By Robert FitzPatrick :
A recent article in Seeking Alpha by author and financial researcher Christine Richard about Herbalife's ( HLF ) "nutrition clubs" included this quote attributed to me, " Herbalife has entered the fabric of Main Street. It has tampered with the souls of millions of people. "
The quote referred to my longstanding evaluation of Herbalife as a force of mass deception in America, distorting values, diverting millions from pursuits of real livelihood and true education and causing widespread financial losses. Ms. Richard used the quote to support her own studied conclusion - which many on Wall Street had ignored or dismissed out of hand - that Herbalife's expanding nutrition club program was an elaborate sham inflicting targeted financial, educational and social harm upon low-income immigrants in the USA and millions more people worldwide.
Ms. Richards also addressed the question of whether the perpetration of a large-scale and sophisticated "income opportunity" scam upon vulnerable people should even matter to Wall Street as long as it is profitable. The need to address that question undoubtedly speaks to Wall Street's special mindset. It would seem otherwise unnecessary to point out that large-scale deceptions usually lead to catastrophic results. Think Madoff, the false claim of weapons of mass destruction in Iraq, the calculated sale of toxic assets into the securities market, the clerical cover-up of child abuse.
But beyond Wall Street's storied amorality and its famous obliviousness at the precipice of disaster, there is another factor relevant to exposing Herbalife that extends beyond Wall Street. This factor is deeper than greed, indifference or ignorance, and more powerful than mere disagreement over interpretation of facts.
It is that the truth about Herbalife - as repeatedly explained in the fraud thesis - is truly beyond belief for many people. To them, Herbalife's supernatural claims of unlimited income for all, salespeople replacing customers, infinite markets, and insatiable demand for its expensive products among the world's poor are less fantastical than what the critics are claiming. This is not because they have carefully weighed the research, documents and analyses on their own. Rather, the momentous and far-reaching truth about Herbalife and the regulation of multi-level marketing are not explained or communicated in the fraud thesis, leaving the claims about Herbalife stranger than fiction. Herbalife remains in the protective custody of the presumed legitimacy of multi-level marketing. Indeed, it is an icon of that sector. Claims that it stands out as a perpetrator of colossal fraud are viewed as extreme, incredible and malevolently motivated.
Even as the evidence mounts of deceptive recruiting, false product claims,
At Herbalife's extravaganza events, followers are lifted to states of ecstasy as they are shown a capitalistic utopia, a haven from the rest of the economy, the chance of a lifetime, possibly their last chance, that is available to all who will believe , follow rules, not quit, recruit their friends and keep buying the company's health-giving potions. The events, the message and followers' passionate responses also carry some Wall Street investors to heights of blind optimism. Growth and profit figures serve as further verification. From this view, critics could only have evil intent, or perhaps they are insane !
The time has come, therefore, to address directly this experience of shunning a reality whose name dare not be said, and an intellectual position that treats critics of Herbalife as conspirators or malcontents. It is necessary to reflect not just on the Herbalife facts, but on the strange andextremereactions to those facts, and to ask, "Why?"
Breaking the Spell
To consider why so many would find it unimaginable that Herbalife is a global pyramid scheme, as the fraud thesis claims, and would hold extremely negative views about Herbalife critics, it is necessary to do a forensic dissection of the Herbalife narrative. The dissection cites hard data, employs fact-based analysis and uses generally understood business terms. Such a reality test begins to break the mesmerizing spell cast upon believers in Herbalife's mythical realm, where faith is said to make due diligence and full disclosure unnecessary.
- Direct Selling : Herbalife cannot be classified as a direct selling enterprise. Herbalife has shown no evidence of the first requirement for direct selling, a sustainable base of retail customers, end-users. Herbalife has also shown no evidence of the second requirement for direct selling, an identifiable sales force, internal or third-party, that earns gross margins from retailing its products.
- Distribution : Herbalife distributors cannot be classified as distributors. There is no evidence of their serving the basic and vital supply chain role of "middlemen, " gaining a profit from finding and delivering the suppliers' goods to a base of bona fide end-users. What the so-called distributors do is find is more of their own kind. They extend the "endless" chain.
- Distributor Allowance : As Herbalife is not based upon retail sales, and its distributors do not distribute, there cannot be a "Distributor Allowance" which Herbalife has touted in its SEC filings as the aggregate retail profits gained by all distributors when they resell the goods. Herbalife even claims the "allowance" constitutes the largest share of total compensation gained by the "distributors." Not only is it not the largest, it does not exist.
