MLM Special Deals: The Fraud Ends Now

We’ve been tip-toeing around this issue for years.

The first question: Is it legal to offer distributors special incentives (in addition to the pay plan) to join a company? Yes. Just like it’s legal to hire the services of a doctor to promote a new medical device.

The second question: Is it legal when the company / distributor fail to disclose the existence of these deals? No. Actually, it’s fraud. And as an industry, it’s been going on for years. We’ve known about it, yet we’ve done very little to stop it (or even slow it down). I tried humor when I wrote why more disclosure is bad. I addressed it more assertively in my “Is It Better to Raid In Plain Sight” article when Epic was aggressively cutting deals. I addressed it from an academic standpoint four years ago in my article “Master Distributors: good or bad?

I’ve been dancing around it for years.

Here’s the bottom line: FAILURE TO DISCLOSE IS FRAUD! IT’S DECEPTIVE. In the competitive landscape of MLM, in order to stimulate recruitment, companies with cash are tempted to drink from the fraud-cup and poach from the more seasoned companies. When the “top leaders” make their move and boast of the benefits of the product and company, it creates synthetic success stories. It creates the appearance of momentum, which creates a more favorable recruiting environment.

What Do These Deals Look Like?

  • Distributors are paid in a multitude of ways. I’ve seen countless deals, and no two are the same. These distributors are incentivized by way of the following methods (or a combination):
  • Given a “power-leg” of volume, which makes it much easier for the distributor to derive income via the pay plan (easier path to larger commissions);
  • Given a percentage override on top of their entire organization i.e. 2% on all gross revenues accumulated in their downline;
  • Given monthly pay IN ADDITION to the payout of the compensation plan i.e. $10,000 per month on top of the payout;
  • Given a percentage of the enrollment fees captured by new participants in their organization;
  • Given preferred compensation based on gross volume i.e. the typical pay plan is disregarded, and a new one is used that pays out more based on gross volume for a specified period of time (“50% of all CV paid out as dollars);
  • Given substantial signing bonuses;
  • Given cash advances against future commission cycles.

Why Should Companies Care?

If companies are building their organizations the right way, brick by brick, deal-free…they’re having the fruits of their labor stolen. And because there’s so little discussion about this practice, it creates an environment where companies can raid effectively without consequence. The non-deal receiving distributors (“lemmings”) follow the distributors because, in most cases, these deal-receiving distributors are great communicators and great recruiters. The lemmings TRUST their upline. But if the lemmings actually knew there was a little extra in it for the promoters….it would slow things down dramatically. The magic would vanish and people would be in a better position to make informed decisions.

Another reason why companies should care: the pressure of these deals leads distributors to play the “my company is better than your company game” in an effort to raid their old groups. It’s like throwing red meat to hungry lions…it causes people to go on a recruiting frenzy, making aggressive claims along the way. In some egregious cases, the leaders are given authority by the company to cut individual deals at the leader’s discretion. This gives the leader more ammunition to raid deep.

What Does the Law Say?

Regarding undisclosed deals, it’s fraud. And it’s getting worse, not better. I’ve flirted with the subject in the past, without much luck. Troy Dooly has published some content about it, without much luck.

It’s time to be more direct. It needs to stop.

Back to the law: In their Testimonial and Endorsement Guidelines, the FTC states, “When there exists a connection between the endorser and the seller of the advertised product that might materially affect the weight or credibility of the endorsement (i.e., the connection is not reasonably expected by the audience), such connection must be fully disclosed. . . . “ These special deals are absolutely material and they absolutely affect the “credibility of the endorsement.” The FTC goes on to provide the following example:

Example 4: An ad for an anti-snoring product features a physician who says that he has seen dozens of products come on the market over the years and, in his opinion, this is the best ever. Consumers would expect the physician to be reasonably compensated for his appearance in the ad. Consumers are unlikely, however, to expect that the physician receives a percentage of gross product sales or that he owns part of the company, and either of these facts would likely materially affect the credibility that consumers attach to the endorsement. Accordingly, the advertisement should clearly and conspicuously disclose such a connection between the company and the physician.

In their FAQs on the subject, the FTC adds extra insight by answering related questions:

A famous athlete has thousands of followers on Twitter and is well-known as a spokesperson for a particular product. Does he have to disclose that he’s being paid every time he tweets about the product?

It depends on whether his readers understand he’s being paid to endorse that product. If they know he’s a paid endorser, no disclosure is needed. But if a significant number of his readers don’t know that, a disclosure would be needed. Determining whether followers are aware of a relationship could be tricky in many cases, so a disclosure is recommended.

I have a small network marketing business: advertisers pay me to distribute their products to members of my network who then try the product for free. How do the revised Guides affect me?

It’s a good practice to tell participants in your network that if they get products through your program, they should make it clear they got them for free. It also makes sense to advise your clients – the advertisers – that when they give free samples to your members, they should remind them of the importance of disclosing the relationship when members of your network praise their products. You might consider putting a program in place to check periodically whether your members are making these disclosures.

Based on these examples, it’s clear: if the FTC expects people to disclose that they received free product, they will certainly expect companies and distributors to disclose the existence of non-public financial arrangements.

And let’s not forget common sense: If someone is proclaiming the greatness of a company while under the influence of a special arrangement that’s NOT AVAILABLE TO THE PEOPLE THEY’RE RECRUITING, it’s misleading.

What happens now?

Ask! Just ASK. When you see a networker making a move, never feel embarrassed to ask “Were you given extra incentives to switch over? Did the upline kick in extra incentives to get you to switch?” If they actually answer, ask, “If not for the incentives, would you join this company as a new distributor?” I’m sure you’ll be attacked, because you’ll be honing in on a very sensitive subject. Basically, you’ll be questioning their integrity because deep down, they know its shady to withhold that kind of information.

Where should you start? Whenever you see an announcement on Business for Home, ask in the comments. Ted Nuyten over at Business for Home is a friend. I like him personally. But his site frequently gets used by companies looking to create a sense of momentum when, in some cases, the momentum is fabricated. When you see announcements about big moves, ask.

