by on January 1, 2013 27 Comments

Herbalife: Why I Made It a 35% Position after the Bill Ackman Bear Raid

This is a guest post prepared by Robert Chapman. Chapman is the founder of Chapman Capital LLC, which is a Los Angeles based investment company specializing in takeovers and turnarounds. In 2000, Chapman Capital was an activist versus Herbalife following the death of Herbalife’s founder Mark Hughes. This is an amazing article. It’s well-researched and easy to understand.  If you’re remotely curious about the future of Herbalife after Ackman’s attack, the mechanics of short selling and the potential value of Herbalife’s stock, this is a MUST read. If you find this article informative, hit the +1 or Like buttons above. Sincerely, +Kevin Thompson

Note: Note: Below is the opinion of Chapman Capital LLC and is not a recommendation or an indication of Chapman Capital’s current or future intent to buy, sell or otherwise transact in Herbalife common shares.

Update: Robert Chapman made some slight revisions to the article. His points are the same; however, he made a few stylistic changes.

As anyone even remotely connected to the world of multi level marketing is surely aware, the perpetually sanctimonious Bill Ackman and his extremely successful investment advisory firm Pershing Square formally launched a massive bear raid on Herbalife (HLF) on 12/20/2012, conducting a 3+ hour, media-packed, web-streamed 300+ PowerPoint slide deck presentation in New York after first selling short 20MM HLF shares for as estimated $1 billion plus in proceeds.   In his presentation and numerous interviews with the business media that day, Ackman declared a target price of zero for HLF’s shares.  In other words, he claims to be so convinced that Herbalife operates an illegal pyramid scheme, he is certain that government authorities and/or HLF’s distributors/salespeople/customers will shortly put the company out of business.

SUMMARY INVESTMENT THESIS: Despite beguiling and specious reasoning, Ackman will fail to influence/cause a material regulatory response or a HLF distributor exodus. Consequently, he will suffer a merciless short squeeze, catalyzed and augmented by a fast and furious combination of HLF share count shrinkage (buyback) and excellent operating performance (beat and raise dynamic).

REGUATORY SUMMARY: FTC has been there, done that.

The Ackman Tell. Many poker games are won and lost upon that infamous turning point when a player properly reads his opponent’s “tell.” To wit, I am confident that during an interview with CNBC’s Andrew Ross Sorkin on “D-Day” (12/20/2012), Bill Ackman slipped his “tell”, confirming my suspicion that he already realized the FTC wasn’t going to make his day by shutting down HLF. I strongly recommend all HLF traders/investors read the transcript of this interview, as Sorkin does a masterful job of fighting the media urge to genuflect before Ackman’s drawn down zipper, otherwise known as “The Whitney Tilson”. Specifically, Sorkin, after hammering Ackman, asked toward the end of this interview, “This is somewhat dependent on the FTC taking action. If they don’t, what happens?” Now, remember that Ackman’s entire thesis rests on his certitude (so he claims) that HLF is an illegal pyramid scheme, which the FTC has a mandate to shut down. If you were 100% certain (with 20% of HLF shorted in your funds alone) of this claim, wouldn’t your answer be, “There is no way the FTC doesn’t take action to shut down the illegal pyramid scheme run by Herbalife.” Instead, Ackman diffidently responds, “I think the FTC is going to take a very hard look. But I think most importantly the new distributor someone is trying to suck into the scheme will be better informed …”

The moment I read this response, after having researched HLF on/off since 2000 (when Chapman Capital had been an activist in HERBA/HERBB shares during Mark Hughes’ LBO efforts), I decided I had to place a monster long bet on HLF. I believe Ackman already had concluded the FTC wasn’t going to assist his crusade. Instead, he realized that he had to focus on existing and prospective HLF distributors, praying the media attention would have a materially deleterious impact on any decision to join or to continue with the HLF team. Indeed, without the FTC taking injunctive actions against HLF, Ackman’s crusade toward “zero” is doomed.

Here are key bullet points on the lack of real regulatory risk to HLF shares:

Internal Consumption Issue Already Clarified/Resolved by FTC in 2004: “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” is a quote from an FTC letter dated 01/14/2004. Essentially, the letter states that if a product is marketable, the FTC is OK with the MLM, making Einhorn’s 05/01/2012 call focusing questions on this internal consumption issue far less relevant than was (mis)understood.

FTC Material Adverse Actions Near Zero Probability:  during my due diligence, I spoke with the country’s top lawyer specializing in MLM/regulatory dynamics. During our conversation, he offered his legal opinion, pointedly stating that there won’t be any FTC injunction, much less any regulatory action to put HLF out of business (“hell freezes over before this happens”). If there is regulatory action of any kind, it simply will be some type of consent order/settlement addressing better disclosure.

Few Consumer Complaints:  the FTC has not received many consumer complaints on HLF products – only 37 in 2010, 36 in 2009, and YTD 05/2012 was only 18 (again around 40 annually).

HLF is Big, Time Tested Veteran:  the FTC can and will shut down companies violating MLM rules, just as it did BurnLounge (online music retailer) in 03/2012 and Equinox in 2000. While such action is rare, the FTC will act aggressively to shut down companies when it sees the need. During the 32 years of HLF’s existence, the FTC has yet to see the need to pursue Herbalife.

Ackman Relied Greatly on Old Cases, Leaving Out Material Facts – Ackman failed point out that the FTC has already commented about the relevance (or lack thereof) of the cases he referenced in his presentation. In fact, most of the post Einhorn reporting has been misleading information;

No Federal Clarity – lots of Grey:  No “bright line” federal statute against pyramid schemes; even the guy with jihad against MLM’s, Pyramid Scheme Alert’s Robert FitzPatrick, conceded that FTC decided too complex to regulate MLM’s in 09/2011 and other anti-MLM consumer protectors have as well; this MLM lawyer thinks DSA should fight for bright line federal standards to eliminate opportunity for short sellers to exploit the grey;

Vast Preponderance of Sales and Growth are International (i.e., Outside Ackman/FTC): 80% of HLF’s business overseas.

The DSA is an Effective Lobby: The DSA serves as a lobbying entity designed to protect the MLM industry from burdensome government regulations. It led a campaign in 2006 where 17,000 comments were submitted to the FTC, all requesting an exemption from the restrictive requirements in the Business Opportunity rule. The DSA was successful. The DSA is more powerful that Ackman’s ally, Pyramid Scheme Alert’s Robert FitzPatrick

DISTRIBUTOR SUMMARY:  “Bill who?”

Chapman Capital’s distributor surveys show no meaningful percentage of distributors had even heard about Ackman’s circus show. Moreover, their evangelical commitment to HLF and confusion as to what 300+ pages of PowerPoint means seem to be causing an acceleration of business growth. Ackman’s payment for Google Ads (pegged to “Herbalife” search) exhibits his desperation to influence distributors, efforts which appear to have negligible effect.

