MLMs, Federal Trade Commission Must Obtain And Publish Distributor Retail Experiences

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ByBruce Craig:

My recent Seeking Alpha article on Herbalife ( HLF ) raised the question whether the company should collect retail sales data it requires its distributors to maintain for two years. My premise being that obtaining and publishing this data could be a meaningful factor in resolving the questions concerning the legality of its marketing plan.

I was surprised by the number of comments submitted, although it quickly became clear that they were not about me, or the finer points in the article, but rather a duel between those holding HLF stock and those either betting short or concerned about the inherent legality of the plan. It is also likely that, if Herbalife gets into legal trouble, other listed stocks with similar marketing plans would also be affected.

Some of these comments were strongly worded and personal in nature. It occurred to me, although it was probably obvious to an experienced trader, that the main reason for this strong language and personal attacks was an expression of real anxiety on the part of persons who invested in Herbalife, or in other similar publicly listed stocks, about enforcement authorities' stated concerns about the legality of these offerings. The drop in HLF's stock price after the Einhorn and Ackman public statements is a good indication of this anxiety, even with the stock's eventual rebound. Similarly, some high-level Herbalife distributors face significant losses if their or Herbalife's business practices come under increased scrutiny or enforcement efforts.

No matter what side of the issue you happen to be on, it makes sense that information about the actual business experiences of participants in these marketing plans should be of value to all concerned. Hoping for the best is not a very good business strategy, either for experienced traders or distributors, particularly when clarifying data is available. This data could disclose the extent of retail sales and indicate what percentage of these sales are being made to the general public and what percentage of sales are to other downline Herbalife distributors. As has been discussed, this is a critical element in determining the presence of a pyramid plan and the legality of a particular MLM offering. A marketing program that is primarily a closed loop of distributors creates serious problems in respect to any pyramid analysis. This is particularly true, as I have previously discussed , when the business offering involves a requirement of inventory purchase as a prerequisite for the right to recruit, for profit, others who are offered the same right to recruit, upon their inventory purchase, and who, in turn, are entitled to make the same offer to their recruits, in the terms of the FTC legal decisions, "ad infinitum." In other words, an 'endless chain.' The same concern is raised when the inventory purchase is a prerequisite for earning commissions on the distributors downline. Published data about significant distributor turnover, and economic failure in the 90+% range, would seem to support this legal concern.

I have urged the Federal Trade Commission to make initial investigative inquiries into this issue and clarify its legal standards so that they comport with prior Commission and Federal Court decisions. I have also urged President Obama to prioritize this matter, as he has with patent fraud issues, because of the concern relating to significant economic impact involved, particularly on lower income ethnic communities. Congresswoman Linda Sanchez has stated this concern in a letter to the Chair of the FTC, Edith Ramirez. The MLM industry presently does about $30 billion in business each year. To put this in perspective, the entire budget of the FTC is 1% of that .

The issue of determining current participant retail sales figures of current MLM participants, as well as net income experience, becomes of even greater importance because the FTC decided to exempt MLM offerings from its recent Business Opportunity Rule. This deprived potential participants of the actual business experiences of those who went before them. It not only kept this vital information from new recruits but it also deprived the FTC of critical data it needed to develop its enforcement posture and legal standards. This has given me serious concern about the objectivity of certain members of the FTC staff that were responsible for this omission.

Having said all that, it would also make good business sense, and be eminently fair to investors and recruits alike, for Herbalife to obtain the actual retail experiences of its distributors, not through a funded study, but through the acquisition of data readily available to it. And in any event, it is incumbent on the Federal Trade Commission to obtain this data and concurrently establish an enforceable legal standard. There is too much money involved for the company to remain in the shadows any longer.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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