If the company cutting undisclosed deals is a DSA member, file an online Code of Ethics complaint here. Reference Section A of the Code of Ethics (available here). Section A prohibits unethical recruiting practices.

As a corporate leader, if you refuse to cut deals, stand up and make yourselves known. Let people see that you’re willing to forgo quick cash for an honorable organization. The average distributor will trust you more, creating more long-term value in your company. I’ll recognize those companies on this site in a separate page.

Conclusion

If this is the first time you’re learning of this issue, how does it make you feel? How can we work together to stop it?

If you’re reading this via email, the video can be viewed here.

Eric Worre’s Go Pro Recruiting Mastery Event

Network Marketing Go Pro 2014

Wow! It’s all I can say about it. I’m not easily excited, and I’m incredibly excited to share with you what I observed at this event. I was deeply honored when Eric asked me to speak at his 2014 Go Pro event in November. When I say “deeply honored,” I really mean it. With speakers like Todd Falcone, Jordan Adler, Chris Brogan, Les Brown, Richard Brooke, Eric Worre, Harry Dent, Paul Pilzer, Kevin Harrington and the lovely Donna Johnson….I was by far the least qualified of the speakers. It’s like being chosen for the all-star team and I was happy to serve as best I could.

I was blown away. Eric Worre has really cracked the code. I’m not a sales kind of person, and if you’ve been reading my blog over the past several years, I never get excited and I never promote. I’m funny about what I do with your attention (which I value and appreciate very much). At this event, people were talking about ethics, integrity, character, trust…elevating network marketing by committing, as a unified community, to doing things right. There were countless companies represented, several thousand distributors from all across the world….and it was a safe environment for everyone. There was no recruiting! Distributors came together to learn about best practices, as a unified group.

This is one thing I appreciate about Eric: he’s not willfully ignorant. He’s not putting his head in the sand, ignoring the problems in network marketing while proclaiming its virtues. He honestly admits that there’s room for improvement, and he confronts those issues. In order to advance as a community, we’ve got to have an adult conversation about the challenges so we can figure out what we need to solve. At this event, speakers were talking about the importance of avoiding hype, the importance of income disclosures, the importance of transparency, honor, etc. As a professional that’s been beating on this drum for several years, it was very encouraging to witness.

I was not paid as a speaker. I do not get paid via ticket sales. There’s no “catch.” I’m promoting the next event because I think the value exceeds the price. I have no idea if I’ll be speaking at it next year. But I do know that I’ll be there. Companies are starting to SAVE money by NOT having a convention and sending their folks to this one. It’s a safe environment where people learn the basics and walk away with a lot more belief. If a client is unable to draw a decent audience for their own convention, I’m going to recommend that they simply send their folks to this one.

Plus, Tony Robbins is going to be there next year. TONY ROBBINS!

Get a ticket. Click here to put your name on a list for next year’s event.

I’ve also included some pictures from this year’s event. I wish I took more! My wife, Sharon, and I had such a wonderful time. If you’re reading this via email, the photos can be viewed here.

Herbalife Settles Bostick Class Action Case

Herbalife announced its settlement to a class action lawsuit. The case was filed within months of Bill Ackman’s initial presentation where he announced his short position, so it could be an example of a law firm seizing on “blood in the water.” But I digress…

The settlement basically amounts to two things: (1) $15,000,000 in cash for product refunds and remuneration for excessive business expenses (with $5M of that fund going to the lawyers); and (2) Several reforms to Herbalife’s marketing practices. Candidly, Herbalife is already doing most (if not all) of the reforms required as part of this settlement. The cash portion of the settlement was quite smaller than I anticipated, given the size of Amway’s settlement to a similar lawsuit a few years ago ($60,000,000).

Already, there’s a group that’s announced they’re going to oppose the settlement. Brent Wilkes, the director of the League of the United Latin American Citizens (“LULAC”) said via a NY Post Article, “We plan to object to the settlement because it won’t begin to pay for the true damages that Herbalife has caused this class.” On a related topic, I have for a few months suspected that Bill Ackman promised to contribute some of his gains (if the bet goes his way) to various civic organizations. I suspect that LULAC is on that list. I sent both Brent Wilkes and LULAC a message via Twitter on Monday morning asking if any funds were promised. I have yet to receive a response. The question is relevant, in my opinion, because it’s important for all material facts to be fully disclosed. If there’s financial motivation in the background, the public deserves to know so the attacks can be judged accordingly. Again, it’s an unconfirmed suspicion. When I get a response, I’ll update the article.

UPDATE: See below. Brent Wilkes denies having any financial motivation in his attacks against Herbalife.

The required corporate reforms are included below. h/t to Seeking Alpha contributor, Ben_Nimaj for typing it up.

1) Simplified Pricing Structure: combine “Package & Handling” and “Order Shipping Charge” into a single “Shipping & Handling” charge

2) Differentiate “Members” and “Distributors”

3) Discourage members from incurring debt to buy product

4) Pay return shipping charges for legitimately returned product

5) Prohibit members from selling “leads” to or purchasing “leads” from other members

6) Prohibit the purchase of product as a condition of being a member

7) maintain procedures for enforcement of these and other rules, ie. implement a member compliance department

8) Include the Statement of Average Gross Compensation (SAGC) of member with any membership application

9) Require any applicant to actually acknowledge having reviewed the SAGC

10) The SAGC must contain the total number and percentage of all members who do not receive any compensation payment directly from Herbalife, [not just numbers from members that actually made money].

Bostick v Herbalife_Preliminary Settlement by kevin_thompson

Time to Revisit DSA’s Code of Ethics: Suggestions

It’s old news now. Avon left the DSA. In their announcement, they stated the DSA’s Code of Ethics needed revision. Specifically, Cheryl Heinonen at Avon said, “We believe the association’s agenda in the U.S. is overly focused on the issues of a few specific brands rather than industry-wide challenges. . . We believe that the U.S. DSA Code of Ethics requires updating to better reflect the current state of the industry in the U.S.”

In a separate article in the Washington Post, Heinonen gave a quote that shed a little light on what she meant. She said,

I think it’s problematic when you sell inventory — bulk product — that the person who is acquiring it can’t use themselves and sometimes may not know how to sell,” Heinonen said. She added that the language in the trade association’s code of ethics on this point and other aspects of consumer protection need to be firmer.

