Moving Forward, Here’s What the FTC’s Order Requires Herbalife to Do

    Kevin Thompson is an MLM attorney, proud husband, father of four and a founding member of Thompson Burton PLLC. Named as one of the top 25 most influential people in direct sales, Kevin Thompson has extensive experience to help entrepreneurs launch their businesses on secure legal footing. Recently featured on Bloomberg TV and several national publications, Thompson is a thought-leader in the industry.

    Photo courtesy of @gulfman1After a two year investigation, Herbalife has agreed to pay a $200 million fine to the FTC and act in accordance with prescribed measures. With this morning’s announcement of a settlement, investors and proponents/opponents of the MLM industry alike are attempting to process what it all means for the Company’s future. Before we provide you an in-depth analysis of the stipulations found within the FTC’s Order for a Permanent Injunction and Monetary Judgment, it’s important to remember that these prescribed actions only apply to Herbalife and not multi-level marketing companies collectively. In response to a question in which she was asked what kind of implications the settlement will have on the network marketing industry , FTC Chairwoman Edith Ramirez stayed mum on its long-term implications and stated rather plainly that the FTC would soon be providing additional guidance on legitimate network marketing companies. That aside, let’s get down to business and clarify what the FTC’s order does and does not say.

    THE BIGGEST TAKEAWAYS

    Macro Perspective

    At the company level, 80% of Herbalife’s revenue from product sales needs to be generated via a combination of retail sales and “Rewardable” internal consumption. “Rewardable” is defined as a quantity less than $200 per month per distributor. The amount of “rewardable” internal consumption cannot comprise of more than 1/3rd of the total revenue, or else Herbalife is forced to reduce its payout by 10% (which basically works as a tax on the top earners). This restriction is a bit odd. The formula is basically a strange way to ensure that 50% of the company’s revenue comes via retail sales. And candidly, it’s not the most problematic for Herbalife long-term. The public appears to be seizing on this 80% metric, thinking that Herbalife must cease operating if the 80% metric is missed. As explained above, the only penalty on Herbalife is a 10% reduction in what it can pay out.

    Micro Perspective

    From the micro-perspective of an individual distributor, Herbalife in the future CANNOT pay any distributor who fails to have at least 66% of his or her total sales (personal and downline included) come from retail customers.  Where am I getting this from? From the line in the Order that states, “Rewardable transactions (i.e., compensation) shall be limited such that no more than one-third of the total value of a participant may be attributed to [internal consumption] transactions.” If you will recall the restrictions imposed on Vemma, the FTC in conjunction with court approval currently allows Vemma to pay commissions to distributors ONLY IF 51% percent of a distributor’s downline sales originate from retail customers (I’ve previously referred to this as the “Vemma overlay” when I strongly suspected negotiations were stalling because the FTC wanted to impose Vemma-like restrictions…..I was right, BTW). Herbalife’s restriction is more burdensome than the Vemma overlay.

    Internal Consumption

    The FTC’s limitation on allowable (“Rewardable”) internal consumption mandates that a participant can only self-purchase: (i) no more than $200 worth of products per month for the first 12 months following the enactment of the Order; and (ii) post-twelve months of the Order’s enactment, no more than the greater of EITHER $125 worth of products per month OR the calculated average amount of what three-fourths of Preferred Customers are buying over the previous twelve months. No more than one-third of a participant’s compensation originate from his/her personal consumption or the personal consumption of the downline. This measure is implemented to prevent inventory loading.

    Rank Advancements

    As a continuation of its efforts to place the onus on Herbalife to acquire meaningful retail sales, the FTC put forth a very meaningful stipulation on rank and bonus qualification. To the extent that Herbalife requires its participants to meet any sort of target or threshold in regards to rank advancement, bonuses, etc., a participant may only do so EXCLUSIVELY through retail sales. This is highly significant and illustrates the FTC’s statement that Herbalife will “restructure [its] US business operations.” While only time will tell how Herbalife will choose to go about effectuating this particular stipulation, this sends a loud message that distributors who are interested in climbing rank and thus becoming eligible to earn larger commissions must do so on the basis of their ability to generate customers and train downline members to do the same.

