MLM Detractor Blatantly Mischaracterizes the Law: Ignores Facts and Precedence

Bruce CraigRetired Wisconsin litigator, Bruce Craig, wrote an article featured on Seeking Alpha titled, “An Investor’s Guide to Identifying Pyramid Schemes.” While the title certainly implies a hint of objectivity, it’s simply false advertising . In a nutshell, the author holds on to his long-standing, 30+ year view that all MLMs are pyramids. Unfortunately, Craig willfully omits several well-known facts that obliterate his entire argument. It’s this kind of willful omission that makes him guilty of the very behavior he claims to be against.

Bruce’s thesis is simple: When analyzing a MLM for legality, retail sales do not matter…at all. In fact, he essentially concludes that all MLMs are illegal. If there’s any sort of recruitment element to a program, it’s “inherently deceptive” due to their “exponential characteristics.” In other words, with no limits on recruitment, epic doom is inevitable. This “all MLMs are pyramids” rationale is made crystal clear in Bruce Craig’s 2009 letter to the FTC when he says, “[The Amway case] has effectively legitimized pyramids, now called MLM’s.”

True North

I always respect people’s right to voice their opinions. While I might disagree with the points, I think good, open dialogue is the only path to progress. But…in the Seeking Alpha article, Bruce crosses a line. He is not providing objective, well-researched information to investors, as implied in the title. He’s making a carefully crafted argument. The article is “Outcome Determinative,” meaning he begins with the end in mind (all MLMs are pyramids) and stitches quotes together in support his argument. While making his argument, he leaves out several material bits of information.

Bruce Craig’s “True North” is ultimately protection of consumers. When he says he cares about consumers, I believe him. But as Abe Lincoln said in the recent movie (“Lincoln”), “What good is True North if you end up stuck in a swamp?” At some point, critics like Bruce need to be practical. Taking the position that all MLMs are illegal immediately removes you from the conversation. Completely. And without influence, there’s no change. The industry is not going away. Instead of drawing hard lines and praying for a nuclear bomb to decimate the entire industry, wiping out even the cleanest of companies, he and critics like him should try to offer suggestions to make the industry better. I have a personal experience of being hammered with the political process. I tried to pass an anti-pyramid bill in Tennessee in 2010. The bill was killed by the DSA. Instead of whining about the political process (as done in nearly every article posted by critics), I joined the DSA. I’m a firm believer that the right ideas win over time. Bruce’s article lacks objectivity, which is why it will only serve to excite the critics and be largely ignored by everyone else, including regulators.

I’m going to address Bruce’s points in no particular order.

Market Uncertainty With Respect to MLMs

When writing about his motivation for the article, Bruce writes, “The recent incident involving David Einhorn and Herbalife (HLF) drew my attention to the stock market and the subject of pyramid schemes. It seemed that the significant drop in Herbalife’s stock price reflected a market uncertainty about the inherent stability and legality of this company.”

This is false. As a quick recap, Einhorn asked a few questions during an earnings call with Herbalife. During the call with Einhorn and shortly thereafter, Herbalife’s stock dropped 20% ($1.7 Billion loss in value). The market was not reacting to uncertainties about Herbalife’s model, the market was reacting to Einhorn. Einhorn is a legend on Wall Street, having successfully shorted multiple companies, including Lehman Brothers and Green Mountain Coffee. The market perceived that Einhorn smelled blood with Herbalife. Herbalife’s stock dropped 10% during Einhorn’s 5 minute conversation on the earnings call. 5 minutes is hardly enough time for analysts to research MLM law and thoughtfully conclude that the Herbalife stock was junk. They were reacting to Einhorn. Despite this “market uncertainty,” the other publicly traded companies in the MLM industry are doing just fine. The average rate of return on the publicly traded MLMs is well over 30%, soundly beating the DOW, NASDAQ and the S&P 500. It’s not even close.

Misleading Analysis on BurnLounge

In his article, Craig referenced a definition in the judge’s final order against BurnLounge. This case represents the most recent case against a pyramid scheme. In the final order, the court defined “Prohibited Marketing Scheme” as:

An illegal pyramid sales scheme . . . in which participants pay money or valuable consideration in return for which they obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users. For purposes of this definition, ‘sale of products or services to ultimate users does not include sales to other participants or recruits or to the participants’ own accounts.

If you were to read this definition out of context, it would certainly seem that it’s illegal to pay commissions on product consumption generated by distributors (known as internal consumption). In fact, if interpreted literally, this sort of definition would spell the end of the network marketing industry, period. Bruce takes advantage of this quote and contrasts it with a seemingly contradictory statement the FTC made in 2004. In the FTC’s Advisory Memo to the DSA, it said, “In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme.

There are 3 key facts that Bruce fails to mention:

1) The definition in the BurnLounge order is IDENTICAL to the definition found in another case against a pyramid scheme twelve years ago (FTC vs. Equinox). The FTC’s advisory memo quoted by Bruce came well after the Equinox case. The FTC made its position clear: Paying commissions on internal consumption is fine.

2) The definition that Bruce quoted was specifically limited to the BurnLounge case. First, it’s clear when it reads, “For purposes of this Final Judgment….the following definitions shall apply.” Second, Bruce failed to reference the other part of the FTC’s memo…the one that clearly says that the definitions found in the Orders do not represent the “general state of the law.” It’s pretty important…and he left it out. The memo says,

[T]he FTC often enters into consent orders with individuals and companies that the Commission has determined have violated the FTC act. To protect the public from those who demonstrated unwillingness follow the law, these orders often contain provisions that place extra constraints upon a wrongdoer that do not apply to the general public. These ‘fencing-in’ provisions only apply to the defendant signing the order. . .”.