The problem: inventory loading. And I’ll drill down a little deeper because inventory loading, when it exists, is a symptom of a larger problem: lack of product value. In other words, when there’s a lack of legitimate demand for product, companies incentivize participants to “load up” on items they might not want or need in an effort to qualify for bonuses.

The cure for this problem has historically been the 12-month refund policy. If you boil down the DSA’s Code of Ethics, the most valuable requirement is the 12-month refund policy. According to Avon, this is not enough. And I agree.

The DSA has invited people to propose changes to the Code. Here’s a start. Call it “The KT Optimus-Prime Plan” (everything is better when you use Transformer names).

(1) Proper Customer Coding

I suggest that companies be required to offer an option for Customers to receive product discounts without joining. The technology exists. The most basic of startup companies in the industry can pull this off. The Preferred Customer concept has been around for at least 5 years, possibly longer. Today, it’s a great source of confusion when we, as an industry, say “We’re not able to deduce the amount of customer activity because many people join to save money on product.” While it’s a true statement, we’re in a position to clear this ambiguity and offer clean data. The alternative is nebulous and unprovable (short of paying for surveys, which has been done by Herbalife). Understand, it’s not illegal to operate without a preferred customer option. The absence of a customer option is not conclusive proof of fraud; thus, it’s not legally required. But, in my opinion, the DSA should not want to swim with average, they should strive to be above-average. Currently, the 12-month refund requirement is good, but by itself, it’s not good enough. There’s a cancer that has developed where companies, using the DSA’s Code, are “looking good” without actually being good.

Requiring that companies clearly track their buyer motivations / offering a clear path for customers will help eliminate all doubt regarding the motivations driving volume consumption. There’s no need to mandate the AMOUNT that needs to come via customers, just to have the ability to clearly track the data.

Also, along these same lines, when it comes to direct sales i.e. belly to belly sales, there needs to be a requirement that companies accumulate receipts from their sales leaders. The excuse that “we’re not able to track the retail activity in the field” needs to end. In the past, the excuse was reasonable. Going forward, it makes little sense.

The downside (or upside, depending on how you view it): regulators, via a subpoena, will be able to clearly see the amount of customer activity.

An argument against this concept: “When people join to save money on product, they might turn out to be productive distributors later.” In my opinion, the likelihood of these participants producing significant volume is slim; thus, the upside is not worth the alternative.

(2) Zero Personal Volume Requirements

This should be easier than the #1 idea above. It’s common for companies to require personal volume each month for participants to earn commissions i.e. move $100 worth of product to remain qualified for bonuses. While companies are smart enough to construct this in a way where it’s technically not required for people to buy the product (because they can qualify by SELLING too), in most cases, participants get on autoship and self-qualify. This is not illegal; however, the concept has been abused. It leads people to buy things they might not otherwise want or need in order to remain qualified for bonuses.

This sort of rule would be consistent with the current state of the law. In BurnLounge, the court cited the fact that participants were required to purchase products in order to qualify for commissions. This fact was used to prove that the participants were buying products primarily to qualify for money instead of the value. While companies today can argue that participants are technically not required to buy, BurnLounge also teaches us that courts and regulators will look at how companies “operate in practice.” If the vast majority of participants qualify via an autoship, it matters not what’s on paper. It’ll be used as proof to show that the opportunity is driving consumption, not the products. Yes, it might be more difficult for companies to get participants to buy products. But if participants do not WANT to buy product, why force them? The DSA, in my opinion, should create space here.

(3) Income Disclosure Statements

The DSA should require its member companies to publish average earnings. We know that EVERYONE makes income claims in the industry. When recruiting, the question always comes up: “What’s in for me?” The pay plan has to be explained, which means that income will be referenced. It’s not illegal to make income claims. It is, however, misleading to make income claims WITHOUT ADEQUATE DISCLOSURE. With this in mind, why allow companies admittance without a solid income disclosure document?

(4) Undisclosed Financial Arrangements

It’s common in the industry for a company to offer additional compensation to leaders in exchange for them leaving another company. While the agreements never explicitly say “We’re paying you to leave Organization X and raid your old downline,” they might as well. This sort of behavior has spun out of control, causing companies to rip into each other and there needs to be a clear signal at the highest levels that this will not be tolerated.

First, the FTC’s Testimonial and Endorsement Guidelines strongly suggests that these sorts of undisclosed deals are fraudulent. I wrote an article on the subject in June of 2010 here.

Second, these sorts of deals are not illegal. It’s only a problem when there’s no disclosure. If the DSA were to require that these deals be disclosed, it might actually curb the activity.

Third, these sorts of deals are bad for the industry because, candidly, they rarely make economic sense. The leader leaves, boasts about the greatness of the new company, takes very few people with him or her and subsequently crashes. This leaves hyperbolic activity in the industry where companies are trying to out-hype each other.

Fourth, the DSA’s Code Administrator, when put onto the case, can easily deduce if a deal has been struck and whether the deal was publicly disclosed.

(5) Compliance Training

Rule 11 in the Code of Ethics states: “Member companies shall provide adequate training to enable independent salespeople to operate ethically.” But what does this mean? If companies are going to be allowed to sell starter packs ranging in price between $500 and $2,000, there needs to be solid training to ensure that the inventory moves properly. Compliance training can be delivered a number of ways: videos, email blasts, etc. If a new distributor was promised easy money, the time to cure this false expectation is at the beginning of their tenure. This is where the company can explain its refund policy, explain that success takes work and also reference its income disclosure statement. And, if the company were confident, it would be a great opportunity to suggest that if the distributor wants easy money, they should quit now and get a refund.

(6) Sales Aides

The Code needs to improve in this category by clearly prohibiting the practice of paying commissions on sales aides. First, it’s clearly pyramiding. Sales aides are not commissionable because there’s no market for the products beyond the network itself i.e. there’s no opportunity for customer sales, i.e x 2 the resulting rewards are “unrelated to product sales to ‘ultimate users,’ i.e. x 3 it’s pyramiding. The Code tries to create space from this practice by saying, “This Code provision is not intended to endorse marketing plans that provide financial benefits to independent salespeople for the sale of company-produced promotional materials, sales aids or kits (“tools”).” The Code needs to revisit this issue and address it head-on.

