John Hempton: Regulators & Courts Don’t Care about ”Diet” and “Community”

John Hempton wrote a blog post that purported to contrast good and bad MLMs. He used a flimsy argument about “community” to somehow distinguish one from the other. He explained that the community effect at his local fitness club or Yoga studio translates into the premium priced protein shake but the same wasn’t true at the GNC store. You might get the impression John will soon extend that thinking all the way to a Starbucks and then eventually conclude Herbalife is simply like Starbucks. Starbucks or the Yoga studio can sell whatever overpriced product they want… so long as they don’t staple it to a pyramid scheme in order to sell far more of it than there is natural demand. That is the not so subtle difference and it is illegal.

Greed is the difference between good and bad MLMs and it shows up in the Pay Plan structure and incentives. It’s why Mark Hughes introduced the Production/Infinity Bonus in 1992, which set off 10 years of huge recruiting. Then Mark Hughes died in 2000 and Herbalife waffled for several years. They changed the Pay Plan again around 2004-2005 when Michael Johnson joined; more recruiting followed. In 2010 they changed the Pay Plan yet again to focus, motive and incentivize Sales Leaders to recruit millions and millions of new participants (this time around the Nutrition Club program).

The 10-year recruiting and growth metrics have been exponential: 10+ million human beings have been defrauded out of billions of dollars since Michael Johnson joined Herbalife.

When Michael Johnson, the President of Disney International, got a call from JH Whitney and Golden Gate Capital, I imagine it was tempting to think in billions and of personally making hundreds of millions. The opportunity presented itself in the Mexico Club programs coining money and taking that around the globe. Never mind that it’s deceptive and predatory of the poorest and most disenfranchised people on the planet. Herbalife would create an illusion of a market for its products and exploit millions and millions of people. Self-directed, unrestrained greed run amok.

Herbalife preaches about products, but in practice it’s all about pushing the program.   Herbalife’s actions speak so loud, I can’t hear what they say.

Regulatory and Court Standard:

According to a 2004 FTC Advisory, “Product-based pyramid schemes rely on upfront fees and/or high margin products and services purchased by an ever-churning base of distributors to fund the compensation paid to participants, with sales to non-distributors playing a minor role.” (Emphasis added)

A pyramid scheme conceals its true nature (that is, an endless chain of recruits) by stapling itself to a product, thereby fooling people into thinking they are engaging in a business opportunity, a healthy lifestyle or some other benign circumstance. I’ve previously written about how Herbalife has manipulated consumer perception with a “Global Brand Imaging” campaign and created the illusion of ordinary retail customers at Nutrition Clubs here.

The BurnLounge appellate court ruling reminded us that, “Not all MLM businesses are illegal pyramid schemes.  To determine whether a MLM business is a pyramid, a court must look at how the MLM business operates in practice. (See U.S. v. Gold Unlimited 177 F.3rd 472, 479-482 (6th Cir. 1999); In re: Amway Corporation, Inc., 93 F.T.C. 618-716 (1979))”

Courts have clearly recognized that low or no initial participation fees are merely designed to engage participants in the program and, to the extent the program is illegal, it can become illegal at a later stage of engagement. For instance, in BurnLounge, the court didn’t concern itself with non-Moguls. The focus was on Moguls. Herbalife should be concerned about its Sales Leaders/Supervisor and Nutrition Club recruiting programs, not those participants who simply enjoy the products themselves and make some modest effort at retailing (the ones we hear so much about).

Let’s assume all participants pay and satisfy the first prong of the FTC’s test, namely “the right to sell a product”.

Satisfaction of the second prong of the test is “the sine qua non of a pyramid scheme” and is characterized by “recruitment with rewards unrelated to product sales.” In Omnitrition the court wrote, “the mere structure of the scheme suggests that Omnitrition’s focus was in promoting the program rather than the products. (Emphasis in the original)

With respect to Herbalife’s Nutrition Club daily consumption model, consider how the FTC treated Futurenet in its Final Order with respect to distributor “training”:

Compensation related to recruitment is any form of compensation that is conditioned upon, derived from or related to recruitment of new persons to any business opportunity involving any multi-level marketing program. This term includes, but is not limited to, compensation paid or provided to participants in a multi-level marketing program as a result of or related to any type of training provided to either new or existing participants in a multi-level marketing program.” (Emphasis added)

Here are three of the most common MLM structures:

  1. An MLM with some distributor churn and a large, stable non-distributor customer base. Distributors are also consumers. This could be free of a pyramid scheme charge, despite a high proportion of “internal consumption” that comes with ongoing recruitment, as those purchases would not be the primary source of compensation to participants. (This resembles Kirby Vacuum, Pampered Chef, World Book, Cutco, Tupperware, etc.)
  1. An MLM with a large and stable internal customer base with little churn and only a small amount of sales to non-distributors. This could also be free of a pyramid scheme charge because compensation to participants would not rely primarily upon recruitment. (This resembles a buyer’s club. e.g. Costco.)
  1. An MLM with a small, unstable non-distributor customer base and a large base of churning distributors, all of who buy products for personal consumption. This model is vulnerable to a pyramid scheme charge. (This resembles Herbalife. “Wear the button, Use the Products, Talk to People”.)

Let’s keep in mind that the BurnLounge appellate court clearly warned about reliance upon recruitment, suggesting the MLM in #3 above has a real problem,

“…the FTC provided sufficient evidence to prove 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 the sales of merchandise.”   “Moguls were meant to be, and were, primarily motivated by the opportunity to earn cash rewards for recruitment.”   “The rewards BurnLounge paid were primarily for recruitment, not for the sale of products.” (Emphasis added.)

