retail sales at first increased and then declined. Even though the number of MLM participants went from 5 to 15 million, the percentage of total US retail sales has remained at less than 1%. (People are the commodity, that’s why they grow faster than the products.) It is simply not an effective method of distribution – except to redistribute wealth within the pyramid, from the bottom to the top. And any comparison to the growing wage gap between CEO and rank/file employees in corporate America is false, because among other things, employees are not the consumers themselves and are not churned out of their jobs every year.

P&G alleged violations of RICO and lined up an expert witness, G. Robert Blakey, a law professor from Notre Dame widely considered an authority on RICO and organized crime. Blakey possesses a legal, legislative and administrative resume that is impressive. He participated in drafting the RICO Act. Blakey wrote a report, which is available online here. Here’s what the report said about Amway:

“My area of expertise includes the structure and function of organized crime groups.  I have reviewed documents that form the basis for a comparison between the structure and function of organized crime, and the structure and function of the Amway enterprise.”  “It is my opinion that the Amway business is run in a manner that is parallel to that of major organized crime groups, in particular the Mafia.  The structure and function of major organized crime groups, generally consisting of associated enterprises engaging in patterns of legal and illegal activity, was the prototype forming the basis for federal and state racketeering legislation that I have been involved in drafting.  The same structure and function, with associated enterprises engaging in patterns of legal and illegal activity, is found in the Amway business.”

That is a bold statement 19 years after the FTC (courtesy of James Timony, Robert Pitofsky, Elizabeth Dole et al.) gave them the green light.  Amway has been sued and settled for RICO and fraud so many times its unreal.

Does Blakey’s statement apply to Herbalife today?  Yes.  And Herbalife is by far the most egregious and predatory of the modern MLM Mafia.  It is outrageous that our federal government allows this criminal activity to continue.

Michael Johnson saw Nutrition Clubs as the model to set Herbalife apart in a MLM class by itself, unique and different.  He sure accomplished his goal.  The predatory nature of Nutrition Clubs may ironically set Herbalife apart from the rest of the MLM industry, shielding the Feds from accusation of “selective prosecution.”  The egregious nature of Herbalife’s violations could then become the catalyst to reform the entire industry, rooting out the entire MLM Mafia. 

 

 

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