If the company, or its leaders in the field, sell tools and pay commissions on those tools, they need to adjust or get out. Tool sales are highly profitable, leading sellers to focus primarily on recruiting new participants to expand the market for those tools (because there’s no market outside the network itself; thus, recruiting is the only way to maximize profitability). It leads to a twisted culture in the field, one that depends on hype and hyperbole. The DSA needs to create space here.

Conclusion

It’s time to have an honest discussion about the future of the industry. Candidly, it’s BEEN time for several years. But, it sometimes takes a good crisis to mobilize support for change. Avon’s departure is a good catalyst for this sort of discussion. I’m not a fan of closed door meetings. Transparency is key. And transparency, at times, makes people uncomfortable. If you know me by now, you know that I’m not one to “kiss the hand” and play political games. In other words, I’m not trying to be liked by everyone.

Leadership at the DSA needs to understand that building a consensus on any of these issues is going to be impossible. In order to “tighten the screws,” it’s going to frustrate some member companies. It needs to prepare itself for a little internal-controversy. Candidly, the DSA avoiding some of these issues has also frustrated members, leading to Avon’s departure. Avon was not a fluke. While this subject matter is unpopular, it’s very important for the health of the industry. I think the best ideas come by way of open discussion. And I’m not afraid to lead it.

Do you agree with any of the “KT Optimus-Prime Plan” items referenced above? Disagree?

Don’t be bashful. Share your thoughts and share this article.


Avon Writes Open Letter to DSA Members Regarding Its Decision to Leave

Avon has recently announced its exit from the Direct Selling Association.  The video includes my thoughts. This is a very significant development and represents extreme discomfort experienced by companies in the industry. The reasons for Avon’s exit. I’ll sum it up: (1) They’re not feeling the love. They feel as though other companies, the companies that do not quite match Avon’s values, are setting the DSA’s agenda; (2) They’re not happy with the current Code of Ethics. They feel it should be updated and that the current Code has too many holes; thus, minimizing the effectiveness of “self regulation.” Watch the video. Read Avon’s letter. This is an important subject to process.

Beginning of letter (h/t to Matt Stewart for transcribing the letter)

To our U.S. direct selling colleagues,

At Avon, we strongly believe in the power of direct selling to enhance people’s lives. Our entire business model is based on our commitment to helping women build better lives for themselves and their families. And we know that multi-level marketing, in some markets and with the appropriate guardrails, is a robust and effective channel for distributing products to consumers.

As you may be aware, this week Avon made the decision to exit the U.S. DSA. This decision came after careful consideration and more than a year of thoughtful discussion. This decision was driven by two key issues:

• We believe the association’s agenda in the U.S. is overly focused on the issues of a few specific brands rather than industry-wide challenges.

• We believe that the U.S. DSA Code of Ethics requires updating to better reflect the current state of the industry in the U.S.

As the U.S. DSA is currently operating, we do not believe that either of these issues will be addressed.

Like any industry, direct selling and multi-level marketing evolve and the associations that support the direct selling industry need to evolve as well. As one of the largest direct selling companies in the world, we at Avon feel that it is our duty and responsibility to protect those just starting out in the industry, as well as those who have made careers as independent direct sellers.

In the U.S., we believe there is a need to enhance the DSA Code of Ethics to better ensure that individuals entering direct selling have the benefit of adequate safeguards. If and when these issues are better addressed by the U.S. DSA in a way that is supportive of the industry as a whole, we would re-consider our membership.

Avon is not exiting the World Federation of Direct Selling Associations (WFDSA}, local market DSAs, or other direct selling trade organizations outside of the United States. We continue to believe that industry associations play an important role for Avon and you, our direct selling peers.

As it relates to Direct Selling Associations (DSAs} around the world, Avon has a long history of involvement. In fact, we were a founding member of many of these organizations. The Direct Selling Code of Ethics, as administered by the DSAs, is a key component of the industry’s self-regulation.

Accordingly, Avon abides by the World Federation of Direct Sellers “Code of Ethics.” There are three major aspects of our business model that we believe further safeguard our Representatives and consumers.

1. The Avon business model does not rely on nor does it encourage sales of inventory, training or business support materials between Representatives. The     core of our business model is Representatives selling our products to an end consumer.

2. Avon has reasonable return policies.  Representatives are not left holding excess inventory.

3. Avon limits earnings to three generations. We do not promise commissions on infinite sales. Rather, we primarily promote and incentivize            Representatives based on their sales to Customers.

By adhering to these principles in every market where we operate, we protect our Representatives and help ensure new recruits have a positive experience with direct selling.

It is also important to consider how consumers view direct selling. Avon’s message to consumers is:

At its best, direct selling is “I tried the product. I liked the product. I recommended it to a friend.” If you are considering entering direct sales (or ‘social selling’) here are three tips to remember:

1. Like the product! Make sure it’s a product you use and enjoy yourself. You will be selling to your friends, family, neighbors and co-workers.

2. Understand the product. All good direct selling/social selling companies will provide training and mentoring support. But you should not need to invest heavily in start-up training and marketing materials.

3. Know who you are buying from and who is paying you. When ordering product for your customers, make sure you will be purchasing from the Company, not the individual who recruited you into selling, and that your earnings will be paid by the Company.

With over $32 billion in sales in 2013, direct sales continues to be a vibrant and growing industry in the United States. Every day, people across the country looking to earn extra money are signing up to become direct sellers. These women and men are hoping to build a business, unlock additional earnings, start a college fund for their children, buy a new car or simply supplement their current income

For well over a century, Avon has been committed to assuring that direct selling remains a viable option for individuals looking for financial empowerment. Our commitment to our Representatives today and in the future will not waiver.

Cheryl Heinonen

Senior Vice President, Corporate Relations & Chief Communications Officer  Avon Products.