TAILWINDS — FAT TAILS AND BUSINESS BAILS  HLF has two secular tailwinds in its favor: lots of fat people (fat “tails”) and no shortage of structurally un/underemployed humans. In fact, one thought for a short in HLF to consider is the following: net/net, does the U.S. government benefit from fewer overweight Americans (lower insurance costs) and fewer people standing in unemployment lines (ever hear of a fiscal cliff problem with U.S. budget?)? If the U.S. government benefits from HLF’s impact on the country’s physical and fiscal health, while enduring only 40 complaints/year about HLF, why shut down HLF? Ponder that for a moment.

BACKGROUND: Short seller roadkill HLF shares were trading as high as $45/share on 12/14/2012, and had been over $70/share (a high teens P/E multiple) earlier this year before the highly respected investor David Einhorn of Greenlight Capital asked some leading questions on an earnings call that implied he was skeptical that Herbalife was operating within the Amway safe harbor guidelines for multi-level marketers. Fear of Einhorn’s excellent record of identifying overvalued short sale targets sent HLF shares into the $40’s in the spring. In contrast, Ackman has been somewhat vague as to when he built the preponderance of his short position (i.e., did he start before Einhorn’s 05/01/2012 questions or was he an unoriginal shadow to Einhorn’s trailblazing?), but I am guessing $50-55/share is his average short cost basis. There is no evidence Einhorn went short at that time or since, but I would be shocked if Greenlight would maintain HLF short positions anywhere near $30/share based on HLF’s international value alone.

Open interest on HLF puts accelerated and the stock’s relative weakness worsened in the fall of 2012 as, I suspect – No evidence here. I’ve just been around the block a few times – people “around” Ackman shorted HLF or bought HLF puts ahead of 12/20/2012 presentation. In fact, I have a pet theory that Ackman’s interest in going massively public was heightened (if not driven) by the HLF stock’s reasonably strong response (into mid-$50/share) attendant with impressive late July and October 2012 financial results. Essentially, my hypothesis is that Ackman, with overall 2012 performance impaired by JCP’s descent into the teens, came to conclude he needed a big winner before year-end 2012.

As word leaked into the market of Ackman’s intention to present publicly the bear case on Herbalife, the stock began a gradual decline, then fell suddenly from ~$41/share to $36/share in the closing market hours of 12/19/2012, when a CNBC reporter with big hair reported that market rumors were true. The next morning, as the PT Barnum of the hedge fund industry delivered his presentation in a New York hotel ballroom on 12/20/2012, and especially through the early trading hours of 12/21/2012 (a very illiquid trading day), the shares went into free fall, reaching a nadir of $24.40/share. My funds made their last purchases at $25.30/share in a brief but painful period of negative marks. HLF shares have since rebounded to ~$30/share as traders/investors have taken a closer look at whether the emperor is running around New York denuded (figuratively speaking . . . fortunately).

ACKMAN’S TIMING OF “INTEREST” Ackman’s end-of-same-year-that-Einhorn-showed-up timing was masterful – when it comes to the power of influence, only top hypnotists can compete. A classic bear raid involves creating abject panic in the market. Concurrently using the proximity to Christmas, the December option expiration, and the depth of his presentation, the Ackman impact on the shares was maximized. The last ten days of December are as quiet as it gets on Wall Street, with most decision makers leaving for vacation, drying up market depth and liquidity. Also, at the peak of the panic not many institutional investors felt the urge to have HLF show up in their 12/31/2012 Form 13-F filing. December is also the final month of HLF’s fiscal year, which puts them in a “blackout period,” prohibiting the company and insiders from repurchasing shares under the $950mm authorized buyback. Moreover, due to the extensive audit period that attends year-end, it will be several months before year-end 2012 results were reported. This blackout removes HLF’s most effective defense to the bear raid: executing a nearly $1 billion share repurchase authorization. Again, if timing is everything, Ackman is every woman (with a nod to Whitney Houston).

PERSHING SQUARE/ACKMAN RESUME:  Let’s review some history on Bill Ackman and Pershing Square, some color on the mechanics of short selling, and Herbalife’s response to the bear raid to date.

Bill Ackman manages a New York based hedge fund called Pershing Square with exceptionally good long-term results. Ackman is not known as a short seller. His fund is generally a long-biased fund. He achieved some notoriety for predicting that muni-bond insurer MBIA was undercapitalized, which eventually proved true during the financial crisis of 2007-2009. His enormous investment in General Growth Properties (GGP) at less than $1/share remains one of the most impressive brains/balls combinations I have ever seen. All the while, however, his ego seems boundless.

He is somewhat unusual among usually media averse hedge fund managers in that his strategy involves publicly trumpeting the merits (and genius) of his investments, which he generally holds for a long time. He manages a concentrated portfolio comprised of very few, very large investments. He also is considered an activist investor. He frequently badgers the board and management of the companies in which he invests with what start as suggestions and frequently escalate to demands as to how they should conduct their business, what their capital structure should be, and the composition of its board.

Though he will rarely, if ever, publicly concede, Ackman makes mistakes just like the rest of us, even catastrophic financial ones (e.g., call options on Target). Indeed, Ackman closed down a previous hedge fund advisory entity called Gotham Partners after he reportedly marooned his investment funds in an illiquid and devastating combination of a closely held REIT (First Union Real Estate) and a portfolio of golf courses (Gotham Golf) for which no exit was possible. So while Ackman is quite good at what he does for a living, his hubris makes him vulnerable to spectacular failure. He has a high financial IQ, but it may be the delusional and narcissistically 15 surplus IQ points he awards himself that have been, and may again be, his undoing. Think of him as the Reggie Jackson (I’m dating myself here) of Wall Street: he swings for the fences, but can cause a lot of pain and break a lot of hearts – or the bank – when he whiffs.

SHORT SELLING PRIMER: A bit more on short selling for those inexperienced in the sport. Short selling is a vital component of the markets. The ability of investors to sell short shares of overvalued companies keeps market valuations in check, and permits investors to hold hedged portfolios that are not dependent on constantly rising indices to make a positive return. There are risks, however, of going short that do not exist on the long side. For instance, if one purchases the shares of Acme Widget at $10/share, and Acme fails, you know precisely how much you will lose – your $10/share, and no more. If you were to short Acme Widget at $10/share and Acme were to discover a vast plutonium mine under their headquarters, those shares that were shorted at $10/share may have to be repurchased in the market at $100/share, $500/share, or even $1,000/share. The potential loss on a short sale is unlimited. For this reason, most professional long/short investors keep the size of their short positions much smaller than their long positions. For instance, if a core long position is 5% of capital, a core short may be 2%. Last week in Barron’s, famed short seller Jim Chanos discussed his lessons learned from the 1999-2000 internet bubble when he saw his AOL short go up eight times in value in his face. The lesson he drew was to keep individual shorts small relative to capital. Ackman’s $1 billion short in Herbalife is almost 10% of his reported $11 billion fund. If he is wrong, he may very well be putting his firm at risk due to the enormity of his short position relative to both Pershing Square’s and HLF’s size, and the potential difficulty of covering a short position of that magnitude in a “short squeeze”. Google the notorious Volkswagen/Porsche trade to see how dramatically these events can play out at the extremes.

