As most of you know, the FTC has filed a lawsuit against Fortune Hi-Tech Marketing, alleging them to be a pyramid scheme. This is the first action taken by the FTC against an MLM since December of 2006. The most informative pleading that shows the FTC’s position is the memorandum supporting the FTC’s motion for an injunction. WARNING: It’s 54 pages…and boring. When describing these cases, I’ve found that it’s always best to give a brief summary of the business model.
Fortune Hi-Tech Marketing (“FHTM”) Business Model
FHTM is a network marketing company that specializes in selling nutritional supplements and beauty products. It also dabbles in selling cable and telecom services. Participants join FHTM by paying a $250 administrative fee. In order to qualify their positions, these “Managers” are required to move (buy or sell) 1,000 volume points. This usually costs between $100 and $400 per month, totaling at least $1,200 annually in product sales / purchases.
Managers can advance to “Regional Sales Managers” by recruiting six additional Managers. RSMs can advance higher by recruiting additional Managers. RSMs are eligible to earn $100 for each new Manager in their downline. While the new Manager doesn’t generate $100 worth of margin based on his or her product purchase, I doubt FHTM is using money from the $250 enrollment for the $100 bonus (which would obviously be a recruitment bonus). Instead, they’re probably allocating some of the breakage in the plan from unpaid commissions from product sales i.e. the majority of reps do not hit the RSM rank; therefore, there’s plenty of money in the pot for the bonus. Using Vander Nat’s “perfect scenario” theory, assuming everyone were to hit the RSM rank, the plan breaks. The FTC is exploiting this as a weakness in the plan.
The FTC’s thesis is simple: the FHTM products are merely incidental to the money making opportunity. The FTC makes itself clear: while FHTM talks about “selling product,” the references to sales are cosmetic designed to conceal a money transfer scheme. Additionally, the FTC is arguing that the structure of the pay plan itself is turbo-charged to reward recruitment over legitimate product sales.
FTC’s Purported Expert a/k/a the Kraken
The FTC’s attack dog throughout the years has consistently been its economist, Dr. Peter Vander Nat. Vander Nat co-wrote an article titled “Marketing Fraud: An Approach for Differentiating Multilevel Marketing from Pyramid Schemes.” In the article, Vander Nat publishes his math formula that he uses when reviewing a multilevel marketing program. Vander Nat is an interesting anomaly in the MLM industry. In my opinion, he’s similar to the the Kraken in Pirates of the Caribbean. In the movie, the Kraken is a large beast residing in the depths of the ocean, only to surface when called upon by its master to destroy a vessel. And when the job is done, it vanishes…
Vander Nat operates in simliar fashion. While the FTC recognizes the legitimacy of the MLM industry, their chosen expert does not share the same sentiment. I suspect they keep him locked behind closed doors for years, only to use his services when they need to sink a ship fast. Can you blame them? Vander Nat has never once found an MLM legal using his math formula. I’m not kidding. In the FTC’s case against BurnLounge, Vander Nat’s credibility as a witness is being contested at the appellate level. In its brief, BurnLounge references Vander Nat’s deposition transcript and writes:
Vander Nat had never studied any MLMs that he concluded were legal. He could not testify that using his analysis, one would ever find an MLM to be legal. . . Nothing was presented to show that his test had gained widespread acceptance. He likewise admitted that he did not know if his test complied with the Koscot/Omnitrition test.”
If you want the full text, check out page 43 of BurnLounge’s Appellate Brief.
I’m not making this up. The FTC’s expert, the man charged with distinguishing good companies from bad companies, has created an impossible standard. And furthermore, if you review his math formula published in his article, it requires a doctorate in quantum physics to truly understand. As if that’s not enough, central to his formula is this definition of “retail sales.” He writes, “We rely on Omnitrition’s findings that for purposes of pyramid analysis, the sale of product to ultimate users means the sale of product to those who are outside the organization.” In other words, for purposes of his formula, commissions triggered via internal consumption are considered “recruitment bonuses.” When you control the terminology, you control the outcome.
On a side note, his reliance on Omnitrition is misplaced. Omnitrition was never held to be a pyramid scheme. But I digress…
What does the FTC say on the issue of MLM internal consumption? Unlike Vander Nat, the FTC takes a softer stance on the subject when it writes, “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.” Clearly, there’s some incompatibility between the FTC’s public statements and their arguments made in litigation. Do they reserve the Kraken for what they perceive to be the most egregious of companies? It appears to be the case.
Why Fortune Hi Tech Marketing
Just to be clear, I’m not defending the Fortune Hi Tech model. I lack adequate information to form an opinion one way or the other. I’ve learned that it’s ill-advised to form an opinion based on the initial complaint. But I do know this: FHTM is isolated. The DSA rolled them under the bus and it only took them 24 hours after the FTC filed its lawsuit. FHTM is not part of the tribe, which means they’re not going to score many sympathy points from industry participants. Will this hurt them? I think so. If they survive the injunction (very high bar there), there’s not going to be enough positive press to keep their sales force engaged. The industry, traveling in a pack, will keep moving in a herd knowing full well that occasionally, some get eaten.
The FTC’s allegations can be summarized in two small sections.
(1) Recruitment Culture.
FHTM heavily emphasizes recruitment over sales. In fact, the FTC commonly places sales in quotes i.e. “sales.” They know that there’s a theoretical opportunity for sales, they just dismiss it as fake. They allege that as a requirement for participation in the plan, Managers must buy (or “sell”) a certain amount of inventory each month. This amount averages over $1,200 per year. Are the prices inflated? The FTC never says one way or the other. The FTC also accuses FHTM of overstating the benefits of their partnerships with nationally known brands i.e. DISH Network, Xoom Energy, etc. The FTC alleges that Managers in FHTM tout these partnerships as validation of the model; however, there’s very little commission to be gained from those sales because those partnerships are just “run-of-the-mill affiliate agreements.”
(2) Income Claims.
FHTM allows its sales force to make inappropriate income claims. The FTC provides a number of crazy claims made by leaders and executives. These statements were taken from all over the place, including company meetings, YouTube videos and, most surprisingly, Twitter. If you’re an executive for an existing MLM, pay attention. Compliance matters. While FHTM has an income disclosure document, the FTC is alleging that FHTM never made it a priority to get it in the hands of prospects. Also, the FTC alleges that the income disclosure document uses fuzzy math to reach its numbers because it excluded a large population of the sales force.
Does it make you nervous knowing that the Federal government can shut down a long-standing business without a judicial hearing? Critic or not, it’s disturbing. If FHTM is a flaming pyramid, it would never have survived a hearing. After being in business for over a decade, where is the imminent threat referenced by the FTC in its motion for an immediate injunction? The Critics, who commonly take a “win at all cost” approach, even if it means heralding a felon as their champion, will say “serves them right!” But be careful…
“And when the last law was down, and the Devil turned ’round on you, where would you hide, sir, the laws all being flat? . . . And if you cut them down, and you’re just the man to do it, do you really think you could stand upright in the winds that would blow then? Yes, I’d give the Devil benefit of law, for my own safety’s sake!” Sir Thomas More, A Man For All Seasons.
If you’re reading this via email, please click this link to view the FTC’s memorandum in support of its motion.