Avon Exits the DSA

Memo by Hedge Fund Manager Robert Chapman: Bill Ackman’s Attempt to Goad Regulators Into a Baseless, Unnecessary Legal Battle

The attacks on Herbalife have been staged on many fronts.  Almost two years into Ackman’s bear raid against Herbalife, the clock is ticking and Ackman undoubtedly needs a government bailout / regulatory action against Herbalife.  Ackman’s thoughts about those on the long-side of $HLF: they’re all idiots.  Kenny Moelis, Bill Stiritz, Carl Icahn, Joele Frank, Boies Schiller, PWC, “uneducated” Herbalife distributors….all operating with inferior minds to his own.  Do Ackman and his gang have an explanation for the 0.25% rate of return on Herbalife products (which offers a 100% buyback)?  Sure they do. It’s magic.  I’m not kidding.  Brent Wilkes, director of a Latin American advocacy group, attributed the low rate of return of inventory to a “magical hold” Herbalife has over its distributors.  In other words, consumers, if they were thinking clearly, would demand more refunds.  

This is not even the tip of the iceberg on the elitist logic used by MLM critics.  Lately, the “influence-by-insult” strategy has been directed towards federal regulators.  With titles like “Does Herbalife Think The FTC Is Dumber Than A Bag Of Hammers?,” the critics are directing their ammo at regulators.  In other words, if the FTC fails to intervene, they’re “asleep at the wheel” and stupid like the rest of us.

Robert Chapman calls out this strategy in a very well-researched memo.  With his permission, I’ve included the full content below.  The actual PDF can be downloaded here.

Begin memo

DATE:            August 8, 2014

TO:                  Herbalife Regulators and Related Parties

RE:                  Bill Ackman’s Attempt to Goad Regulators Into a Baseless, Unnecessary Legal Battle

Introduction.  As has been covered widely by the media, Pershing Square Capital Management’s Bill Ackman has been engaged in a nearly two-year campaign to profit by putting Herbalife out of business.  Ackman’s goal appears quite obvious:  to add $2 billion to Pershing Square’s and his own wealth while feeding his apparently insatiable appetite for ego and reputational aggrandizement.  The first goal – earning profits for himself and his investors, is the cornerstone of legal and socially acceptable capitalism.  As such, it deserves no rebuke.  However, Ackman’s unconventional method of accomplishing that profit goal – making what I and an indisputably respectable list of Herbalife institutional and individual investors view as a seemingly endless string of false, exaggerated, and/or misleading statements via an unprecedented $50 million “research” (propaganda) campaign–  is worthy of the high volume of criticism it has received.

My Motive.  Unlike Ackman and his gang, I shall not attempt to obfuscate the motive underlying this communication, nor will I make false claims about what conclusions I believe the short sellers have drawn.  Unlike the short sellers preposterously stating that the shareholders of Herbalife believe it to be an illegal operation, I shall not baselessly state that the short sellers of Herbalife believe it to be a legal operation, although there are various signs that Ackman belatedly has come to realize that is the case and thus shall pivot next to goading lawmakers into changing the law itself.  I shall state my motive honestly and clearly: to portray accurately my view of this last ditch tactic being used by Ackman and his gang – to goad and attempt to shame regulators into a baseless, unnecessary legal battle against Herbalife.

Desperate Situations Require Desperate Measures.  Having incurred an estimated $200 million – $400 million in realized and unrealized losses on this one investment, Pershing Square finds itself in a fragile reputational position.  Particularly following Ackman’s unapologetic yet highly influential role in the dismantling and near bankrupting of 100-year old retailer JCPenney, his status as an investment superstar is in further jeopardy with Pershing Square’s Herbalife debacle, which unlike massive money losers JCPenney or Target, is far from over. Having proclaimed ubiquitously that Pershing Square’s research on Herbalife had led to this “best investment idea ever,”  — this despite Ackman’s reported decision not to have even one meeting with Herbalife management before launching his bear raid in December 2012 — his reputation, and potentially his franchise should there be legal repercussions, is on the line.  Indeed, the investment and regulatory worlds appear to be converging on an agreement that Ackman’s claims vs. Herbalife are mostly wrong.  Moreover, there exists no shortage of those who believe that Ackman now appears to know that his emotionally fraught analysis was and remains “wrong.” Even so, he persists in a quixotic and  most un-valiant holy war against an enemy of his own fabrication.

Ackman’s Final, Desperate Strategy:       Goad/Shame the FTC into a Self Serving, Baseless Legal Battle