To go short a company’s stock, one must borrow the shares to sell from a broker. Shorting without a proper borrow is called “naked shorting”, and is illegal. Holders of stock give their broker the right to lend out their shares in exchange for the flexibility of keeping margin accounts, and to participate in a portion of the fees short sellers incur for access to those shares. Short selling is conducted by the investor calling his broker, securing a borrow, and then executing the sale. Most companies have ample shares available to borrow, and this process yields little drama. However, in the case of controversial stocks, the demand to borrow shares may exceed the supply in the brokers “box”. If long holders sell shares brokers had out on loan to short sellers, the short seller must replace those borrowed shares he has lost access to with newly sourced shares. Should none be found, he will be forced to cover that portion of his position, and if unwilling to cover, the broker will involuntarily “buy him in”. This dynamic is what leads to short squeezes, where heavily shorted issues rapidly appreciate in the absence of any fundamental reason. Just look back to 2008 when the US government suddenly prohibited the shorting of financial stocks to see how painful that result can be for short sellers.

One effective defense for the short seller would be to have his broker contract on his behalf with a lender of shares to provide a quantity of shares for a specific term, at a negotiated payment. This insulates the short seller from buy-in risk for the duration of the contract. However, these contracts are individually negotiated, and somewhat rare. Also, they frequently permit the long holder to regain access to his shares if the company were to, for instance, conduct a self-tender offer for its shares. It is not known if Ackman has such an arrangement.

Ackman’s self-reported short position of 20 million HLF shares is over 75% of the reported short interest in Herbalife. At this point, the “borrow is tight” – there appears to be a near zero supply of shares available to sell short. The few brokers that will supply a borrow are charging as much as 20% of the value of the short annually for that access. This is a monster number – between the 20% negative-borrow and HLF’s dividend, it would cost nearly 25% each year to stay short HLF, all things remaining constant on those two variables.

HLF’s DEFENSE IS COMING:  Given the holiday timing, the best defense HLF has been able to muster has been to put a video of CEO Mike Johnson on its IR webpage defending the company broadly, and to schedule an investors’ day two weeks later, for 01/10/2013 in New York to address Ackman’s accusations in detail. The company has hired an impressive team of advisors. While most would have expected Bank of America/Merrill Lynch to get the assignment given their execution of last spring’s $400mm share repurchase, the task has been given to Moelis & Company, a well regarded, Los Angeles-based boutique investment banking firm. The firm’s namesake, Ken Moelis, is a disciple of Mike Milken from the height of Drexel Burnham’s power in the mid-1980’s. Moelis went on to a successful career at DLJ and UBS, where he became the premier investment banker to the casino gaming world, before launching his own shop.

Additionally, Herbalife has reportedly hired Boies, Shiller & Flexner the law firm founded by famed litigator David Boies. Consider Boies’ HLF team to be the Navy Seals Team 6 of litigation – you really don’t want them on the other side of your war. Note, I have no evidence that Bill Ackman is related to Osama bin Laden, and thus worthy of being targeted by DEVGRU (figuratively speaking, of course).

HLF promises a detailed rebuttal of the Ackman allegations on 01/10/2013, and I expect it will blow away the skeptics with a point-by-point dissection of Ackman’s claims. I presume Boies was brought on to bring suit against Ackman for some combination of libel, slander, defamation, tortuous interference and other imaginative causes of action. No matter how this turns out, the discovery, depositions and testimony should be highly enlightening and probably quite entertaining.

HLF’s DIRT CHEAP VALUATION:  So now, how might one value the shares of HLF in the bull case where Ackman is convincingly discredited by HLF CEO Johnson (a singular American bad-ass, according to my sources who know him personally here in L.A.) on 01/10/2013, and the market no longer ascribes risk to the feared FTC intervention (if I hear “headline risk” one more time …). EBITDA is a preferred valuation metric for a company like HLF that doesn’t have heavy capital expenditure requirements, and converts much of its reported earnings to cash that can be distributed as dividends or used to repurchase shares. Herbalife will produce over $725mm of earnings before interest, depreciation, and amortization (EBITDA) this year, a growth-stock worthy increase from $634mm in 2011 and $480mm in 2010. The few analysts that cover the stock project $800mm in 2013. Think of HLF’s gushing cash flow this way – HLF is printing EBITDA of over $2mm/day. That’s a heck of a lotta cheese with which to fight Ackman, who has and will be spending his own and his investors’ money on litigation and other matters (which won’t bother his limited partners until the stock is going up on a daily basis). HLF is lightly leveraged, with $500mm of bank debt, and quite liquid with $700mm of unused borrowing capacity and $300mm of cash. HLF currently pays $1.20/share in dividends annually on its ~108 million shares outstanding.

In the absence of controversy, the market would typically accord a fast growing, capital efficient company such as HLF a premium multiple. Let’s just assume the S&P 500 index current multiple of 8x EBITDA. This would yield a total enterprise value of 8x $725 of EBITDA = $5.8B. Deducting ~$500 million of debt, but giving credit for $150 of the cash (that is excess to the operating needs of the business), would yield a total equity value of $5.45B, which divided by the 108mm shares works out to $50.46/share. The current price of ~$30/share implies an EBITDA multiple of 4.7x. Tupperware, which is a MLM free from controversy, trades at 9.3x EBITDA, and Avon trades slightly higher. At $50/share, the share still would sport a dividend yield of 2.4%. Herbalife should report net income of about $4 per share this year and $4.50 in 2013 (ignoring the massive buyback I see coming). $30/share implies a 2012 P/E multiple of around 7x. The current S&P multiple is about 13x. For a company growing 15%+, you would expect to see a premium multiple, which is why brokerage firm analysts who cover the stock have target prices from $65 to $101. My valuation is lower, but should the Ackman-induced cloud be lifted, I can’t say those targets are absurd.

In fact, between the technical short squeeze that is in the making, the massively accretive impact of a $1B buyback, and the FTC risk fading away, I can’t say that I’d be surprised to see HLF trade back to its old highs of $70/share. If HLF has $500mm of 2013 net income, and buys back 30mm of around 110mm shares, the ultra-low interest rate environment makes the net income impact from interest expense miniscule (the HLF 13% EPS yield is 3-4x borrowing costs). Getting over $6/share in EPS is really not that hard to financially engineer, and between the short squeeze, comparable valuations, a below-market 11-12 P/E multiple would take HLF back into the $70s. Indeed, it could turn out even more financially salubrious than even these scenarios.

Ackman’s essentially fired nuclear missiles at HLF’s business model and its legality. When (and not “if”) HLF’s regulators and distributors essentially blow off Ackman’s claims as either old or no news, HLF will for all intents/purposes become bulletproof and battle tested. This may/should garner it a higher valuation than before Einhorn or Ackman ever showed up. That “what if” scenario gets you a $100/share stock price potential (again, only 15x $6-7/share in EPS gets you there; I’m not talking about a NFLX-level valuation here).

This hypothetical rally toward triple digits is not farfetched. In the event of a self-tender by HLF, or even without one, should the large institutional shareholders proactively remove their shares from the stock loan supply, there is great potential for short sellers being forced to cover as the borrow dries up. A panic to the upside could occur as the shorts are forced to buy in 25 million shares in a market unable to induce that many sellers. I am sure HLF and its capable teams of advisors are looking at the myriad of options to create value out of the chaos caused by this spectacular bear raid. Indeed, it does not take great imagination to see what could make these numbers dance.

