Update on the Fortune Hi Tech Case – FTC Passes on Scalpel, Goes for Sledgehammer

As a refresher, in early February of 2013, the FTC got an injunction issued against Fortune Hi Tech Marketing. The summary of the lawsuit can be found here: FTC vs. Fortune Hi Tech.

FTC’s Strategy

FTC passes on the scalpel and picks up the sledgehammer.

FTC passes on the scalpel and picks up the sledgehammer.

Since the lawsuit was filed, I’ve had a lot of time to study the FTC’s arguments against FHTM. In particular, I closely studied the FTC’s expert report prepared by Dr. Peter Vander Nat. The FTC’s entire case hinges on the validity of Peter Vander Nat’s report.

In the lawsuit, the FTC passed for the scalpel and picked up the sledgehammer. In summary, they’re no longer relying on Vander Nat’s convoluted math formula, which I discussed in my last article regarding the FTC’s economist. If you’re following the news with Herbalife, I think you’ll find this next point interesting. Currently, there’s a lot of bickering back and forth between MLM proponents and critics alike over the interpretation of Vander Nat’s formula. People are discussing how Herbalife stacks up to the standard. With one word, I can put the entire debate to rest for both sides.

Are you ready for it?

The word is:

IRRELEVANT

The formula is irrelevant. In Vander Nat’s lengthy declaration used against Fortune Hi Tech, the formula is never mentioned. Not once. Why? The answer is obvious. The FTC is distancing itself from it because the formula is too broad and too confusing. The FTC’s case against BurnLounge (sued in 2006) is jeopardized due to the ambiguity of this standard. The case is currently under appeal. The main source of contention: Vander Nat’s qualification as an expert. Vander Nat had never studied an MLM that he concluded was legal. Where’s the fairness in using an objective standard to measure right from wrong when you never find anything right? There’s no wisdom in designing a water-filter if there’s no opportunity for water to pass through.

Sledgehammer

In his declaration, Vander Nat opines and argues that FHTM was operating as an illegal pyramid scheme. Instead of relying on his formula, he bases his finding on a few assumptions. Those assumptions are all addressed in Charles King’s declaration (available below). Dr. King was retained by FHTM as its expert in their effort to dissolve the injunction. Out of Vander Nat’s assumptions, there’s one that should be concerning for all people in the network marketing industry: commissions triggered via internal consumption are “recruitment bonuses.” In other words, rewards triggered via distributor consumption are illegal. This argument represents a dangerous and irresponsible strategy employed by the FTC. In one of the footnotes in his declaration, Vander Nat writes, “…I also understand that the ultimate users of the products – for purposes of the Koscot test – are people who are not participants in the business venture.” With this framework, he pulls out all revenue garnered from distributor consumption. He then compares the money left over (not much) with the money paid out in bonuses. He then concludes that the pay plan is underfunded and relies on “recruitment bonuses” to survive. Charles King sums it nicely when he writes:

Since Vander Nat is not counting commissions generated via internal consumption, it creates the impression that the plan lacks sufficient revenue from product sales to support the commissions. He treats the difference between revenue available for commissions and the amounts paid as recruitment bonuses. Using his own definition of “end user,” he’s able to dramatically shrink the commission pot; thus, creating the false impression that the Commission Plan is insufficient and underfunded.

Optimal Scenario

Vander Nat also relies on an economic theory known as “Optimal Scenario.” Using the Optimal Scenario framework, Vander Nat assumes that if EVERYONE were to hit the high levels in the FHTM business, the plan would be underfunded. The reality: not everyone hits the levels nor does everyone try. While Vander Nat acknowledges that breakage exists (money in the plan from un-earned commissions), he ignores it completely. In network marketing, the participants operate with various goals. There are some that want to earn a few hundred dollars a month, some do it for social reasons, some want to save money on product, some are supporting a friend or relative, etc. They’re not all trying to “max out” the pay plan. This assumption was faulty and led to a faulty conclusion.

What does all of this mean?