  • Goading/Prodding Just the Latest Tactic at Manipulating Regulators:  It is no coincidence that Bill Ackman kick started his July 22nd Herbalife-bashing presentation with John Hempton’s thoughtless categorization of the global nutrition products company Herbalife as “scumbags” in a 2012 CNBC interview.  Ackman’s nutrition club presentation followed Bruce Craig’s letter from the day earlier to FTC Chairwoman Edith Ramirez, in which the anti-MLM campaigner went over the heads of both FTC Bureau of Consumer Protection (CPB) Director Jessica Rich and FTC CPB Marketing Practices Director Lois Greisman in an overtly hostile attack.  Essentially, Craig publicly accused Ramirez subordinate Jessica Rich of having the wrong priorities (based on a March 2014 speech whereof in a MLM clampdown was not highlighted) and preposterously seemed to categorize her subordinate Lois Greisman as a feckless shill for the MLM industry, based apparently on the absurd theory that since her prior boss at the FTC was Amway’s lawyer, she must be aligned with the MLM industry herself.  I can only imagine how Ms. Rich and Ms. Greisman felt when they read how they were being depicted by Ackman ally Mr. Craig to their own common boss.
  • The Order Apparently Has Been Sent Down from Pershing Square:  Very recently and non-coincidentally, one can hardly read any of the myriad Seeking Alpha “articles” or other short seller propaganda without recognizing an obvious pattern of the short sellers trying to shame the FTC into shutting down or otherwise impairing Herbalife.  In the most recent post by Bill Ackman’s close personal friend and Herbalife short seller Whitney Tilson, Tilson claimed that many of Herbalife’s investors “concede the company is deceptive, but invest because they think regulators are spineless.”  Tilson is surprisingly shameless in displaying his coopting of Ackman’s “goad the FTC” tactic.  As one of his correspondents (per Tilson’s own concession) wrote to him on July 26 and then published proudly by Tilson, “I believe you are correct that the regulators will ultimately be goaded into action.” Tilson’s correspondent then took a shot at goading the regulators himself:  “Many of our regulators are not fond of complex cases and hard work.”  One can expect more disrespectful propaganda like this coming from those who stand to strike it rich by maiming or dealing a “death blow” to Herbalife.  They indeed seem willing to try virtually any tactic to manipulate the markets, media or regulators to that dire end.
  • Short Sellers Must Know Their Claims Are False:  The short sellers are spreading these transparently manipulative and, in my view, knowingly false depictions of the true investment thesis of Herbalife’s investors.  The true long/bullish thesis I actually do hear is that the Company is a legitimate, legally operating global MLM selling products desired and purchased by ultimate consumers, both internally and externally.  Again, whether it be D.A. Davidson’s (Tim Ramey) or Barclays (Meredith Adler) with their in-depth sell-side research, or 19% Herbalife owner Carl Icahn’s repeated public statements that he believes Herbalife is a legitimate, legally run company selling products that help people worldwide, there is not a single Herbalife investor amongst the many with whom I have spoken who ever has indicated in any way that Herbalife is ‘deceptive’ or ‘fraudulent’.  Even John Hempton’s careless choice of words in 2012 was intended to convey his view that the MLM industry has participants, including some distributers of Herbalife products, who are overly aggressive and opportunistic.  Moreover, that singular statement, no matter how taken out of context by Bill Ackman, did not represent anyone but John Hempton’s apparent view at that particular time.
  • Short Sellers Insult the Regulators’ Collective Intelligence:  The irony and hypocrisy of the Herbalife Short sellers vis-à-vis the MLM’s regulators is nothing short of astounding.  Ackman and his cabal of profiteers are not dissimilar to a small but high pitched gang of school yard bullies who repeatedly egg on an honors student to start a fight by shouting, “Come on!  He called you a wimp!  You really gonna take that?”  As I shake my head in disbelief, I wonder how Ackman & Co. actually believe that these truly sedulous regulators, who have a history of taking on the likes of the Mafia, international drug dealers and money launderers, possibly could be goaded into doing the short sellers’ bidding with this patently obvious shaming tactic.
  • Charming, Cajoling, Overwhelming, Bullying and Now Goading and Shaming Regulators:  In mid-late 2012, nearly two years ago, it appeared that Bill Ackman began his version of a charm offensive with the FTC, SEC and other state regulators.  Exhibiting a typical lack self-awareness, Ackman essentially told the FTC, the SEC, and state regulators that Pershing Square was doing these regulators a huge favor by blessing them with his propriety analysis that supposedly proved Herbalife to be a “criminal enterprise.”  Again, allow me to emphasize, Ackman essentially accused these regulators of having been asleep at the switch for nothing short of decades, and, as such delinquents, they all require Pershing Square’s collective perspicacity to finally do their regulatory jobs.  When his unique form of enchantment predictably failed, Ackman moved on to overwhelming the regulators with a deluge of documentation estimated into the thousands of pages.  As that tactic did not attain the immediate prosecution Ackman sought, Ackman moved onto his well-practiced approach of bullying, enlisting a relatively small segment of LULAC and a U.S. Senator to replace his own public face of his war.  In March this year, some 15 months after his first public presentation, Ackman’s final bullying thrust seemed to pay dividends when the FTC launched the formal investigation for which Ackman had agitated.  However, there is a great distance between the investigation and shutting down of Herbalife, as the now 1.5 year SEC investigation exhibits.  One may want to ask the following hypothetical:  “What might Ackman do if the SEC has turned its focus on Pershing Square and/or one of its current or former employees involved in Herbalife? What theoretically might Ackman do if he begins to sense that the results of the FTC investigation were heading toward actually vindicating rather than crucifying Herbalife? Might Ackman and his gang then begin to goad, prod and attempt to shame the FTC into a fight that was baseless and solely served the interests of those who have sold short Herbalife’s stock?”  This is precisely what I believe is happening.
  • Regulators of Herbalife are Diligent, Not Spineless:  At the risk of stating the obvious, every bull on Herbalife shares I know thinks the FTC/SEC/AGs/DOJ are anything but spineless.  Instead, they are extremely diligent in prosecuting truly illegal, endless chain pyramid schemes that primarily compensate distributers for ENROLLING their downline (vs. selling product/inventory to that down line).  The FTC, and the Illinois, Kentucky and North Carolina attorneys general hardly were “spineless when they worked for years together ahead of halting truly illegal pyramid scheme Fortune High Tech Marketing.  For over half a decade, the FTC investigated and then prosecuted truly illegal pyramid scheme BurnLounge, successfully pursuing justice through 2014 all the way to the Ninth Circuit Court of Appeals. The diligently laboring Securities and Exchange Commission (SEC) hardly was “spineless” when it slapped TelexFree with a lawsuit on charges it sold fraudulent and unregistered securities to mostly Brazilian and Dominican immigrants, who served as its promoters.  New York Attorney General Eric Schneiderman, amongst a plethora of other effective and legitimate law enforcement, ferociously has pursued enforcement against the High Frequency Trading players, whose business model involves front running the investments made indirectly and directly by America’s hard working citizens.  California Attorney General Kamala Harris has risen to superhero status on a national scale for her hard charging battle against the nation’s top banks to win a $20 billion settlement for mortgage fraud.  This is but a tiny sample of many examples of strict, appropriate enforcement.  The list of “fully spined” regulators and their persistent pursuit of justice via the prosecution of legitimate, non-falsified or fabricated cases is truly endless.  Therefore, I apologize for the many I failed to include in my list above.

ConclusionThat regulators refuse to be cajoled, bullied, prodded, goaded and “shamed” into pursuing Bill Ackman’s profiteering and self- aggrandizing agenda does not come anywhere close to making them “spineless.”  This is so obvious that any reasonable observer, Herbalife investor or otherwise, would have to agree. Bill Ackman and his compliant operatives should feel ashamed for their transparent attempts to manipulate not only the markets[1], but those who assiduously and honorably have been regulating them for decades.

