- Italy has an easier time stopping MLMs by focusing on conscripted consumption, and false product claims.
- In the US Anthony Powell fled Herbalife for Vemma, Vemma soldiers moved to Jeunesse and Xango in droves.
- Recent tax ruling against Amway makes it clear MLM-deductions are on shaky ground.
For Herbalife (NYSE:HLF), the fat lady has been dawdling on stage, but has not even begun to sing yet. Herbalife is certainly going for some kind of record in their ‘talks’ with the FTC, which hilariously Carl Icahn was at such pains to keep ‘confi’ that he was misheard by the press and over-eager analysts. But… we may have cast the wrong person for the part. And that’s not just because FTC Chair Edith Ramirez is too skinny for the part, or can’t sing. The FTC may be the wrong party to do the singing. The overture perhaps, but not the coda.
Sometimes it pays to look overseas. In Europe team Vemma departed for Xango when FTC troubles took Vemma Europe down even before the US operation. Interestingly Italy was the first to shut Vemma down, before the FTC took any action in the US, and Xango had already been shut down in Italyin 2010 for the same reasons. In fact, that ruling cited:
- the entry fee
- conscripted consumption of an otherwise unsaleable product
- false health claims
Interestingly, this ties in nicely with the recent suggestion by Robert FitzPatrick here on SA, that the FTC should focus on the issue of “pay to play” as he called it in his recent SA article on the Spanish Prisoner fraud, here. It’s the “pay to play” feature in terms of up front fees and conscripted consumption (autoship) that is the lifeblood of pyramid schemes, because it guarantees the cash flows that make them possible. There are always more people who would continue to pay up in hopes of some day making money, as long as their commissions depend on meeting certain personal monthly quotas.
The Federal, state and local agency hit parade
On June 25th, Forbes reported yet another Amway tax case lost by a distributor who tried to deduct his losses as business losses, but the court ruled it must be treated as a hobby, as they had ruled in previous cases. It appears pretty pragmatic to treat a ‘business’ that produces 99% loss rates as a ‘hobby’ for tax purposes, and not a business. In other words, the MLM companies that (usually) heavily promote the deductibility of “business” expenses, are on thin ice, as they are potentially all promoting tax evasion, and the IRS could have a long term interest in the matter. After all, other taxpayers are funding what amounts to the illegal gambling losses of MLM distributors, 99+% of whom lose money.
Separately, we should always be mindful of the fact that the SBA deems MLM distributorships unworthy of its loans, evidently because they understand the staggering loss ratios.
It remains dubious if the extensive, and very restrictive contracts in MLM in the long term can be reconciled with the idea of “independent contractors.” In short, the Dept. of Labor potentially has an interest in the situation, even more so with the free labor in Herbalife nutrition clubs.
The Herbalife “nutrition clubs” in particular tortuously try to circumnavigate various legal and regulatory requirements for retail business, food establishments, and labor laws, and action on this front has barely even started yet, but it is almost inevitable. As I have noted here before, my own district in the Bronx had the highest concentration of Herbalife nutrition clubs in New York City, and we certainly have an interest in the matter. We recently made it a point of refusing MLM/pyramid schemes at events of our Community Board, and I communicated with FTC chair, Edith Ramirez about the topic, seehere.
Needless to say, both the FTC and SEC have plenty of reason to do anything they can to make up for forty years of failing enforcement, but in the end this is not really a regulatory issue. Key to the whole thing is to understand that a pyramid scheme is a fraud disguised as a direct sales business, not a direct sales business that just needs to be regulated better. It has been observed again and again how entire groups of people move from one MLM to another when the going gets tough. When Herbalife became too hot for Anthony Powell, he moved to Vemma, where his operating style was tolerated, until they ran into FTC trouble too, but just in time, Powell had moved on again, this time to his own venture. In short, the made guys in MLM are a fungible commodity, and the price is omertà – support the lie – and adopt MLM-doublespeak instead of plain English.
These phenomena are the reason why in the end the suggestion of Prof. Richard Blakey, that MLM must be compared to the mafia, and needs to becombatted with a RICO prosecution needs to be taken seriously. Unfortunately, so far all the candidates for leading roles seem to be distracted, Kamala Harris in California refused to even enforce an existing consent decree on Herbalife, apparently because she was too busy getting elected for the Senate. In New York it would appear that AG Eric Schneiderman likewise is distracted by his own interest in running for governor.
