In March, the Federal Trade Commission entered an order against multi-level marketing company BurnLounge, prohibiting the company and its founders from making certain misrepresentation and requiring them to disclose certain things in the future. Over the last few months, the heat has been on Herbalife, after short seller David Einhorn asked some important questions on a conference call. (Don’t let HLF tell you the questions were elementary or not important. They are very important.)
There is no doubt that Herbalife has had much financial success over the years. It is the largest publicly traded MLM, and its stock price has increased greatly since 2007. But are there things to be worried about? If you know something about multilevel marketing, the answer is YES.
Multi-level marketing is a type of business in which constant recruiting is required to replace distributors who quit, and the retention rates are dismal. If you look closely enough, you will see that on average, 99% of participants in MLMs lose money. Recruiting new representatives requires presenting an “income opportunity,” but if the potential recruits know they’re almost guaranteed to lose money, they are unlikely to sign up.
This is why multilevel marketers – - selling everything from makeup, to vitamins, to weight loss products – - depend on withholding information from recruits and focusing on misleading disclosures. Most of the time, MLMs get away with this. They have a very strong lobbying organization in the Direct Selling Association, which bills itself as a “trade association,” but really focuses its efforts on ensuring laws are not enforced or created against MLMs.
After years of fighting, the FTC finally settled a case it brought against MLM BurnLounge in 2007. Multi-level marketing companies like Herbalife, Mary Kay, Medifast, Pre-Paid Legal, and Usana work hard at distancing themselves from the phrase “pyramid schemes.”
But BurnLounge wasn’t so lucky. The regulators saw it for what it is and pursued it for nearly 5 years. And the case ended with BurnLounge being shut down by the FTC.
Could a company like Herbalife be in danger of being shut down by the FTC? I have no knowledge of whether or not the FTC is looking at Herbalife. But below, I am going to compare the problems at BurnLounge (as cited in the complaint in the FTC case) with what I know about Herbalife. You decide whether Herbalife could be in danger of action from the FTC or other regulators.
|BurnLounge recruited participants by selling them so-called “product packages,” ranging from $29.95 to $429.95 per year.||As seen in this graphic, distributors can sign up for $57.75 or $95.55|
|More expensive packages purportedly provided participants with an increased ability to earn rewards through the BurnLounge compensation program.||It is implied or stated by some recruiters that those who are more serious about Herbalife will buy the more expensive option.|
|The BurnLounge compensation program primarily provided payments to participants for recruiting of new participants, not on the retail sale of products or services, which the FTC alleges would result in a substantial percentage of participants losing money.||Like other multi-level marketing companies, Herbalife contends that commissions are paid to distributors for product sales, not for recruiting. However, the commissions are paid to the upline when distributors order products from the company, regardless of whether those products are actually sold. A ruling against Herbalife in a Belgian court said endless recruiting is the name of the game.|
|Consistent with the incentives of the BurnLounge compensation plan which favor recruitment over music sales, the efforts of Defendants in promoting and training others to promote BurnLounge emphasizes recruitment over sales of digital music.||From the Herbalife 10-K: “We are focused on building and maintaining our distributor network by offering financially rewarding and flexible career opportunities through sales of quality, innovative and efficacious products to health conscious consumers.” We see here that recruiting is the real business.|
|BurnLounge operated an illegal pyramid scheme, making deceptive earnings claims, and failing to disclose that most consumers who invest in pyramid schemes don’t receive substantial income, but lose money, instead.||A Belgian court said earlier this year that Herbalife is a pyramid scheme. Most recruits lose money in Herbalife. And while a U.S. Court has not declared Herbalife to be an illegal pyramid scheme, the Belgian court’s decision seems to point to the truth about this opportunity.|
There are many more comparisons that could be made between BurnLounge and Herbalife. If you examine the MLM industry in the United States, you see that these companies skate dangerously close to the line at which they can be called pyramid schemes. Certain lawyers cater to MLMs, advising them exactly how to set up their companies to comply with the letter of the law and fly below the radar so as not to be called pyramid schemes.
Sadly, the MLM industry is thriving, even in a struggling economy. But it is thriving by taking money away from eager recruits who are almost guaranteed to lose money. Money their families could use for important things like feeding their children and putting a roof over their heads.
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