[1] Herbalife’s illiquid convertible bonds (2’s of 2019) in the past few weeks have been sold down aggressively and disproportionately to the common stock, with some speculating that Pershing Square directly or indirectly (via CDS bidding) having influenced their lower pricing to create the appearance and related media “reporting” of a symptom of financial distress, despite the company’s healthy debt service coverage.

End

FTC Settles with TriVita. Is the word “Inflammation” off limits when you’re selling a health product?

InflammationThe FTC has spoken and we better pay attention. Recently, the FTC announced a $3.5M settlement with TriVita, a network marketing company. TriVita is an Arizona corporation that advertises, markets, distributes, and sells Nopalea. Nopelea is a nutrient rich drink derived from the superfruit of the Nopal cactus. TriVita peppered the marketplace with an aggressive marketing campaign that touted the curative properties of Nopelea. The theme of the advertisements: Nopalea is a drink that will reduce bodily inflammation, which will lead to a reduction in pain associated with inflammation-related diseases.

In May, the FTC obtained an Injunction against TriVita because of the aggressive claims. In the lawsuit, the FTC found the following claims about Nopalea offensive:

• Significantly reduces or eliminates the effects of inflammation on the body
• Provides significant relief from pain, including but not limited to, chronic pain, joint pain, back pain, nerve pain, phantom pain, and pain from inflammation, arthritis, fibromyalgia, surgical procedures, or other conditions;
• Significantly reduces or relieves swelling of joints and muscles;
• Significantly improves breathing or provides significant relief from respiratory conditions, including but not limited to, sinus infections; or
• Provides significant relief from skin conditions, including but not limited to psoriasis.

The FTC found these claims to be disease claims. The FDA defines disease as “damage to an organ, part, structure, or system of the body such that it does not function properly (e.g., cardiovascular disease), or a state of health leading to such dysfunctioning (e.g., hypertension).” Under this definition, a common cold is considered a “disease.” Basically, if an ingredient is marketed expressly or implicitly as having any kind of positive effect on a disease (as defined above), it’ll be treated as a disease claim and subject to further regulations/penalties.

As a result of the settlement, TriVita has agreed to pay a $3.5M fine a refrain implying that its product can be used in the treatment of any diseases.

Regarding the product claims above, they’re obviously over the line. References to diseases like arthritis, fibromyalgia, sinus infections and psoriasis are obvious examples of what not to do.

But what about inflammation?

If a company states that a product can limit the effects of inflammation, is that considered a “disease claim.” In this article by MonaVie, the word “inflammation” is referenced 16 times. Vemma went so far as to commissioning a report on Vemma’s affect on inflammation. I’m not picking on MonaVie and Vemma, I’m just referencing the links to show that it’s quite common for juice companies to talk about their products’ affect on inflammation in the body.

The big question is whether “inflammation” is now in the government’s little black book of unusable words. Based on their position in this case, it would certainly seem to be the case. While one could argue that TriVita was not sued SOLELY because of their use of the word inflammation, it was certainly a strong factor.

If a company promotes a product as an anti-inflammatory, the logical conclusion is that the field will take it one step further. While “inflammation” by itself is not a disease, the easy association of the word to several ailments will result in the inevitable (and predictable) disease claims. The field will naturally explain that inflammation is a leading cause of various diseases, with arthritis and fibromyalgia being on top of the list.

TriVita was too aggressive. Nopalea was advertised as a product that could do more than alleviate ailments, it was advertised as a product that could treat and cure. TriVita, and its field leaders, marketed the product explicitly as one that can mitigate horrible disease symptoms. They portrayed their product as the Ferrari of all anti-inflammatories.

Takeaway

The FTC is taking its job seriously. If a company is going to play in the gray with the word “inflammation,” it’s playing with fire. Again, “inflammation” might not be a disease by itself; however, it’s going to be nearly impossible to prevent field leaders from taking it to the next level. If a company insists on keeping the word “inflammation” in its marketing literature, it needs to take EXTRA precautions to ensure that the field is not extrapolating the message and stating that the product can cure or mitigate diseases associated with inflammation. This is where compliance enforcement is critical i.e. disciplining people when infractions are observed.

Bottom line: While it’s treacherous water to promote a product as one that can reduce inflammation, it’s not illegal to swim there. If the FTC or FDA releases a clear statement regarding their thoughts on whether “inflammation” is an actual disease, I’ll update this article. In the meantime, companies need to tread cautiously. Candidly, I would advise my clients to stop using the word “inflammation” because the message in the field is nearly impossible to control and the downside is too great.

What do you think? Do you think this is a fair outcome for TriVita? Should the word “inflammation” be a privilege only allowed by FDA approved drugs?

MLM Startup Conference, Direct Selling Edge #9, On September 4th

DS Edge - Nashville | MLM Startup

On September 4th, it’s a great time to be in Nashville, Tennessee!  We’re once again hosting our MLM Startup Conference, the Direct Selling Edge.  Click here to purchase your tickets: DS Edge.  Use the promo code: LEGAL-EAGLE.

This two-day educational conference is the best for new and young direct selling companies because the quality of the content presented is excellent. It is pure education….with the exception of one night on the town if you’re interested.

We cover a lot at this conference

You’ll learn….

  • what recent Federal Trade Commission decisions means for you
  • best practices and step-by-step instructions for creating an ethical and effective presence in the social media landscape
  • the legal limits for raising capital and the legal rights inherent with stock ownership
  • the differences between different types of compensation plans and how to assess which plan type is best for you
  • the ABC’s of successful recruiting
  • how to select the right MLM software
  • why you need to have a distributor compliance system for your network marketing or party plan company
  • all about sales tax, 1099′s, unclaimed property reporting, and state income taxes

and more!

Personal Appointments

At the end of each day, from 5 until 7 pm, you’ll have the opportunity to meet with conference speakers for 20 minute appointments at no additional cost!

Where?

The Direct Selling Edge Conference will be held in Franklin, Tennessee (just 20 miles from Nashville) at the Drury Plaza Hotel Franklin on Thursday and Friday, September 4 and 5, 2014.

Built in 2012, the new 338-room hotel offers a daily free hot breakfast, free soda and popcorn, free food at 5:30pm, free local and long distance calls, free parking, and a microwave and refrigerator in every room.

