This week New York State Senator Jeff Klein and Public Advocate Letitia James issued a scathing report on multi-level marketing company Herbalife (NYSE: HLF). The report, The Amercian Scheme: Herbalife’s Pyramid ‘Shake’down, is based on complaints filed by 56 Herbalife victims. It definitively calls the company a pyramid scheme and highlights the company’s deceptive practices.

The key findings include:

• Since 2004, only 56 Herbalife victims in New York have been brave enough to file complaints against the company. Most victims are afraid of betraying family, friends, and neighbors.
• The 56 victims that have filed complaints reported nearly $1 million in financial losses ranging from $90 to $100,000. The average amount loss was approximately $20,000.
• Over 60 percent of new members make initial investments larger than the required $60 to $100 for the new member kit. The average initial investment is $1,800, but some are as high as $10,000.
• Herbalife distributors purport that supervisors can make as much as $20,000 in monthly income.
• Of 56 complaints analyzed, only eight victims received a check directly from Herbalife for their royalty claims. The average amount was $100.

This statement is also enlightening:

Consumers who are convinced and pursue the business opportunity designed by the company are promised a low start up cost in exchange for inflated future income if they are able to recruit as many new members as possible.

The “business plan” for a distributor seems simple enough. Sign up with Herbalife, purchase products at a discount from suggested retail price, and sell them at a profit. It is often suggested that this “business” can be run in just a few hours per week. How does someone run up $20,000 in financial losses with such a seemingly innocent plan?

During the information session, current Herbalife members as well as new recruits sit through two to three hours of various presentations. Each presentation is conducted by an Herbalife member that claims to have experienced enormous success. The speakers share their testimonials, which often start with an immigrant story. They share their experiences as immigrants to the United States from poor rural towns in pursuit of the American dream. They share the hardships they have faced in the United States since their arrival, and then transition into the opportunity Herbalife has provided them.12 They inform recruits that after five years of hard work as an Herbalife distributor, they can earn up to $20,000 in monthly income if they can commit to start a membership and recruit new members.

When describing the recruitment plan, labeled the “90 Day Plan,” the presenters scan over ways in which new members can accelerate to supervisory status. Becoming a supervisor is heavily emphasized because as a supervisor, members can claim royalty fees on their recruits’ sales.

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While in theory a 90 day plan would only require a new member to purchase the $60 to $100 new member kit, and then provides them with three months to recruit and sell $2,500 worth of products during two consecutive months or $4,000 worth of products in one month to obtain supervisory status, meaning they can claim royalty fees, this is not the case.

In fact, recruiters and presenters use the privilege of earning royalty fees as the sales pitch to encourage new members to become supervisors as quickly as possible. A combination of overemphasizing royalty fees and sharing exorbitant monthly incomes urges new members to make an initial investment greater than the simple $60 to $100 for a member kit. While some cannot make the full $4,000 investment that is required to automatically become a supervisor, others take the less financially burdensome route and make an initial $2,500 investment. With $2,500 to $4,000 worth of products, new members must act fast to sell the products to receive a return on their investment. Once many find themselves without a large enough client base to sell the overstocked products, they turn to their recruiters who pressure them to lie about the products’ health benefits to increase sales and encourage them to shift focus and work on their recruitment efforts to increase the network size.

The study included an analysis of complaints as well as an undercover component. MLM supporters often cite the low cost of starting as a distributor, and say that no one is forced to buy or stock products. But in practice, things are not so simple:

Moreover, our analysis of complaints retrieved revealed that new members do not only purchase a new member kit upon signing up, but tend to overstock in inventory to be able to sign up as supervisors and claim royalty fees. In fact, close to 60 percent of new members made an initial investment that was larger than just the $60 to $100 required for the new member kit; and of the 60 percent, half of the initial investments were above $2,500. On average, individuals made an approximate $1,800 initial investment upon signing up, with some as high as $10,000. Ultimately, recruiters convince new members to make such large investment by promising future monthly income that can range from $2,000 to $20,000 according to our complaint analysis. To support our analysis, a 2013 report of 500 surveys conducted by Make The Road indicated that of those who join Herbalife as an independent member, 35 percent did so as supervisors.

Retailing the products offered by MLMs in order to turn a profit is nearly impossible. The report notes:

However, as the complaints indicate, selling this many products becomes a challenge for new members. As a result, they reach out to their recruiters for help who in exchange pressure them to use lies about the health product’s benefits to increase sales. Over 30 percent of complaints filed with the Office of the Attorney General indicated that an existing Herbalife member informed them of the products’ disease curing capabilities including cancer and diabetes. In addition to pressuring new members to use lies to increase sales, the complaint analysis shows that of all 56 complaints analyzed, 66 percent claim that as new members they were urged to focus their efforts on recruitment.

The distributors turn to recruitment when they realize how difficult it is to develop a profitable retail business, but quickly learn that the money really isn’t there either:

New members are determined to sell and recruit to be able to claim the promised royalty fees paid directly by Herbalife, but according to our analysis so few ever receive a monthly check from the company. Of the complaints filed with the Attorney General, only eight indicated having received a check from Herbalife International, with the largest monthly checks ranging from $92 to $700.

MLM evangelists will tell you that those who lost money are to blame… they didn’t try hard enough or long enough. But that’s often not true:

Notwithstanding the relatively large financial burden incurred by new members in exchange for a relatively low return, their tenacity prevails. On average, claimants in our analysis assert to having devoted approximately two years to this business endeavor before feeling defeated and waving the white flag.

Technically, Herbalife might not appear to be a pyramid scheme under the FTC’s rules. But the report goes so far as to say that Herbalife allows distributors to operate an illegal pyramid scheme:

As applicable to Herbalife International, the FTC does not classify the organization as an illegal pyramid scheme because the required $60 to $100 fee to receive a membership kit is not money used to compensate higher up distributors who recruit. Furthermore, once an Herbalife member becomes a supervisor, she is allowed to maintain the title and royalty collecting privilege for an entire year before having to re-qualify. However, our research and investigation reveal that Herbalife distributors do not follow the rules set by the FTC and are in fact running an illegal pyramid scheme. Our analysis demonstrates that higher up distributors encourage recruits to make large first-time product purchases, which the recruiters stands to gain on. And once the new members are unable to sell off their inventory, recruiters encourage them to recruit other members to increase their compensation claims and maintain operation. By contractually following FTC guidelines, Herbalife International has managed to skirt the law, but in reality their lack of proper financial disclosure and supervision over their members allows distributors on the ground to operate illegal pyramid schemes to the benefit of Herbalife International.

The authors of the report suggest proposed legislation to hold multi-level marketing companies like Herbalife accountable for the scam being run on consumers. Will anyone listen and act?