Medifast Take Shape For Life: Endless Chain?

A recent filing in the Medifast appeal (the case in which Medifast sued me and others, and lost miserably) raises some interesting questions about whether Take Shape For Life (TSFL) is an endless chain recruitment scheme. From that filing:

A. Medifast’s Evidence Does Not Prima Facie Show That FitzPatrick’s “Endless Chain” Statement is Provably False

Medifast’s reply again does not demonstrate that FitzPatrick’s endless-chain statement is false. Because Medifast has alleged libel, it must make a prima facie showing that challenged statements are untrue. Masson v. New Yorker Magazine, Inc., 501 U.S. 496, 516 (1991). Courts also evaluate whether an average reader would consider the statement to be fact or protected opinion. Carver v. Bonds, 135 Cal.App.4th 328, 344 (2005).

Medifast disregards its prima facie showing obligation, arguing that the Court must accept the declaration of its witness Daniel Bell (“Bell”) as true and cannot weigh FitzPatrick’s credibility against Bell’s. (ARRB, p.25.) This ignores Medifast’s threshold duty to establish that FitzPatrick’s statement, about TSFL being an endless chain under California law, is provably false. Indeed, Medifast still contends that it correctly cited to the FTC’s definition of what constitutes a “pyramid scheme” – not California’s definition of an “endless chain.” (ARRB, p. 29.) FitzPatrick, however, states that “my report examines and offers an opinion whether Take Shape for Life operates as an ‘endless chain’ as defined in the California Penal Code.” [ER 54.]

Because Medifast is relying on the wrong definition, it cannot establish that FitzPatrick’s statement is provably false. Even after FitzPatrick emphasized in his principal brief the differences between the California definition and the FTC Act definition, Medifast offered no analysis of its own. It only states that “no analysis was necessary as Sammartino already determined such a statement was provably- alse.” (ARRB, p.29.) Because this Court’s review is de novo, Medifast’s failure to refute FitzPatrick’s analysis warrants reversal.

Although Judge Sammartino quoted Penal Code section 327 and cited to the California case People v. Bestline Products, Inc., 61 Cal.App.3d 879, 914 (1976), her analysis was based on Bell’s declaration. She accepted Bell’s equivocation that under TSFL’s plan no compensation is paid “merely” for recruiting, that bonuses are not paid “simply” for introducing new participants, and that “the vast majority of orders” are placed by clients who are not participants. [ER 16.]

However, Bell’s negative pregnant explanation did not disclose all elements of TSFL’s compensation system, which itself establishes that FitzPatrick’s statement is not provably false. If participants are not paid “merely” for recruiting or “simply” for introducing new participants, clearly part of their compensation is for recruiting and introducing new participants. That violates California’s endless chain law, and Medifast failed its burden. These new recruits, who themselves recruit, purchase inventory through internal money transfers, which generates upline commissions and also violates California’s law.

Under section 327, it makes no difference whether participants receive part of their compensation from sales to non-participants; the crucial consideration is whether participants receive any compensation for introducing new members. Bestline reached the same conclusion that it is only pyramid sales plans, underwhich compensation “is limited” to payment for sales to persons who are not participants that are outside the definition of an endless chain. Ibid., 61 Cal.App.3d at 914. This point was emphasized again in Bounds v. Figurettes, Inc., 135 Cal.App.3d 1, 18-19 (1982), which discussed Bestline at length. Figurettes explained that pointing to the importance of non-participant “retail sales” did not matter because “retail sales do not legalize the pyramid marketing scheme which violates Penal Code section 327.” Id. “The fact that some retail sales occur does not mitigate the unlawful nature of the recruiting.” Id.

Bell admits that in TSFL’s scheme, participants pay to become members [ER 1014], with charges for semi-annual renewals, which gives them the chance to receive compensation for introducing new participants. [ER 1005, ¶21]. “Bonuses” also are paid, including: “client assist bonuses” when a participant (coach) sponsors another participant; and, “growth bonuses” paid to senior participants who grow their business. [ER 1016-1020.] Indeed, Medifast’s complaint confirms that TSFL is an endless chain. “Health coaches (participants) receive commissions based upon …products they sell either to non-health-coach clients, or to other health coaches… The only benefit that health coaches receive from recruiting additional health coaches is a residual commission …” [ER 32, ¶¶ 32-33, emphasis added.]

All of this meets the definition of an endless chain under section 327 (“an ‘endless chain’ means a scheme…whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation …”). By paying to become participants, Medifast’s health coaches receive “the chance to receive compensation” for recruiting new participants through commissions as well as bonuses. Medifast cannot show that FitzPatrick’s statement about TSFL being an endless chain is provably false. Accordingly, Medifast failed to meet its burden of establishing a probability that it will prevail on its libel claim.

B. As a Matter of Law, FitzPatrick’s Evidence Supporting His anti-SLAPP Motion Defeats Medifast’s Evidence

Because Medifast did not make a prima facie showing that FitzPatrick’s statement is provably false, this Court does not have to consider whether his evidence defeats Medifast’s as a matter of law. However, as an alternative reason for reversing the District Court’s ruling, he also showed that his statement is true.

In his declaration, FitzPatrick discusses that in 2011, the SEC required Medifast to restate its 2009 10K filing and make additional disclosures. Among them were that Medifast also markets “income opportunities” through TSFL, which includes financial rewards tied to an expanding sales force. [SER 731.] Medifast states further that it distributes its products through “the Take Shape for Life network of independent health coaches …that buy products themselves” and are “distributors” in a “network marketing system.” [SER 734, ¶18 and fn. 6.] This was followed by the admission to its shareholders that “[o]ur direct selling distribution channel is subject to risk of interpretation of certain laws pertaining to the prevention of ‘pyramid’ or ‘chain sale’ schemes.” [SER 736, ¶25.]

As discussed above, FitzPatrick showed through Medifast’s materials, that participants in TSFL pay for the ability to participate in the scheme [ER 1013-14]; and that they, then, have the chance to receive compensation by introducing others into the scheme [ER 1006-1007] though commissions and bonuses [ER 1016- 1017]. This evidence alone defeats Medifast’s as a matter of law in confirming that TSFL is an endless chain.

FitzPatrick also used information from Medifast’s website to show that over time, health coaches using the pyramid structure would exponentially out-earn those who relied on client sales. [ER 78.] That was the incentive to recruit and not rely on retail sales.

FitzPatrick further exposed a primary indicia of an endless chain by calculating the attrition rate of health coaches. Bell concealed the rate by revealing only the overall increase in coaches and not disclosing how many quit. FitzPatrick used Medifast’s SEC reports in conjunction with Bell’s comments to calculate a 60% attrition rate. [SER 746.]

FitzPatrick defeated Medifast’s evidence as a matter of law. In doing so, FitzPatrick also revealed how insidious pyramid schemes are and that Medifast has been manipulating data to conceal the telltale signs of TSFL’s endless chain – the high attrition rate of those at the bottom of the pyramid.

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