    Verification of Retail Sales

    Some smaller but nonetheless important details from the Order deal with how the Company will track retail sales and its disengagement from certain industry norms. In order to verify retail activity, Herbalife must take “reasonable steps” that include “random and targeted audits.” These audits will monitor retail sales and ensure sales occur in the manner in which they are reported. Speaking of such reporting, the Company will have to collect retail sale information from participants detailing: the method of payment; the product and quantities sold; the date; the price paid; first and last name of purchaser; contact information including information like telephone number or home address; and the signature of the Customer for any paper receipt.

    Monthly Volume Requirements

    Herbalife must discontinue practices commonly associated with network marketing companies. The Company can no longer require a participant to have a minimum quantity of products. Additionally, the FTC is outright banning Herbalife from providing participants with autoship, even an OPTIONAL autoship. After what happened in Vemma and now this, it appears safe to say that regulators greatly disapprove of personal volume quotas and autoship requirements. Just for the record, I called on the DSA 2 years ago to modify its Code of Ethics to prohibit companies from requiring monthly volume quotas (See item #2). The idea gets shot down whenever I bring it up. Regardless of the narrative spouted by companies, gravity naturally pulls distributors to train other distributors to simply “buy to qualify” i.e. “get on autoship to stay qualified and recruit others to do the same.”

    While there are other restrictions imposed by the order, the items referenced above are more worthy of our time and study.

    CONCLUSION

    Largely hailed as a victory in the general media on account of the pyramid label omission, Herbalife faces significant challenges to its domestic survival. With participants now facing the requirement of having two-thirds of their sales originate from customers and the Company being required to operate with a pay plan that more closely resembles a rubik’s cube than an MLM pay plan, the FTC’s game plan is crystal clear: (1) take money off the table today without firing a single shot ($200,000,000); and (2) force Herbalife to prove its legitimacy over the next several years.

    The FTC’s avoidance of the pyramid label is very interesting and surprising. As I’ve said since January of 2013, the FTC has weak pyramid arguments against Herbalife. If they would have sued on that basis, they would have lost. When it comes to prosecuting pyramid schemes, the current body of case law makes the FTC’s job more difficult to impose its own vision of “fairness.” Put another way, the FTC is not happy with the current state of the law. Instead of going down the pyramid road, the FTC is making a broader argument, stating simply that Herbalife’s plan is likely to cause harm because it’s inherently unfair. What’s an “inherently unfair” compensation plan? It appears the FTC is going to argue that an unfair pay plan primarily incentivizes recruitment over retailing. Did the FTC avoid the pyramid word by way of negotiations with Herbalife? Or was it done with specific intent to avoid the challenges associated with a pyramid argument? We’ll find out soon enough.

    The FTC got a big bite at the apple. They got a lot of money up front. And they got Herbalife onto a different wrestling mat. Instead of alleging Herbalife to be a pyramid scheme, which would be like nailing Jello to a tree, the FTC can simply call upon this order in the future if Herbalife fails to comply. It reminds me of the old adage, “Good matadors never go after a fresh bull. They stick it a few times, let it bleed, then strike.” Herbalife is going to bleed under these restrictions. But they’ll honor the terms of the deal while focusing on their international operations. If they can scale those operations fast enough, the growth overseas will exceed the losses they’ll likely face domestically. And who knows….maybe Herbalife can thrive with this new model. We’ll learn a lot in the next few quarterly reports.

    What does this mean for the industry? Pay plans need to be revisited, sales cultures need to be re-trained and expectations need to be managed. Slow growth is the new fast growth. And the DSA needs to adjust its sails, big time.

    I’ve included a video below that summarizes these thoughts.

    I’m curious to read your thoughts. Chime in below and let’s discuss.

      Kevin Thompson is an MLM attorney, proud husband, father of four and a founding member of Thompson Burton PLLC. Named as one of the top 25 most influential people in direct sales, Kevin Thompson has extensive experience to help entrepreneurs launch their businesses on secure legal footing. Recently featured on Bloomberg TV and several national publications, Thompson is a thought-leader in the industry.

      • Peter Arnold

        Hey Kevin:

        THANK YOU for your excellent take on this, giving clarity on this breaking news!

        As a 30-year (part time) participant in this industry (whose “business model” I personally respect, as a Business & Financial Consultant) – and having had the priviledge of serving on the Board Of Directors of its professional association for 4-years, representing Canada – the Association of Network Marketing Professionals (ANMP – formerly, the DRA) – I see this action by the FTC as one which will [should] put all other MLM companies on RED ALERT – including “publically owned” MLMs.

