Tracy Coenen, a forensic accountant and fraud investigator with
Sequence Inc. in Chicago and Milwaukee, is author of the Fraud Files
Blog. She is also a critic.

"Multilevel marketing companies are pyramid schemes that the
government allows to operate," said Coenen. "The only difference is
that Herbalife, or any multilevel marketing company, has a tangible
product that they use to make their pyramid appear legitimate."


http://articles.chicagotribune.com/2013-02-10/business/ct-biz-0210- herbalife-20130210_1_pyramid-schemes-mlm-companies-multilevel-marketer
or
http://tinyurl.com/ph3jo77

The fine line between legitimate businesses and pyramid schemes

Companies say sellers can make six-figure salaries; critics call
multilevel marketing firms a scam

February 10, 2013|By Gregory Karp, Chicago Tribune reporter

Controversy is again casting a shadow over the multilevel marketing
industry, as nutritional supplement company Herbalife Inc., which has
thousands of distributors in the Chicago region, has been publicly
called a pyramid scheme by a prominent investor — an allegation the
company vigorously denies.

Meanwhile, a different multilevel marketer, Fortune Hi-Tech Marketing,
was shut down in recent weeks after a lawsuit was brought by
regulators and several states, including Illinois, alleging the
company scammed consumers out of $169 million. The scheme affected an
estimated 100,000 Americans, including some in Chicago, where it
targeted Spanish-speaking consumers, the Federal Trade Commission
alleged.

Most people outside the industry might have only a vague notion about multilevel marketing, also called network marketing and direct
selling. It often involves personal sales of cosmetics, wellness
products or home decor items — or as critics flippantly call it,
"pills, potions and lotions" — usually sold through product parties
hosted by friends or relatives.

For sellers, the companies offer the appeal of starting a business on
the cheap with little training, working from home and being their own
boss, if only for part-time money. Some might recruit friends and
family to become sellers, which augments their own commissions and
gives them a shot at the six-figure compensation many such marketing
companies tout but few distributors attain.

The largest multilevel marketing companies, often known as MLMs, are
household names: Avon, Mary Kay, Pampered Chef and Amway. MLMs have
annual sales of about $30 billion, with about 16 million people in the
United States selling their products, according to the industry group
Direct Selling Association, which represents these firms and others.

The recent controversies might raise the question: What's the
difference between a legitimate multilevel marketing company and an
illegal pyramid scheme, in which only people who get in first — at the
top of the pyramid-like structure — make money and everyone else is a
dupe?

The harshest critics maintain there is no difference, that there's no
such thing as a legitimate MLM and that the industry's secrets stay
safe because of a cultlike mentality and a blind eye of regulators.

Jon M. Taylor, who was once a seller for an MLM company, said he has
studied the industry for 18 years and analyzed more than 500 MLM
companies. He maintains the website MLM-thetruth.com and offers a free
e-book there.

"I have not yet found a good MLM — a good MLM is an oxymoron," Taylor
said.

He said all MLM companies have the same flaw: They depend on endless
chains of recruiting new members. "There is no more unfair and
deceptive practice than multilevel marketing," Taylor said.

Tracy Coenen, a forensic accountant and fraud investigator with
Sequence Inc. in Chicago and Milwaukee, is author of the Fraud Files
Blog. She is also a critic.

"Multilevel marketing companies are pyramid schemes that the
government allows to operate," said Coenen. "The only difference is
that Herbalife, or any multilevel marketing company, has a tangible
product that they use to make their pyramid appear legitimate."

The Direct Selling Association says MLMs are legitimate businesses,
and that the group has about 200 members carefully screened by the
organization to ensure they are not pyramid schemes and don't use
deceptive practices.

The Federal Trade Commission agrees there are legitimate MLMs. The
difference between a legitimate business and pyramid scheme comes down
to products.

If the company and its distributors make money primarily from the sale
of products to end-users (and not boxes of product accumulating in a distributor's garage), it's OK.

By contrast, a pyramid scheme compensates those at the top of the
pyramid with participation fees paid by those recruited at the bottom.
It eventually collapses when the scheme can't recruit more people.

But identifying a pyramid scheme can be difficult because MLMs
typically have product sales, along with recruitment fees and
recruitment incentives.

"It gets cloudy when you have a situation where you have fees being
paid for both," said Monica Vaca, assistant director of the FTC's
division of marketing practices. "It's very nuanced."

While prosecuting an MLM can seem somewhat of a judgment call, cases
have a common factor: deceptive promises about how much money
distributors will earn, Vaca said.

In the Fortune Hi-Tech Marketing case filed last month, C. Steven
Baker, director of the FTC's Midwest region, said, "These defendants
were promising people that if they worked hard they could make lots of
money. But it was a rigged game, and the vast majority of people lost
money."