The BurnLounge Defense made a point of asking the Court to consider the appropriateness of Dr. Vander Nat’s testimony and analysis. The Court did, and found it relevant and reliable. In their decision they repeated Dr. Vander Nat’s words: “…he explained that a “pyramid scheme is an organization in which the participants obtain their monetary rewards primarily through enrolling new people into the program rather than selling goods and services to the public.” (Emphasis added.)

Three Days after the Court of Appeals upheld BurnLounge, the FTC posted this to its Bureau of Consumer Protection blog: “The Ninth Circuit had some interesting things to say about the legal determination of what’s a pyramid scheme. The Court concluded that the test for establishing a pyramid scheme doesn’t require that the rewards for recruiting others be “completely” unrelated to the sale of products. Evaluating how BurnLounge operated, the Court observed, “Recruiting was built into the compensation structure in that recruiting led to eligibility for cash rewards, and more recruiting led to higher rewards.” The Court further stated that based on the evidence presented at trial, “Rewards for recruiting were ‘unrelated’ to sales to ultimate users because BurnLounge incentivized recruiting participants, not product sales.” (Emphasis added.)

The changes that were made to the Herbalife Pay Plan in 1992, 2004 and 2010, together with Management Presentations to Wall Street analysts around those dates and the subsequent operating results and metrics of the company, it is plain to see that the focus (and the changes, in particular) was designed to motivate and incentivize program participants to recruit new members.  The changes implemented in 2010 included unique and specific features to accelerate the Nutrition Club recruiting model and resulted in exponential growth.

Now that we have a legal context, let’s get honest about Herbalife and pyramid schemes.

In The Matter of Amway Corporation, Inc. the FTC Administrative Law Judge James P. Timony blundered in his Initial Decision. The Commission in their Final Order by Robert Pitofsky adopted those findings as fact.   In the 35 years since, the Direct Sales industry has been run over by pyramid schemes. We rarely hear their names, but we have those public servants to thank. I’d be curious to know what they think about the proliferation of pyramid schemes since their decisions.

Pyramid schemes have aspired to hijack the public perception and brand awareness of traditional direct selling companies for decades, most notably in 1989 when Amway tried to buy Avon, at the time the oldest and largest traditional direct selling company.  At the time, Avon said Amway was replete with civil and criminal charges to its business practices and personnel, was a defendant in suits by its distributors and the target of enforcement action by Wisconsin over its recruiting and had paid tens of millions in fines for evading taxes and duties.  Many years later, Avon caved to market pressure and adopted an MLM model and damaged their once-strong reputation and business.  Pyramid schemes have been trying to associate themselves with the likes of Pampered Chef, Kirby, World Book, Cutco and Tupperware, to name a few.

Most consumers know Kirby sell vacuums, World Book sells (or sold) encyclopedias, Pampered Chef sells cooking stuff, and Cutco sells cutlery all through direct sales forces, primary door-to-door or in the home.  In contrast, consumers know very little about what Herbalife actually sells or does, except they recognize the lime green herb logo, plastered in all the right places, on all the right sports jerseys, has politically connected spokespeople, and seems to be a legitimate company. Michael Johnson put his Disney-esque Global Brand Imaging stamp on the company. But beneath that veneer, Herbalife is rotten.

Herbalife sells false Hope. It is an illegal pyramid scheme that conspires with 50 or so non-independent mega-recruiters (Founder’s & Chairman’s level) and 1,000 or so top non-independent recruiters (President’s Team) to systematically target the unsophisticated, poor and disadvantaged hopeful human beings while simultaneously wrapping itself in a veneer of Corporate Legitimacy, Global Brand Imaging, sponsorships and government advisors.

The only questions are (1) can the government prove it, and (2) will the government do anything about it?

Herbalife supporters are evasive, circular and carefully worded in their defenses. We hear things like; Distributors are “producing” instead of “recruiting” – which is a no-no word for MLM lawyers. Before you know it, they’re talking about internal or external consumption and distributor “intent”, neither of which the FTC or any court has given serious weight to.   If that doesn’t work, they rely upon anecdotes like Hempton’s Yoga studio or fitness club “communities” as important differentiators, instead of critical thinking and analysis of regulatory and court precedent. It is all an intentional distraction.

I’m not a fan of multi-level marketing, because without strict regulation and oversight it tends toward abuse. Unrestrained, self-directed individuals tend toward selfishness and greed. (It is human nature and history is littered with examples.)

I’ll leave you with this thought.  A year ago, I bumped into a friend I had not seen in many years. She sent me an email about her new business. I invited her to my house and we talked for 2 hours, including much about the “business opportunity”. I told her, very directly, that I new a thing or two and it was a pyramid scheme and the profit she was seeking would come from the losses of others she recruited – whether they were friends, family or a long list of anonymous people. She would be deceiving them in order to line her own pocket. Was she ok with that? Could she sleep at night knowing that? Did she know that’s what it was?   When she answered, here demeanor changed; she lost the “Tony Robbins enthusiasm”. To my surprise… she told me she knew exactly what she was doing. And she did not care. She was tired of being poor. Tired of working dead-end jobs. Tired, in fact, of living in her brother’s house. She didn’t care how she was going to make money – this was a “new opportunity” and she was getting in early so she could be near the top. I told her I had no judgment (and I really didn’t) and I just wanted to make sure she went into it with her eyes wide open. She gave me a free bottle of whatever cosmetic thing she was selling along with the scheme. The thing that struck me was – and I don’t see much of it in this Herbalife debate – when I confronted her with the truth, she was completely honest.

The evidence is all around us, so we are without excuse. I see only three available choices if you’re a Herbalife supporter. You’re a Laughingstock, a Liar, or a Lunatic.

This entry was posted in Herbalife and tagged , , . Bookmark the permalink.

Leave a Reply