        I believe each of us need to ask ourselves … “How does MY COMPANY stack up”?

        IF we see it ‘failing’ in some of the areas the FTC is targeting (most “are)” – I believe each one of us ought to openly express our concerns to top management – to (hopefully) head off a similar attack by these regulators – and thus, not be pushed into a situation where we have to “defend” the resulting negative publicity.

        More importantly, let’s hope that MLM company owners and CEOs themselves, are taking a sober look at what’s happened to Herbalife (and Vemma, recently), and reflecting on how “they” can AVOID such targeting by the FTC, next.

        Personally, I think this (Herbalife) story is far from over.

        I happen to agree with at least three (3) parts of this outcome:

        1)- No more FORCED AUTOSHIPS

        2)- Far more emphasis on gathering CUSTOMERS (Retail Sales) than on recruiting DISTRIBUTORS (Leverage)

        3)- No more PAY-TO-PLAY, in order to “qualify” for higher financial rewards (including the heavy cost of many Starter Packs).

        I think this is only “tip of the iceberg” for our industry (where hopefully, GOOD things will come from it, over time).

        We are witnessing transformational (and needed) changes coming for our industry, in my opinion.
        Greatly appreciate your speedy analysis on this.

        Peter Arnold, CLU, CFC / Canada
        .

        • Kevin Thompson

          Thanks for the kind words, Peter. It will be interesting to see the guidelines the FTC pushes out for the rest of the industry. With the Herbalife story, I see two tracks: one for the shareholders, and the other for the USA distributors. We’ll see how it all shakes out.

      • Richard Bliss Brooke

        Great job Kevin. I think it is important to note that when a company operates in an ethical, honorable way, (with VALUABLE products, priced attractively to customers, without unresolved complaints and without chronic negative media) the FTC or any other agency will not likely ever know they exist let alone target them for these kinds of actions. When you live by hype you can obviously die by it. I hate to see such draconian orders being forced on any company. These will be very very difficult for HLF. But they had many years to clean things up. Therein lies the curses of being public. You can’t really reinvent your business and let sales slip and you cannot prevent the short sellers from feeding on your bones. The DSA call this week is going to be epic. They should have jumped on your federal regulation proposal years ago!

        • Kevin Thompson

          It’s a really unusual settlement. I have to think that Herbalife would not agree to these terms if they really felt it would jeopardize their domestic business. Based on what I’m hearing, their leaders are ok with it. They really did have a lot of “discount buyers” in the network. Once they’re teased out and re-classified, there’s a chance we find that Herbalife was a healthier business than the FTC alleged.

          • Karey Nickel

            Interesting to see your thoughts – thanks for the video and written comments. It’s an important bit that you’re saying about their leaders being ok with the agreement. I hope that’s so and that all this does is codify good behavior and healthy business and make it more measurable, lending more credibility to the industry. It seems like a whole lot of hoops to jump through, and it seems like a number of them are completely arbitrary. How does the FTC not effectively “write new law” when they come up with numbers like 80% and 51% and 66%. Aren’t they just pulling these numbers out of the air? What stops them from applying this new standard to all MLMs in the future as if it were established “case law”?

            • Kevin Thompson

              These are great questions, Karey. I agree that it’s a good sign the Herbalife leaders are signing off on the changes. Regarding the FTC’s choice of those percentages, I too agree that those numbers are grounded in law. We’ll learn more in the next few weeks or months how the FTC wants to regulate the industry going forward.

              • Karey Nickel

                Thanks for the response, Kevin. So are you saying that just as I’m fearful of, these percentages and benchmarks are in effect becoming as they are “new law” that will potentially be used to judge all MLMs? Is this really all within the jurisdiction and authority of the FTC? Somehow I imagined that their power was not so great as this and that any MAJOR changes would have to be actually written as law by our legislative branch, elected by the people? Am I wrong? It seems like so much power in the hands of a group of unelected people and with no opportunity for any input. The power to effectively outlaw or regulate to death an entire industry if those in power deem it necessary. With no opposing power to sue or appeal the process… It seems to make the existing case law (for instance the Amway case, etc.) almost irrelevant. But I’m not even close to being an expert on the law. What am I missing?