Joe Mariano, president of the Direct Selling Association, said MLM
companies typically use multilevel compensation as an alternative to traditional advertising. Companies use money they would otherwise
spend on ads or shelf space to instead pay distributors.

"Pyramids are bad guys," Mariano said. "Their mere existence confuses
the marketplace and makes it more difficult for legitimate direct-
selling companies to do business and to be understood."

Key to the association's code of ethics, which members are expected to
abide by, is a prohibition on deceptive sales practices, including
promises of outsize earnings. Fortune Hi-Tech was not a member of the association, Mariano said.

Indeed, it's often true that the vast majority of distributors don't
earn near enough to make MLM selling their primary job. The Direct
Selling Association puts median earnings at $2,400 per year, although
critics say the vast majority earn nothing.

Still, Mariano is quick to point out: "Somebody who works hard at this
has the potential to do very, very well."

Los Angeles-based Herbalife, a 32-year-old seller of weight-loss
shakes and wellness products, became news in December when Bill
Ackman, founder of Pershing Square Capital Management, made a $1
billion bet against Herbalife by shorting the stock. He has repeatedly
called the company a pyramid scheme and gave a lengthy and public
explanation of why.

(Ackman's Dec. 20 presentation is available at factsaboutherbalife.com
while Herbalife's Jan. 10 response is available at its website for
investors, ir.herbalife.com

In the Chicago area, Herbalife has a huge presence, with more than
16,000 distributors in the metropolitan region, about a quarter of
whom are avid sellers or "leaders," according to the company.

In an interview, Herbalife President Des Walsh said the company is not
a pyramid scheme because it sells "real products to real people" and
doesn't directly pay for recruiting new distributors. He points to the
company being in existence for three decades, operating in 88
countries and continuing to grow. "That growth has been based on more
customers consuming our products every single day around the world,"
he said.

He said Ackman is "seeking to disseminate false and misleading
information" about Herbalife to lower the stock price and profit from
his bet against the company.

Beneath the fray of high-finance skirmishes is Pablo Caicedo, 38, of
Chicago, and his story is typical.

He said he started using Herbalife products, lost 35 pounds and felt
like he had more energy. He learned he could get a discount on the
products he used by becoming an Herbalife distributor, which he did.
He began selling to friends as well. After three months, he was making
enough money to quit his job as a parking valet, he said. And for 14
years since, he's sold Herbalife products.

He said the negative publicity around MLMs and Herbalife, in
particular, doesn't bother him, chalking it up to other people's
opinions. "There are always two sides to an issue," Caicedo said,
adding that he has been satisfied with Herbalife. Caicedo said he
wasn't comfortable disclosing how much money he earns annually from
Herbalife sales.

However successful Caicedo is financially with Herbalife, others
aren't nearly so.

In fact, 88 percent of Herbalife distributors earned no commissions in
2012, according to company numbers. That excludes potential profits distributors might have earned on sales of products to others, but it
also excludes sales expenses distributors incur, figures Herbalife
says it doesn't have.

Why do so few make money?

Herbalife says it's because 73 percent of its sales force only join as distributors to get a wholesale discount on products that they use
themselves. For those people, paying the $59 or $109 to become
Herbalife distributors, depending on the starter kit, is like paying a
fee to join a Costco warehouse club to get better prices, Walsh said.
The product discount for those distributors is 25 percent.

But even the vast majority of those who are sales "leaders" at
Herbalife, the top 20 percent of sellers, don't earn enough to live.
Last year, more than half of the 82,464 sales leaders earned $1,000 or
less in commissions for the whole year, according to Herbalife.

Walsh said that's because most of them make Herbalife a part-time
business, viewing profits as incremental income, perhaps to pay for a
family vacation. "It's an additional form of part-time income that
really can help significantly impact their lives," he said.

However, like all MLMs, the very top sales people can profit
handsomely. Of those who achieved the sales status of "leader," 0.7
percent make six-figure dollar amounts in commissions. And 194
distributors, 0.2 percent of leaders, had average gross payments from
Herbalife of $724,030.

Such earnings disparity is common in multilevel marketing.

Often MLMs will suggest the difference in earnings stems from a
difference in effort, that some sellers are more serious about the
business than others.

However, critics say high earners are part of a deception and
contribute to the lottery mindset of sellers.

Herbalife isn't the only company in the news.

On Jan. 28, the suit by the FTC and several state attorneys general
shut down Fortune Hi-Tech Marketing, a network marketer whose
distributors sold products that included health and beauty goods and
those from certain wireless providers.

The company's distributors earned little for selling goods and
services and made more signing up additional sales people, regulators
allege. Most paid $100 to $300 in annual fees, and some paid
additional money to be eligible for sales commissions and recruiting
bonuses.

Fortune officials could not be reached for comment.

At a news conference in Lexington, Ky., the FTC's Baker reportedly
declined to comment on whether the move against Fortune Hi-Tech means
the agency is making a more aggressive push against direct marketers.

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