It’s crystal clear. Despite what Bruce was suggesting in his article, the FTC was not contradicting itself in the BurnLounge order. It’s doing exactly what it’s been doing over the past twenty years. Bruce Craig is not a disinterested reporter looking to provide help for investors. He’s an opportunist taking advantage of media generated by David Einhorn to lob a grenade at an industry he clearly hates.

3) Bruce fails to reference the BurnLounge Statement of Decision. Prior to the Final Order, the judge wrote a 31 page opinion where he stated his conclusion about BurnLounge. I summarized this BurnLounge Statement of Decision on my site. While Bruce argues that retail sales have no place in pyramid scheme analysis, the judge in BurnLounge dedicated almost 10 pages to the value of the BurnLounge product (or lack thereof). He ultimately concluded that the products had SOME marginal value; thus, he discounted the amount of consumer harm. If everything hinged on the “exponential characteristics” of the marketing plan, as submitted by Bruce, there would be zero need to discuss the product. Bottom line: retail sales DO matter. If the products have legitimate value as demonstrated by retail sales, it’s indicative of a legitimate program. Speaking of retail sales, even the FTC’s own economist, Peter VanderNat, wrote about the importance of retail sales when distinguishing legitimate MLMs from pyramids. There’s just no way around it: retail sales matter.

The rationale that led Bruce Craig to reference a single sentence out of context while ignoring the 31 page Statement of Decision is beyond me.

Tolman Case

While Bruce was eager to reference two pyramid cases from over 35 years ago, he ignores a case that was published in 2004. In Tolman, the court held that paying commissions on downline purchases “does not, by itself, render a multi-level marketing scheme an illegal pyramid.” Paying commissions on internal consumption is perfectly legal.

Bottom Line

Critics are desperate. It’s not just Bruce Craig. There have been a number of negative reports lately, all having commonality on a certain line of thought: “MLMs say that everyone can win….and since people fail, it’s fraud.” They’ll use words like “destined to collapse” without referencing a single case of market saturation. And they’ll never reference the technology tools available today that eliminate all geographic barriers for distributors; thus, negating their saturation arguments. They simply hate the space and they want it gone. And now they’re growing angry because they’ve been largely ignored by the FTC over the past several years. It’s not a surprise: their position is logically, politically and economically untenable.

The space needs to improve. I agree on that point. I’ve written exhaustively about my ideas to improve the MLM space. The industry is not perfect, but it’s still a great space. And whether the critics like it or not, the business model is accelerating. Peer to peer advertising is a much more cost effective and efficient means of distributing unique products and services. While I agree that the space needs to improve, I take exception when another lawyer makes an argument while leaving out material information. It’s just poor form.

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  • http://www.facebook.com/david.steadson David Steadson

    I missed this one when you posted it. Excellent response Kevin.

  • http://www.mlm-stopthefraud.com E. Robert Smith

    Hey my friend, It’s the real E. Robert Smith

    You’ve read it before, I’m thinking you must have forgotten it.

    much more efficient than the traditional marketing model.

    “I ask you, doesn’t this scenario look plausible? Of course, but the problem is, the idea that it is more efficient and cost effective is a patent lie. When MLM companies
    and promoters tell people that by eliminating the middleman, they pass on the
    saving to their independent sales representatives, in the form of sales
    commissions and override bonuses, they are lying.

    “Why? Because,
    upon analysis, the MLM model for marketing products and services is, without a
    doubt, the most inefficient and costly means of bringing a product to an end
    user known to man. Why, because, if you were to calculate the number of people
    in the downline, between the product and the final sale, it would be in the
    hundreds, even thousands, in some cases.

    “Now, if you
    were to calculate all the money that these people are spending to be positioned
    in the downline chain—I’m talking about the products they’re purchasing,
    expenses for sales aids, motivational and tapes, seminars, gas for their cars,
    not to mention their time—you would discover that the total amount of money
    spent by these individuals drastically exceeds any profit on the products or
    commissions made for selling them.

    This is hardly an efficient and cost effective way of marketing a product, unless of
    course, you are the company at the top of this scheme. What I’m saying is, the
    total amount of money spent between the manufacturer and the people to whom the
    product is sold is staggering. And worse, 99% of the people doing the spending
    are making little to no money for their contribution. How can anyone call this
    an efficient marketing model?

    • Kevin Thompson

      Robert, I deleted the block quotes that you inserted from your book. When you comment here, try to address the issues identified in the article. The article was not about the cost-effectiveness on the model, though that is something worth discussing. It’s pay-for-performance, which minimizes the company’s exposure. When GNC opens up a new store, there are employment issues, costs of construction, marketing, inventory, etc. With independent contractors, the cost is much lower and the speed is much greater.

      Yes, the participants absorb the costs by way of their own marketing efforts. They do this with the hopes of turning a profit. Yes, the majority do not turn a profit, whether by their lack of skill, motivation or the fact that they’re selling a shoddy product. Whatever the reason, people are FREE to make their own decisions. The costs can greatly exceed the revenues, which seems to get the majority of attention. But in most cases, the costs are minimal. This is especially true when there’s a generous refund policy.

      I know you vehemently oppose these ideas. There’s no use in haggling over these issues here.

  • http://www.mlm-stopthefraud.com E. Robert Smith

    Thanks Kevin. Understood.