In addition, Ackman has no shortage of enemies from my own polling of the audience. The odds favor Herbalife in this aspect of the battle. Ackman truly went all-in telling the world he has shorted ~20% of a relatively unlevered company trading at ~4x EBITDA.

BUT WHAT IF ACKMAN IS RIGHT?  His target price of zero implies the company is shut down globally, not just here in the US, which comprises only 20% of HLF’s global revenue. Is it possible? I guess so, but in my view no more than a very slim probability. More probable, in the unlikely case the FTC responds to Ackman’s presentation and reopens the same issues they have been policing for 32 years in the case of HLF, it is possible that the company could be forced to change some elements of how it conducts business in the US, and maybe elsewhere, leading to lower sales and margins. No doubt this would spook the market with fears that there was even more scrutiny to come, leading the market to value Herbalife at a discounted multiple on reduced earnings.
So let’s take a cut at that. Let’s say the FTC somehow compels business practice changes that reduce sales by 20% and lead to current pre-tax margins contracting by 25%. This would yield EBITDA of approximately $450mm, which at 5x would yield a share price of $17. Personally, I think there is about a 10% chance of this outcome. So weighting a 10% chance of $17/share, and a 90% chance of $50/share, I come up with a fair value of $47/share, which is why I own a boatload of shares purchased into the panic created by the bear raid. In fact, there is far more likelihood of another LBO of HLF (Golden Gate/Whitney stole it the first time around) than any other “headline risk.”

Ackman took his shot; now it is HLF’s turn.

Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM News Tagged With: , , , , , , , , , , , , ,
by on December 27, 2012 2 Comments

In a Twisted Turn of Events, Herbalife Retains Anti-MLM Firm, Boies Schiller

Humor me for a second. Suppose prominent law firm, Dewey Cheatham & Howe, initiates a class action lawsuit against cigarette maker, Marlboro. DCH alleges that Marlboro sells cancer sticks. DCH achieves a windfall settlement from Marlboro i.e. $20,000,000! Now suppose a doctor accuses Marlboro’s competitor, Winston, of also selling cancer sticks. And when it comes time to choosing a law firm, Winston chooses……Dewey Cheatham & Howe.

Do you see the problem?

Herbalife has retained mega firm Boies, Schiller and Flexner

Before discussing Herbalife’s decision, it’s important to provide a little background. Bill Ackman, hedge fund manager and founder of Pershing Square Capital Management, dropped the proverbial hammer on Herbalife. In what has been referred to as “dizzying takedown” of Herbalife, Ackman gave a 330+ slide presentation at the Ira Sohn conference in New York, arguing that Herbalife is an illegal pyramid scheme on the verge of collapse. When choosing his tools for the Herbalife autopsy, Ackman skipped right over the scalpel and went straight for the sledge-hammer.

Herbalife’s decision to retain Boies Schiller came to light in the Wall Street Journal’s story titled “Herbalife Goes on Offensive.” Out of all of the law firms in America, it’s extremely confusing to me why Herbalife would retain Boies Schiller (assuming the report is true). Currently, it’s unclear what exactly Boies Schiller will be doing for Herbalife. Given the timing, I suspect they’re being asked to help Herbalife deal with Ackman i.e. suing Ackman. If this is the case, hell has truly frozen over.

Boies Schiller recently received a settlement from Amway, resulting in legal fees “up to $20,000,000!” I’m not making this up. In late 2006, Boies Schiller initiated a class action lawsuit against Amway. In the lawsuit, they made most of the same arguments used by Ackman in his presentation i.e. there are minimal retail sales, the products lack quality, the buyback policy is ineffective, internal consumption is bad, etc. Their anti-MLM sentiment is made obvious in the first paragraph of the lawsuit against Amway (included below, written and filed by Boies Schiller!):

This pyramid scheme [Amway] is fraudulent because it induces individuals to invest in products and marketing tools and to recruit new victims into the scheme with the false promise of enormous profits. . . Because [Amway] distributors most often do not sell products to consumers who are not also distributors, they can obtain a return on their investment in the [Amway] program only by recruiting new distributors who will then buy products and recruit more distributors who will buy products.

And this firm has been asked to protect Herbalife.

Soon, I’ll be providing a more detailed analysis of Ackman’s position against Herbalife. In summary, the MLM industry is about to change, for better or worse. There’s no doubt about it. While there have been plenty of attempts in the past by lawyers and disgruntled distributors to air the dirty laundry of companies, there has never been anything like Ackman. Not even close. He’s all over the news, seemingly rubbing the FTC’s nose in a pile of poop. He’s creating the impression that the FTC has fallen asleep at the wheel. Whether that’s true or not is a topic for another post.

How can Boies Schiller effectively represent Herbalife? And really, they’re not only being asked to protect Herbalife, they’re indirectly being asked to protect the legitimacy of the entire industry. It seems bizarre for a firm to profiteer on two sides of the same issue….especially when those sides are on polar opposites.

In this fight with Ackman, Herbalife needs to restore confidence in its business model. Retaining Boies Schiller is a huge step in the wrong direction.

See below for the class action lawsuit filed by Boies Schiller against Amway

See below for Ackman’s presentation about Herbalife

There are a lot of similarities in Ackman’s arguments and those used by Boies Schiller against Amway.

Filed Under: mlm attorney, mlm legal, MLM News Tagged With: , , , , , , , , , ,
by on December 21, 2012 Leave a Comment

Amway Does Something Unusual

Amway and bHIP disputeSomething strange happened recently….Amway lost a lawsuit!  Cue the Rocky soundtrack. The little guy won this fight. In a lawsuit filed against another MLM in 2010, Amway ultimately ended up losing after a full jury trial.  Amway alleged that a competing MLM (bHIP) was interfering with Amway’s relationships with its distributors.  The jury decided differently.  Check out the press release below. In most of these cases, they never reach a jury. They’re normally settled out of court (like in the Amway / Pokorny case) or litigated in confidential arbitration (where distributors normally lose). This is very interesting news and appears to be a clear victory for the pro-distributor movement. Stay tuned on this one. It’s likely far from over…

BHIP TRIUMPHS IN TWO YEAR LEGAL BATTLE WITH AMWAY CORP.

The dispute between bHIP and Amway began in September 2010 after Amway obtained an order from a Texas State Court outside the presence of bHIP counsel requiring it to cease all business activities with Casey Combden and any distributor sponsored by Mr. Combden into the bHIP opportunity.

After expedited discovery a Collin County Texas Court heard evidence and arguments of counsel. Following a five hour hearing the Court dissolved the temporary order and determined that a temporary injunction was not warranted.

Amway dismissed the state court action and re-filed their claims of tortuous interference with a contract, business relations and prospective business relations as well as assertions that bHIP misappropriated, stole, or converted Amway’s trade secrets (limited Line of Sponsorship Information).

In the federal court filing, Amway also added a claim for false advertising of the business opportunity and products of bHIP under the Lanham Act. Amway claimed that Mr. Combden joined bHIP in violation of his distributor contract with Amway, and that bHIP induced him to do so. Further, Amway claimed that the distributor agreement that Mr. Combden signed in 1989 incorporated the Amway Rules of Conduct which were amended in 2004 to include a covenant not to compete.