We’ve negotiated excellent rates for you. Click this link to reserve your room:  https://wwwc.druryhotels.com/Reservations.aspx?groupno=2212903

Questions? Shoot me an email at: [email protected]  I hope to meet you there!

MLM Attorney, Kevin Thompson, on Bloomberg TV

I had the privilege of being on Bloomberg for a small segment talking about Bill Ackman’s latest presentation. The 7-minute segment can be viewed above. Ackman’s presentation today, if you can spare 3+ hours, can be found here.

Before summarizing his argument, it needs to be said that he heavily promoted this presentation yesterday. He was like Muhammad Ali talking about the Thrilla in Manila, saying it was “the most important presentation of his life.” He further said that this would be the “death blow” to Herbalife. He successfully spooked the market, causing it to sink 11%. Instead of “conclusively proving fraud,” which was his intent, he ignited confidence in the market due to the lack of substance. After the presentation, the stock UP 25% (same day). I’m not making this up. Up 25% the day of the death blow. Only on Wall Street.

I’ll summarize his thesis:

    • Herbalife’s usage of “Nutrition Clubs” operates like a bait and switch for consumers.
    • The prospects are lured into the clubs on the auspices of hanging out with friends and sampling products.
    • These prospects are then pressured to “get on the treadmill” and join as distributors and recruit more people to visit the clubs.
    • The Club concept is designed to recruit, not to sell.
    • Herbalife’s stance that the clubs foster community efforts for weight loss is smoke and mirrors.
    • He goes further and argues that the positioning of some of the clubs as “success universities” is misleading because they’re not accredited as real universities.
    • He further argues that the Clubs violate various labor laws since the members are expected to help out in keeping the club operational i.e. free labor.
    • He argues that Michael Johnson learned of these strategies of penetrating the hispanic market while at Disney. In my opinion, he gave Michael Johnson way more credit than he deserved in this regard. The Nutrition Club concept was likely an invention in the field.

We discuss the presentation during the interview. Herbalife has issued its own response, including the findings from an economist about its model. Based on his data, he concluded that the vast majority of revenue is attributable to legitimate product consumption i.e. people buying for legitimate value. The data is significant, as it essentially puts the pyramid scheme argument to bed. If true, the majority of commissions are driven via legitimate economic activity by “ultimate users.” This is why, in my opinion, Ackman paid very little attention to the law today. I think he knows the law is not in his favor on a macro level with Herbalife. Instead, he was arguing the facts on a micro level, painting a picture that there’s a massive bait-and-switch occurring with the Nutrition Clubs. In his mind, if he can kill the Nutrition Clubs, he can kill Herbalife.

Commentary from me

Herbalife needs to avoid gloating. They sort of spiked the football today with their remarks. Yes, Ackman’s presentation went off like a snap bomp instead of the full scale firework show we were promised. But, with that being said, he’s certainly not someone to poke. He’s obviously emotionally charged on the issue. He cried on a few occasions during the presentation. In his mind, he sees himself as a “Superman” that needs to rescue these poor, hispanic citizens. While 93% of Herbalife Nutrition Club operators are happy with their experience (based on a recent survey), Ackman would argue that they’re under a trance that only he can break. Referencing the history of his great-grandfather that came to America from Russia, Ackman sees Herbalife as preying on people like his great-granddad, causing significant damage for future generations.

Bottom line: he’s amped up. And his puts expire in January of 2015, which means he needs to land a punch soon to get the stock to soften before he eats the loss. I think he’s done his worst to Herbalife. It’s now in the hands of regulators. Speaking of regulators, he did not provide them with any new ammunition today that they did not already possess yesterday. I stand firm with my initial opinion, made in January of 2013. Admittedly, I could be wrong. But I do not think the FTC will file an action against Herbalife. Instead, I think there’s going to be some sort of negotiated settlement that will involve some sort of penalty for past transgressions. They’re the Federal government…they’re going to find something. Give me Ackman’s investigatory budget of $50,000,000 and I’ll find dirt on whatever you want. The return on his $50M investment was anti-climatic and the market made him pay.

What do you think? What’s next for Herbalife? What’s next in Bill Ackman’s playbook?

(ARTICLE FEATURED IN SEEKING ALPHA) Battle Over BurnLounge: Both sides claim victory

Below is an excerpt from my article about the Ninth Circuit opinion on BurnLounge.  The article can be read in full over at Seeking Alpha.  It’s an important subject.  Click here to read it.

Summary

  • The Court successfully threaded the needle on the issue of “ultimate users,” essentially creating two classes of participants.
  • The Court provided several factors throughout the opinion to help outsiders deduce the motivation driving consumption. This is especially helpful in assessing $HLF.
  • The Opinion will require the FTC’s pyramid scheme expert to create another analytical framework to distinguish pyramid schemes from legitimate direct selling companies (assuming they need one).
  • The Court adopted the logic provided by the FTC in its 2004 Staff Advisory Opinion.
  • The Court eliminated all confusion regarding Omnitrition as it completely ignored the widely referenced dicta that consumption from participants cannot count as sales to “ultimate users.”

On June 2nd, 2014, the Ninth Circuit published its long awaited BurnLounge Opinion. Within hours, both sides of the Herbalife battlefield issued statements claiming victory about the decision. I’ve taken the week to process the opinion. During this time, I’ve tried to keep up to speed with the online chatter regarding various interpretations. One thing is clear: the gray space in MLM law separating legitimate direct selling companies from pyramid schemes has been minimized considerably.

On the one side, Bill Ackman’s Pershing Square spun it as validation of its argument that commissions in the Herbalife plan were derived primarily by opportunity driven demand (recruitment rewards) instead of legitimate product consumption. On the other side, the MLM industry (myself included), breathed a sigh of relief, submitting that the decision validates a lot of our main points in responding to common criticisms of the model. This article is intended to cull out the key nuggets in the BurnLounge decision and interpret what it means going forward.

End of Excerpt

Click here to read the rest of the article on Seeking Alpha.  Seeking Alpha is a news site dedicated to publishing content about publicly traded companies.  The article took me quite a bit of time to prepare.  I hope you find it informative.