Change is coming. Stay tuned. In 2004, the FTC said that the amount of internal consumption is inconsequential for pyramid scheme analysis. Based on their recent case against FHTM and various posts on their website, the FTC appears to be back-tracking. It’s going to take strong leadership to steer this conversation in a favorable direction for the industry. And strong leadership requires that we at least acknowledge the areas where we’re weak. Cultures of hype need to stop. Product value matters. Without question, the industry is going to look different within 18 months. How different? We’ll see.

If you’re reading this via email, click this link to review the declaration prepared by Charles King.

  • [email protected]

    Please comment about Bidify/Bidsson auction and the stranded affiliates. Also perhaps that is relevant the Towah collusion with Bidify/Skifry to steal affiliates money with a trumped up fraud allagation.

  • http://www.themlmattorney.com/about Kevin Thompson

    Scott, they were asked a specific question and they gave a specific answer. Plus, the Amway case from the 70s even accounts for the legitimacy of paying commissions on internal consumption. Plus, the FTC has said it was fine. Plus, there’s specific federal caselaw that says its permissible (Tolman). There’s nothing wrong with paying commissions on internal consumption. When the FTC discounts all revenue generated from the sales force and treats the resulting commissions as “recruitment bonuses,” it literally comes out of nowhere.

    Second, I deleted your reference to Amway. I do not want you using every post as an opportunity to puke about Amway. I’ve seen you turn straight hostile over the subject and I do not want to go anywhere near it.

    • http://www.facebook.com/profile.php?id=100004703082660 Scott Johnson

      The other co-author of the paper Vander Nat has been given full credit for (because he used to work at the FTC) has stated the response was misinterpreted, which means the response may have been specific, but was far from clarifying. See http://seekingalpha.com/article/1199681-herbalife-icahn-cometh-could-the-stock-be-worth-103-93-per-share comment by William Keep, dated 17 Feb, 03:18 PM.

      I don’t have an issue with paying for internal consumption and neither does Vander Nat, as long as there is adequate external sales. Did you even read his paper? While I don’t agree Vander Nat and Keep’s “>50%” criteria is necessary to show adequate external consumption, at least they produced a simple math model that is a starting point for discussion, which quite frankly hasn’t occurred in a serious manner since the paper was written over a decade ago.

      I don’t “puke about Amway,” I am against ANY MLM that lies about the hidden and massive profits the Amway Tool Scam (ATS) represents. I just happen to have studied the ATS since 2005 and was an Amway IBO from 1993 until my termination in 2009, so I am an expert in this area. I don’t pretend to be an expert in other MLMs, but feel very comfortable that other MLMs behaving similar to Amway are also committing RICO fraud. As I commented earlier, this problem is common throughout the MLM industry and needs to be stopped. However, I think the FTC and/or the SEC need to go after a particular company with this issue before developing a generic rule that applies to the entire MLM industry, or NOTHING will happen.

      • http://www.facebook.com/profile.php?id=100004703082660 Scott Johnson
      • http://www.themlmattorney.com/about Kevin Thompson

        I’m familiar with Bill Keep. He has written nothing on the subject in over 10 years. I do not give him credit for the article because I do not think he’s a legitimate expert. I think he was the gateway to get Vander Nat’s article published. Vander Nat is the mastermind. Plus, since the formula in the article was not even referenced in the FTC’s case against FHTM, Keep is no longer relevant. And it makes sense for the FTC to distance itself from that math formula: motivation varies as to why people join MLMs. There’s no way to quantify a formula on paper. This explains why the FTC is trying out a behavior-focused approach.

        Yes, I have read the article. Have your read Vander Nat’s declaration used in the FHTM case. He never references the formula, which was the point of the entire article.

        FHTM did not have a field that operated satellite tool companies. I’m confused by your statement that you’re against MLMs that lie about hidden and massive profit. The issues associated with tool companies is unique only to Amway. I have never represented a single client that has that component in the field.