Mr. Combden and others testified they were not aware the non-compete was added. bHIP urged that an independent contractor should not be allowed to be sued based upon an agreement to which they have no real input or right to object. Additionally, if Mr. Combden was not aware of the contract, bHIP could not be expected to be aware of it. bHIP also made the case that names and contact information of people that Mr. Combden had long standing relationships with were not Amway’s trade secrets.

The contact information of people sponsored into a business is developed by the independent distributors, not the company. bHIP stood firmly on its philosophy that the time, energy and money spent to develop a leader in a company entitles that distributor to advise those individuals of other opportunities in which they may be involved. When this matter was initially filed in state court, it did not include an allegation of false advertising under the Lanham Act.

Amway claimed that bHIP improperly induced distributors to join bHIP and sell bHIP products rather than Amway products. Amway claimed that bHIP over stated its financial strength as a company and stated that its products made medical claims about benefits they provided other than providing the consumer with energy. Relying on information from its manufacturers, bHIP provided two documents to a limited audience as educational materials concerning theingredients in the products, not the products themselves.

After hearing seven days of testimony from nineteen witnesses, the jury heard closing arguments from counsel for both sides and deliberated. The jury returned a verdict unanimously in favor of bHIP which resulted in the entry of a judgment that Amway take nothing on its claims.

When asked about his thoughts on the two year ordeal, Founder and CEO Terry LaCore said

“In life there is right and wrong. Sometimes, no matter how painful, you need to stand up for what is right.” It is bHIP’s desire that the network marketing industry renews its beliefs in the value that an independent distributor brings. “Without each and every distributor working on behalf of the company and selling its products, there would be no company for them to be tied to.” said Terry LaCore.

For more information, please contact:
Jenifer L. Grace
General Counsel bHIP Global, Inc.
Melissa, Texas 75454
[email protected]

Filed Under: Distributor Resources, mlm attorney, mlm legal, MLM News
by on December 14, 2012 Leave a Comment

MLM Startup Conference – DS Edge #4

Ultimate MLM Startup Conference

The Direct Selling Edge conference for MLM startups is back!  The event kicks off on Thursday, January 10th in Las Vegas.  See below for a link to purchase your ticket.  The details for the conference can be found on our MLM Startup Conference page. We received some great feedback after our last conference and we’ve made the agenda even better. In addition to our already stellar lineup of MLM professionals, we’re very pleased to announce our latest guest at the DS Edge Conference. Len Clements.

I’ve written in the past about Len Clements. Len Clements’s influence in the network marketing industry cannot be understated. I can say with 100% certainty that Len is one of the most knowledgeable individuals in the country with respect to the direct sales industry. Len will have a segment dedicated to separating fact from fiction in the network marketing industry. We will also have the following speakers:

 

Donna Marie Seretella: As the founder of Direct Selling Solutions, she leads MLMs and leading distributors in the areas of compliance consulting and distributor compliance relations.  She’s literally written the book on the subject.  We’re very excited to have her again!

 
 

Karen Clark: Karen is the founder of My Business Presence, a social media training company for network marketing companies. She began her direct selling career as an independent representative who achieved the highest title in her company’s compensation plan in just seven years. Karen now works with independent consultants of direct selling companies to master the world of internet marketing, including the effective use of social media. She’s also the co-author of two books, Incredible Business and Direct Selling Power.
 
Daren Falter: Daren is a MLM celebrity. Daren has experienced success both as a distributor in the field and as a company owner. Daren wrote one of the most widely read books in the network marketing industry: How to Select a Network Marketing Company. Daren will be speaking about one of the most important topics: Recruiting Top Leaders. It’s going to be fun!
 
 
 
 
 
 

Conference Agenda

DS Edge – 2013 Agenda
 
 
We’re also happy to be working once again with MLM software guru, Mel Atwood, MLM software provider from YourSolutions.net. Mel brings an incredible level of commitment, energy and passion to his work for MLM clients.  Whether he’s serving as the Vice President at the Association of Network Marketing Professionals or adding value as a fellow DSA supplier member, Mel’s activity inside and outside of his software firm adds tremendous value to the industry.

And of course, Jay Leisner of Sylvina Consulting will provide tremendous value regarding compensation plan design. Jay has an amazing ability of taking complex principles regarding compensation design and explaining them in terms that are easy to understand and actionable.

Satisfaction is 100% guaranteed.  

At the end of each day, from 5 until 8 pm, you’ll have the the opportunity to meet with conference speakers for 30 minute appointments at no additional cost! Add the six hours up and you’re easily walking away with over $1,000 worth of consultation.

Register Now

Click the link below to purchase your ticket. Details on hotel accommodations are included on that page. Reference the “Edge Conference” and you’ll be able to reserve a room under $40 a night. The deal they’re giving our attendees is fantastic.
Eventbrite - Direct Selling Edge Conference for New and Young MLM and Party Plan Companies

I sincerely hope to see you there!

Testimonials

    • Definitely worth the money. As a matter of fact, after 30 minutes, I think I got my money’s worth. I found out that my business plan was not legal and by the end of this, I’ve learned all the tools and information to make this work. It’s a really good program.  Zach Taylor
    • Thank you for the most crucial information supporting my Party Plan Business. This 2 day class was exactly what I needed! Great job by everyone! Absolutely every aspect of my business was covered. Thank you again. Cheryl Wollrab
    • I was amazed at the information. I thought it was going to be a broad stroke event to get you with different vendors. I was very surprised to see all of the targetted topics, how in depth they went into discussing very important issues, for anyone whose considering getting into the MLM business as a startup company. Mike Duke


Written by +Kevin Thompson

Filed Under: Uncategorized
by on December 14, 2012 1 Comment

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.

If you found this post informative, please hit the +1 button above. And to continue following me, check out my Google Plus page. Also, feel free to subscribe via email.


Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM News, MLM startup Tagged With: , , , , , , ,
by on October 29, 2012 Leave a Comment

FTC Business Opportunity Summary – MLM

This is a guest post from top MLM consultant, Jay Leisner. Jay is the President of Sylvina Consulting. Compensation plan design, business performance reviews, and software consulting are three of Sylvina’s specialties. Jay is also a partner with me for the Direct Selling Edge conference for MLM startups. While Jay is not a lawyer, I have yet to see a better summary of the Business Opportunity regulation than this one. I could not have written a better summary than the one prepared below.

There’s a lot of uncertainty surrounding this new business opportunity regulation. In my opinion, 99% of the traditional MLMs out there have nothing to worry about. However, with the newer internet based companies that rely heavily on lead generation, the regulation poses a significant challenge. I hope you find this article informative.

——
Begin

This month, I attended the 2012 Global Regulatory Summit held by the Direct Selling Association in Washington, DC. It is an annual event attended primarily by lawyers and employees of direct selling companies who are responsible for legal compliance.

In March 2012, the Federal Trade Commission or FTC promulgated a significant new Business Opportunity Rule known as Rule 16 C. F.R. Part 437 (click here to download a full copy of the regulation). Direct selling companies are not specifically or explicitly excluded from this rule.