However, even local prosecutions may be possible, after all to represent as a business opportunity something that both the IRS and the SBA don’t consider worthy, and which statistics show has a 99% loss ratio, and to take people’s good money for it, is also known as fraud. And a company like Herbalife perpetrates such fraud-in-the-inducement two million times a year just to stay even. In the end there’s no difference between the advance-fee fraud of MLM (“pay to play”), including Herbalife’s Club 100, and “Success University,” and the scams of Trump University or Corinthian Colleges.
H.R. 5230, the Trojan Horse
The DSA (Direct Selling Association), has kept up its customary game of trying to convince its membership that in spite of all jurisprudence to the contrary, its wishful re-interpretation of the law will prevail in the end. And, we have to grant them, they’ve been pretty good at their particular kind of make-believe for a long time. After Truth in Advertising drew attention to the fact that DSA Award winners are violating the DSA’s own ethics code, there was an outburst on a very pro-MLM site, Business for Home, asking if the DSA is still relevant, where some MLM owners wondered if the membership dues were worth it, if DSA members “in good standing,” were being prosecuted on several occasions if they were following the organization’s counter-factual advice.
In organizing a group around the H.R. 5230 proposal, the DSA apparently assumed it could fool all of the people all of the time, and nobody would notice that this proposal seeks to legitimize the very life-blood of pyramid schemes, conscripted consumption. Hopefully America’s lawmakers will know better, lest we become like Albania, and have to be bailed out by the IMF.
As Prof. Bill Keep pointed out in a recent article (MLM Industry Acts Like It’s In Crisis), the whole action surrounding H.R. 5230 reeks of desperation on the part of the DSA, and it looks like a Hail Mary pass to try to defeat the legal obstacles the so-called ‘industry’ faces, and eviscerate the FTC completely. The Truth In Advertising site has excellent analysis as well as a the perfect spoof of this absurd proposal on its site:
- Does This New Federal Bill Promote Pyramid Schemes?
- Dr. Peter vander Nat on why it is wrong for consumers.
- An Open Letter to Congress on H.R. 5230, from Dr. William Keep,Dean of the business school of TCNJ.
Pershing Square is a side show
The MLM-cabal tries to divert the attention by pointing out the travails of Pershing Square, which are a completely separate issue. Bill Ackman is an experienced guy, and everything says he is right on the merits in respect to Herbalife, but what happens with him or his company has nothing to do with the price of beans. Not even if he closes out his Herbalife position prematurely, which is unlikely, but it wouldn’t matter. Bill Ackman was merely the guy who called on the FTC to do their job, which they seem to have trouble doing.
This is not about Bill Ackman, this is not even about regulatory responses like from the SEC or FTC, in the end the only thing that will stop this particular pestilence would be a RICO prosecution. Communities are fed up with it. The fact that New York’s Senator Klein has been working on local legislation speaks volumes, but it is too ridiculous that federal regulators would fail to such an extent that this is even necessary. Perhaps the FTC will take the next step to enforce a Vemma-like settlement against Herbalife. More likely the case would go to court.
While MLM lawyer Kevin Thompson is trying to organize the mutiny in the DSA by running ahead on the Vemma terms, it would seem the MLM-‘industry’ is hoping for a settlement that allows Herbalife to continue to fight another day. That would be a disaster, however, Herbalife would soon be eviscerated by newer, younger MLMs, for the saturation level is now too well known. If regulators and law enforcement do not conclusively deal with MLM this time, it is going to be a free for all and kill or be killed for the country and the world are too small for the thousands of pyramid schemes that are already operating.
The upshot is, a business like Herbalife uses regulators like FTC and SEC deftly for credibility, as long as they dance to the tune of the DSA and maintain the advice that MLM can be legal. MLM may be legal, unless proven otherwise…, so all an MLM has to do is make it prohibitively expensive to prove otherwise… and invest a lot of money in training regulators where not to look, and keep them busy with harmless stuff, red herrings and the like…
Times are changing however. You can’t un-ring the bell. Nobody can deny that Pershing Square’s position and action shone a light on this problem so it could no longer be denied. It is now just a matter of time and it should be very clear that the endless delays in Herbalife’s ‘talks’ with the FTC do not bode well, and the Vemma terms would be the end of Herbalife as we know it.
The best advice remains to get out of Dodge, and if you can get confident of the timing, a short is a better bet now than when Ackman first put it on. Carl Icahn will end up with another billion wiped out from his balance sheet. It just took a little longer than expected. What should mystify us is why he is so patient with this management. For the rest of us, there’s no use waiting for the singing to start, whoever the singer may be.
Article Source: SeekingAlpha.com