        • http://www.facebook.com/profile.php?id=100004703082660 Scott Johnson

          I understand Bill has talked with you in the past, and he said it was a waste of time. I know how he feels, I felt the same way….and found out he is right! LOL From this discussion: http://beta.fool.com/shwetadubey/2013/02/21/why-bill-ackmans-key-argument-flawed/24926/ it appears Bill was not a mere “gateway.” The article itself clearly stated it was not the “be all, end all” regarding MLM, but was a scholarly and mathematical approach to illustrate the concepts behind various court decisions. THAT was the point of the article.

          Who said a tool scam has to be field operated? I recently spoke with Joseph Isaacs, who helped bring down FHTM, and he stated the promotional DVDs were changed out almost monthly, when new companies were added and removed, which happened on a constant basis, and cost $5 each. Profit was probably made at their conventions as well. This may be why Amway has a low bonus payout; not only do the LCKs clean up on their tool scams, which allows Amway to keep more of their product profit, the other companies can be more “generous” with their payouts because they keep the tool scam profits. Whether the upline or the company runs the tool scam, misleading IBOs regarding where the money that creates profit is clearly unfair and deceptive, and therefore in violation of the FTC Section 5 rules. Just because you haven’t represented a single client that has a field run tool scam doesn’t mean they don’t exist. MonaVie had Brig Hart and Orrin Woodward for years, there are probably others. But again, from a distributor standpoint, it is a moot point WHO is running the scam, the end result is the same.

          • http://www.facebook.com/profile.php?id=100004703082660 Scott Johnson

            P.S., I noted you didn’t respond to the issue of neither Vander Nat nor I are against internal consumption bonus payouts. In fact, it isn’t clear to me that paying for internal consumption was even a part of the original question the DSA asked about. Rather, it appears to be related to relative amount of internal versus external volume.

          • http://www.themlmattorney.com/about Kevin Thompson

            Scott, you are mistaken. Read my article. And read Vander Nat’s declaration used in the FHTM case. Vander Nat is completely dismissing revenues accrued from distributors. He’s treating commissions triggered via internal consumption as recruitment bonuses. And suppose, for the sake of argument, Vander Nat is ok with internal consumption. How much is too much?

          • http://www.themlmattorney.com/about Kevin Thompson

            While you say the formula was not intended to be the “be all, end all,” it was used by the FTC against BurnLounge. There’s a chance that decision will come back to bite them, as the BurnLounge case is on appeal for that very reason. The formula in that article is not objective for a number of reasons. This is why the FTC is no longer using it.

            MonaVie no longer allows tool companies. As for a company keeping profit on a DVD, or website, or admin fee, or whatever, it’s not a crime. If there’s no commissionable value to the item, the people buying clearly know that the money, and any resulting profit, go to the company. It’s the field that needs to be adequately armed with disclosures if the profit comes from multiple directions.

            Scott, to boil down to the brass tax, what’s your solution? I see Keep complaining. I see everyone complaining. But where’s the leadership among these critics? What meaningful ideas are they brining to the table to make the FTC’s job easier? Do you want more disclosures? If a company allows a tool company to operate, do you want those numbers to be included in an income disclosure statement?

          • chad

            You shouldn’t trust anything Joe Issacs says. I am a former FHTM rep and that is not true. We only had to change DVDs when there was a major payplan change and we were encouraged to burn copies. I never paid more than 50.00 for tools combined over 3 years. Amway was a different story. I spent way too much on tools every month and did not realize how much money the emeralds and up made on tools until after I resigned. With today’s tech Away leaders should be able to educate their reps for under $20 a month using downloads apps webinars but that would cut out the tool system profit so I doubt they will. I am not happy about what went down at FHTM and I won’t do business with that management team again but Joe Issacs is a blackmail extortion artist. Don’t believe anything he says about any mlm and don’t allow him to join your company or he will blackmail you too, he is a cancer on the whole industry.

          • Common Sense

            You talk as if you have personal knowledge of your accusations. The truth is he brought down Orberson (the real MLM cancer) and you are pissed you could no longer scam your friends out of their hard earned money.

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