If your company is subject to this rule, potential buyers of your business opportunity must be given a one-page disclosure statement at least seven calendar days before the prospective buyer signs an agreement or pays any amount of money for the business opportunity.

If you have a direct selling company with independent representatives who recruit others to sell and recruit, anything that slows down the recruiting process isn’t good for recruiters or your company because during the waiting period, some new recruits will change their minds and opt not to enroll! Fortunately, there are things you can do to not be subject to this new rule.

Before explaining these things, I’d like to tell you about the one-page disclosure statement referenced above. It must include full disclosure of any civil or criminal legal actions that the company or any of its key personnel have been the subject of within the last 10 years (regardless of the outcomes). This means that if your company was sued by an independent representative and you were the prevailing party, you would still need to disclosure this legal action. The disclosure statement must also include the names and telephone numbers of at least 10 people who have purchased this business opportunity from the seller. If the seller has sold the business opportunity to less than 10 people, then all of them must be listed. In addition, the person receiving the disclosure statement is notified that if he or she purchases the business opportunity, that person’s identity may be disclosed to future prospective business opportunity purchasers.

Rule 16 C.F.R. Part 437 defines a business opportunity as a commercial arrangement in which:

  1. A seller solicits a prospective purchaser to enter into a new business; and
  2. The prospective purchaser makes a required payment; and
  3. The seller, expressly or by implication, orally or in writing, represents that the seller or one or more designated persons will
    1. Provide locations for the use of operation of equipment, displays, vending machines, or similar devices, owned, leased, controlled, or paid for by the purchaser; or
    2. Provide outlets, accounts or customers, including but not limited to, Internet outlets, accounts, or customers, for the purchaser’s goods or services; or
    3. Buy back any or all of the goods and services that the purchaser makes, produces, fabricates, grows, breeds, modifies, or provides, including but not limited to payment for such services as, for example, stuffing envelopes from the purchaser’s home.

A new business means a business in which the prospective purchaser is not currently engaged, or a new line or type of business.

A required payment is all consideration that the purchaser must pay to the seller or an affiliate, either by contract or by practical necessity, as a condition of obtaining or commencing operation of the business opportunity. Such payment may be made directly or indirectly through a third party. A required payment does not include payments for the purchase of reasonable amounts of inventory at bona fide wholesale prices for resale or lease.

Providing locations, outlets, accounts, or customers means furnishing the prospective purchaser with existing or potential locations, outlets, accounts, or customers; requiring, recommending or suggesting one or more locations or lead generating companies; providing a list of locator or lead generating companies; collecting a fee on behalf of one or more locators or lead generating companies; offering to furnish a list of locations; or otherwise assiting the prospective purchaser in obtaining his or her own locations, outlets, accounts, or customers, provided, however, that advertising and general advice about business development and training shall not be considered as “providing locations, outlets, accounts, or customers.”

The first two elements of a business opportunity as defined above clearly apply to you as your direct selling company offers a new business for which a required payment is made. It is the third element that may or may not be relevant, that is, whether your company suggests or provides customers or lead generating companies to the purchasers of your business opportunity.

Some direct selling companies provide leads to their representatives or suggest the use of lead generation companies. If a company refers prospective customers or representatives to existing representatives, will this practice cause a direct selling company to be subject to this new business opportunity rule? If a company has a relationship with a lead generation company and encourages its representatives to buy leads from this third party, will this similarly be a problem? Does it matter whether these practices are disclosed by your company to new representatives at the time they join? Does the number of leads provided as compared to the total number of new customers or representatives enrolled have any relevance? If leads are given only to representatives who have achieved a specific rank or higher in your compensation plan, does that matter?

Party plan representatives may offer a hostess who signs up on the night of the party to be a consultant the opportunity to be credited with this party as her own, that is to say, she may offer the party and its customers and sales to the joining consultant as an incentive to purchase the business opportunity. Could this practice cause the party plan company to be subject to the new business opportunity rule? If a company doesn’t encourage this practice, does that make this practice irrelevant to the business opportunity rule?

I wish I could tell you the answers to these questions, but I can’t because the rule is new and we just don’t know exactly how it will be interpreted and enforced. With this information, you can choose to change nothing and just wait and see what happens, or you can take steps now to respond to the new rule in town. The most conservative approach would be to (a) not recommend the use of lead generating companies, (b) not provide leads or customers to representatives, and (c) not suggest that representatives “gift” a party to a hostess. All of these steps are achievable, although they may be a change to how you’re doing business today.

End article
——

See below for the FTC’s short summary of the regulation.

Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM startup Tagged With: , , , , , ,
by on October 15, 2012 2 Comments

Front Loading: excessive orders upon enrollment

In the past, I wrote a detailed article exploring the boundaries of inventory loading. In that article, I gave a few conflicting definitions used to define inventory loading. The courts have their definition, the FTC has its definition and the Direct Sales Association has its own. Without boring you with the minutia, inventory loading basically exists when distributors purchase product in bulk quantities they can never reasonably sell or use in a month. Why do they do this? They do it mainly to qualify for commissions. The courts add another layer to this definition that muck it up a little: inventory loading can occur when distributors are purchasing a minimum amount of product in an effort to qualify for bonuses. FTC vs. Omnitrition

Due to people’s zeal to make money fast, we’re seeing more programs launch that rely on inventory loading. And to be more specific, we’re seeing more FRONT LOADING in programs today. “Front loading” occurs when the new reps are required or financially incentivized to buy an extraordinary amount of product upon enrolling. Legally, the purchase of inventory must always be optional. This is crystal clear, MLM Law 101. So you might be asking, “If the initial purchase is made voluntarily, what’s the problem?”

The answer lies with one word: MOTIVATION

Regulators try to analyze the motivation driving people to purchase the product or service. If the motivation is pure and distributors are purchasing product due to a sincere want or need, the program is in great shape. If, on the other hand, distributors are purchasing product primarily to qualify for additional bonuses, it’s a problem. This is known as “Opportunity Driven Demand.”

Here’s the question

If we know that regulators want to see consumers / distributors purchasing product for the right reasons, why do some companies continue to provide distributors with financial incentives to buy a lot of inventory upon enrollment? It’s a long question, I know. I’ll break it down into two parts:

  • Regulators want to see people buying product for the right reasons; therefore,
  • why are some companies offering extra rewards to encourage people to buy more product?

BurnLounge got roasted for doing this. If you need a refresher, I wrote a summary on the BurnLounge case. In BurnLounge, participants were required to purchase an expensive, $400+ product product to qualify for a particular bonus. The court concluded that it was the additional financial incentives that ultimately led the distributors to purchase the premium products.

Gerry Nehra recently wrote an article on the subject, titled Where Have All The Products Gone?. He and I both see a dangerous trend: the products are becoming less relevant in an age where people are looking to make easy money with clever pay plans. In his article, Gerry summed it nicely:

The argument that purchases are for intrinsic value is seriously weakened if the purchases are:

Required to be made to be allowed to sign up as a distributor.
Required to be made by a distributor to “open a product center.”
Required to be made by a distributor to qualify for a compensation plan payment.
Required to be made by a distributor to advance in the compensation plan.
Required to be made by a distributor to “re-enter” the same or a different “phase” or “cycle” of the compensation plan.
Required to be made by a distributor to “buy in” to a higher compensation plan title or pay level.

emphasis mine.

I highlighted the sections that are more relevant for this article on front loading. If we know that regulators want to see pure motivation driving product consumption, companies need to stop adding sweeteners for bulk orders. An example would be when a company offers to pay a distributor at a higher rank for a year IF the distributor purchases a builder pack, usually consisting of a lot of inventory costing between $1,000 and $4,000. I understand the logic of having it: “We want them to get started right” or “We want to reward the ‘serious’ builders.” The real reason why we see the extra sweeteners: they want to create a “fear of loss,” putting the distributor in a position to make a long-term decision. New distributors ask themselves, “Do I buy the minimum and forgo the extra money, or do I go ‘all in’ and maximize my earning potential?”

Conclusion

If you’re a company that’s considering offering an additional bonus for bulk orders, be careful. To misquote one of the greatest philosophers of all time, “Check yourself before you wreck yourself because excess inventory is bad for your health.” – Ice Cube.

Front loading by itself does not render a program illegal. However, rest assured it’ll be part of the kitchen sink that gets thrown at a company if the company upsets the wrong regulator.

Filed Under: mlm attorney, mlm legal, MLM News, MLM startup
by on September 18, 2012 2 Comments

Letters to a Young Networker

Three months ago, I made a commitment to Richard Brooke that I’d have content prepared for a book by September 3rd.  Well, September 3rd has come and gone and there’s still not enough content.  I accept responsibility for the shortcoming.  I flubbed on it.  I’ve only got excuses, which are a dime a dozen.  I was interviewed on CNBC, which threw me off for a week, I started a law firm with my partner Walt Burton and the Zeek Rewards disaster lit my hair on fire.  But who cares about excuses? The bottom line: I failed to honor a commitment.  

But…

I’m 40% done.  The title is: Letters to a Young Networker: Separating fact from fiction in direct sales.  The book is comprised of a series of questions and answers between our protagonist, Kate, and myself.  I’ll be publishing excerpts from the book periodically, asking for feedback.  See below for the Table of Contents.  I’ve highlighted the completed chapters in bold.  If you have specific questions that you’d like addressed in the book, please leave me a comment.  This is going to be an iBook, which means it’s only going to be available on iOS devices.  I plan on adding a few videos, images and powerpoint presentations.  There will eventually be a text edition, but first things first.  

Table of Contents (tentative)

Forward from the author

Introduction

Is network marketing even legal?

Has the FTC approved of our business? No news is good news, right?

What constitutes a pyramid scheme?

Can I be held liable when I make product claims?

Can I show off my checks to a prospect?

Can you explain the 70% rule? I’ve read somewhere that 70% of my company’s volume must come from outside customers. WTH?

Guest Chapter: What are the differences between party plans and network marketing companies?

I’ve got friends that have enrolled in multiple positions in the compensation plan? Is this ok?

The MLM critics talk about “market saturation.” Do they have a point?

When I approach a prospect, should I lead with the product or opportunity?

Should I be concerned when I hear of MLMs experiencing challenges in other parts of the world?

Can my current company really sue me if I leave and go somewhere else?

Filed Under: Distributor Resources, mlm attorney, MLM News, MLM startup Tagged With: ,
by on August 19, 2012 2 Comments

Zeek Rewards Recovery

It’s been a busy few days in the MLM industry, to say the least. We recently had one of the fastest growing companies in MLM history, Zeek Rewards, come crashing down after being shut down as a ponzi scheme by the SEC. On my site, I summarized the SEC’s action and wrote about the implications for the MLM industry in general. The article can be found here. After writing the article, I was literally flooded with hundreds of messages from people that were affected by this disaster. The stories were remarkable. People left their jobs, cashed in on their retirements and drained their savings in an effort to maximize their earnings with Zeek.

The funds in Zeek Rewards have been voluntarily placed with a court appointed receiver. Zeek is not contesting the allegations in the SEC’s complaint. The receiver is now obligated to take stock of the assets and distribute funds back to the investors. Given the volume of victims, it’s going to be a very long process, in our opinion. Due to the volume of investors in Zeek, which is projected to be close to one million, we’re not sure how the receiver is going to effectively communicate with the class of investors. In an article on Forbes.com, the author put it into perspective when he wrote:

“While investor losses pale in comparison to those experienced by Madoff or Stanford investors, the sheer number of Zeek investors is on a magnitude that has never been dealt with before in a receivership or bankruptcy context. To illustrate, assuming Zeek had one million investors, a simple 1-page summary for each investor summarizing contributions and withdrawals, stacked together, would be 101.3 meters high, or roughly 300 feet. The staggering number of victims suggests that investigation of the fraud and establishment of a distribution process will likely be a drawn-out process involving hundreds, if not thousands, of people.”

Given my expertise in dealing with MLM law, and my partner’s experience with receiverships, our firm is uniquely positioned to communicate with the receiver on behalf of Zeek victims. Instead of getting lost in the stack, we can build numbers and collectively get a seat at the table.

If you invested in the Zeek program, please fill out the form below. If the form is not showing up in your inbox, please click here. There are no obligations after filling out the form. We’ll be publishing an action plan on Friday.

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Filed Under: Distributor Resources, mlm attorney, MLM Consulting, mlm legal, MLM News, MLM startup
by on August 17, 2012 11 Comments

Zeek Rewards Shut Down

Disclaimer: This article contains my opinions. I’m not stating with certainty that Zeek is fraudulent; however, in my opinion, I believe that to be the case.  I think the investigation is timely and will serve a valuable function.    

It’s official.  Zeek Rewards has recently closed its doors.  Literally.  In fact, the SEC and U.S. Secret Service are now involved. This is what we know: the doors are locked and the website is down.  It’s not looking good.  Was this done voluntarily?  Were they required to do this by the SEC?  This all has occurred recently after the North Carolina AG’s office expressed “concern” over the Zeek model.

I’ve got mixed emotions.

I’m both angry and relieved.

Why am I angry?

  I really think we lost our minds with this model. The MLM community took the bait and walked off a cliff like a herd of lemmings. Do you want to know what happened?  I’m going to be candid:

Zeek exploited the gray.  They took a bath in it.  They skinned it and made a coat out of it.  They hired the right people and adopted the right lexicon.  And who is going to pay the price?  The entire industry.  This is bigger than just the participants.  There’s an ocean of gray separating legitimate network marketing companies from pyramid schemes.  Instead of shrinking the gray, we fight like hell to obfuscate.  As an industry, we’re self-delusional.  It’s true.  We think it’s better to have vague standards.  But now we’re seeing first hand what happens when the inmates take over the asylum.

“Those are not investments, those are ‘samples’ given to ‘customers’ in an effort to entice them into buying more….it’s like Amway distributors giving samples of soap to customers.”

It’s not the same thing! Amway distributors are not spending $50,000 on soap, giving it all away to strangers while dramatically increasing their earning potential. Amway distributors have a direct, real connection with customers.  With Zeek, it’s just a combination of 1s and 0s on a computer screen.  Who in the hell were these customers?  Where were they coming from?  Were they real?  Were they ever asked to verify their accounts? Nobody knew and nobody seemed to care.  People knew the angle.  They read from the script, mastered the narrative and explained with eloquence why Zeek was “just like Amway, but with penny auctions.”  Zeek affiliates were essentially rewarded IMMEDIATELY after they bought the bids, regardless if they were ever used. This is not consistent with traditional MLMs.

I’m angry because they leveraged your credibility. They leveraged the credibility of my colleagues and competitors. They leveraged mine.  And we all look like idiots.

I’m angry because this recent news is going to be devastating for tens of thousands of people.  People that will likely associate this horrible experience with “network marketing.”  These were the people that cashed in on their 401(k)s because they were promised tremendous gains in a short amount of time.  These were the people that “invested” more money than they could afford to lose, hoping that maybe, for once in their life, they could get a decent ROI. If the money ends up being locked away in receivership, which is a possibility, it’s not coming out without a court order. Will everyone get their money out? I’m not sure.

I’m angry because this actually impacted my relationships with clients, current and former.  When I gave my candid advice, I was sometimes met with hostility.  I was considered “out of touch.”  I was told that Zeek was “spending countless dollars to be compliant” and I was just envious to be on the outside.

I’m angry because we allowed the cancer to infiltrate the host and spread.  We opened the door and welcomed it with open arms.  Zeek leadership took on top positions with trade associations, recruited top distributors from reputable companies and networked intelligently with industry influencers.  Have cash?  We’ll dance. We provided them with the semblance of legitimacy, and they ran with it. We empowered them.

Why am I relieved?

I’m relieved because the conversation is finally over.  I’ve been fielding calls at least twice a week with somebody else looking to launch their version of Zeek.  It’s hard to tell someone “no” when there’s someone across the street making a fortune with the exact same model.  Finally, it’s over.  We can resume normal business.

I’m relieved because this should mark the end for companies having to defend themselves from Zeek. Zeek was soaking up a lot of leaders from a lot of different companies, causing a considerable disruption in the space. Companies, trying to hold onto their people, found themselves in the cross hairs between zealous distributors looking for a quick buck and industry pundits, all defending the Zeek model. It put company executives in an awkward spot.

What did we learn?

Money Clouds Judgment

When people have a serious economic position with something, they’ll fight hard to protect it. They’ll go to great lengths to find a mental justification, even if it defies all logic and intuition.  There were a lot of distributors in Zeek that really should have known better.  They were around for the FutureNet, SkyBiz and Equinox cases. They knew better. And despite that experience, they really believed they were in the clear on this one.  I think their belief was genuine. They were just under a spell.  Once they got a taste of the enormous commissions, they were hooked and went to great lengths to defend the business.  Adults under the influence of serious cash are like teenage boys with girls…all logic goes out the door.

Watch Out For Name Dropping

People relied heavily on the credibility of Zeek’s lawyers: Gerald Nehra and Kevin Grimes.  They said “These guys are good; therefore, we’re good.”  I can speak on this first hand: hiring an attorney by itself does not legitimize a program.  At the end of the day, we MLM attorneys explain the boundaries for our clients and provide advice.  It’s on them to follow the advice and stay within the lines. I can guarantee you of one thing with 110% certainty, Zeek is not surprised by recent events. Grimes and Nehra are both good attorneys and good competitors. I’m confident Zeek was fully informed of these potential issues. MLM attorneys can lead horses to water…we can never make them drink.

Commissions Must Be EARNED

If someone promises you easy, run fast!.  We can do better.  Any measure of success in life requires hard work. Really, really hard work.  In the network marketing industry, we need to stand for meritocracy: as you perform, so shall you bonus.  We work hard to ensure the pay plans are fair and that reps are rewarded commensurate with the work they do.  With Zeek, the general tone was that people could make money with minimal effort. There was very little effort involved in reaping the rewards from the penny auction platform (with the exception of buying some customers and placing ads online). I understand that measures were taken to strengthen the program i.e. the compliance course, eliminating the customer co-op, etc; however, rewards were still allocated immediately upon purchases, regardless if the bids were ever used. This was a problem. There must always be a direct connection between the rewards received and work performed.

With modern technology, there seems to be more “make money while sitting on your rear-end.” And as typical Americans, we’re drawn to it! As network marketers, we need to promise VALUE instead of promising EASE.

If It Looks Like a Duck….

Richard Brooke recently said, “If it quacks like a duck, it may not be technically a duck but duck hunters WILL KILL IT!”  Zeek just looked too much like a security. I understand that there are countervailing arguments, but the bottom line is simple: Zeek fought hard to train people to NOT call it an investment opportunity because that’s exactly what it looked like.  People, when they were pitching the program as an investment opportunity, were just following their instincts.  Why?  Because it looked like a duck….

Conclusion

There are a number of issues that will likely come to light during this investigation.  Is it a Ponzi scheme?  Is it a pyramid?  Is it an unregistered security?  Is it all of the above?  Will criminal charges follow?  Who knows…

As an industry, I think it’s time to tighten up the skates.  This should serve as a wake up call. This is embarrassing.  Absolutely embarrassing.  Zeek flew under the banner of protection provided by US, the network marketing community.  They danced in the gray and profited. We need to stop drinking our own kool-aide and shrink the gray. When I first started practicing, I wrote an ebook that has been read over 12,000 times. It’s titled, Pyramid Schemes: Saving the network marketing industry by defining the gray. I propose some ideas on ways to make the space better. I think it’s time. Otherwise, this WILL happen again. And at the pace of technology, it will happen soon.

As for my representation of Bidify, which I’m sure will be an issue, they’re paying attention to this situation. Since retaining me, they’ve made a number of difficult decisions. I’m not going to comment further on their business other than to say they’re working hard to get their model in order. Their recent decision to reduce the max cost to 5,000 euros forever is proof of it. If you want to park a lot of cash, Bidify is not the spot for you.

If you learned something, please hit the +1 or “Like” button above and get it out there. Thanks.

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Update

The SEC filed suit against Zeek Rewards. See below for a copy of the complaint. The most shocking sections are paragraphs 44, 45 and 46.

44. Defendants represent that daily awards are calculated by dividing “up to 50%” of daily net profits by the number of Profit Points outstanding among all Qualified Affiliates. This calculation results in a daily dividend paid to each Qualified Affiliate that consistently has averaged approximately 1.5% per day.

45. In fact, the dividend bears no relation to the company’s net profits. Instead, Burks unilaterally and arbitrarily determines the daily dividend rate so that it averages approximately 1.5% per day, giving investors the false impression that the business is profitable.

46. Despite encouraging affiliates to purchase and give away VIP Bids to promote and drive traffic to the Zeekler penny auction website, Defendants fail to disclose that almost none of the VIP Bids given away by Qualified investors are actually used on the Zeekler penny auction website. Of approximately 10 billion VIP Bids purchased by or awarded to investors, less than one-quarter of one percent have been actually used in auctions on the Zeekler penny auction website. Thus, the VIP Bids do little or nothing to actually promote the retail business.

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