- Income Opportunity : Herbalife cannot be said to offer an "income opportunity" to large numbers of people. Within Herbalife's own disclosures, revealed with some analysis and arithmetic, is the hard data showing that even among Herbalife's top-tiered upper 20% participants, the so-called Supervisors, the mean average annual "gross compensation " of 99% of all "Supervisors/Leaders" in the USA in 2012 was $21.46 per week. This "average income" is before all purchase costs and all other business expenses are deducted. Among the 80% below the level of Supervisor, there is, effectively, no means at all of making a profit.
- Social Value : Offering a chance for profit that is worse than is available at Las Vegas gambling tables, it follows that Herbalife is not a provider of "livelihood" to any significant number of people. To the contrary, Herbalife is the source of large-scale consumer losses for millions of households. The median average income (half make more and half less) of Herbalife "Supervisors" is zero.
- Members : Recently, Herbalife redefined over 70% of its sales force as "members." In fact, they are contractors , a legal status defining separation and distinction from Herbalife. They are "independent." They have no control, no voice and no right to speak for Herbalife. They would be sued if they did. The true status of Herbalife contractors is the opposite of membership.
- Customers : Herbalife's contractor salespeople/recruiters cannot be classified as open market customers . The pricing of the goods they purchase from Herbalife under terms of their contracts is non-negotiable . Return of goods requires resignation or termination from contractor status. Bargaining or competitive shopping is forbidden. While under contract, their own livelihoods are restricted by non-compete provisions. Even what the "customers" can do with the products after purchasing them - selling on eBay, for example - is controlled by Herbalife under contract terms. Under no known usage of the term "customer" could it apply to Herbalife's contractors.
- Leaders and Supervisors : The majority of Herbalife's "Supervisor/leaders" do not lead or supervise. 49% of Supervisor/Leaders receive no payment during a year from Herbalife. 27% recruit no downline. 49% dropout or lose status within one year. 67% of first-year "Supervisors" drop out within a year. Far from an earned achievement, which the title seems to imply, a consumer can become a Herbalife "Supervisor" by merely buying $3,000 of Herbalife product, and instantly gain all privileges of the rank. In Las Vegas terms, Supervisors are "whales."
- Competitors and Markets : Herbalife does not compete in the diet/weight loss/meal replacement market, and should not be characterized as a "weight loss" company. Herbalife's competitors are not identified by their "products" at all. Herbalife's only competitors are all other multi-level marketing companies, regardless of products . Herbalife's non-compete clause in its sales contract prevents its contractors from working for any other multi-level marketing company, not other diet companies (unless they are also multi-level marketing). Herbalife, therefore, should be classified as "multi-level marketing, " a special and legally undefined sector of enterprises in which the true products are the MLMs' own contractors, euphemistically called distributors, coaches, IBO, associates, etc. MLM companies are characterized by one common hallmark. It is the offer of "unlimited income" to all contractors that enroll, pay fees or buy products and recruit other contractors, endlessly . Herbalife does not compete with other diet product companies for market share of protein shake sales. It competes only for recruits with allother MLM companies that also traffic in those souls.
- Pricing and Profits : The prices for Herbalife's protein powder mixtures, and therefore Herbalife's gross profit margins on those products, are not based on the competitive market of such products. The "traffic" that the Herbalife's pricing can bear has to do with how much the newly recruited contractors can be induced to invest with Herbalife over time before they quit. Most will quit the company within a year, and virtually all will turn over within several years. Price per product is irrelevant, since Herbalife contractor-buyers do not engage in price comparisons. Since they have no customers beyond other recruited contractors, they have no concern for a retail margin. In any event, they cannot negotiate for pricing with Herbalife or any of its other contractors. Their eyes are not focused on product prices, but on an "unlimited" income promise. People will pay almost anything for a product they are told can make them rich.
- Manufacturer's Suggested Retail Price : As a corollary to the non-market pricing, Herbalife's MSRP is a fiction, and all references to it are misleading; there is no evidence that any significant number of people actually ever pay it. The only relevant economic figures for Herbalife are numbers of recruits, amounts of investments gained from them during their short tenure and the rate of replacing dropouts.
- Health Claims : Herbalife's products do not cure illnesses, and have no inherent value even for weight loss, and therefore, have no inherent value for improved health. Any weight loss and related improvement in health associated with ingesting Herbalife protein powder drinks occurs not from ingesting the product, but from lowering overall calorie consumption. Herbalife's products lead to weight loss in the same way that merely eating less food or any lower calorie food would. For many years, Herbalife did actually sell a real product that did actually, by itself, stimulate weight loss. That product contained ephedrine , now banned by FDA due to causing death.
- Sales Leads : The Herbalife-related "sales lead" companies (now no longer affiliated with Herbalife) do not sell valid and useful leads. Just as Herbalife "distributors" are actually the company's true commodity, the purchasers of the leads are themselves the target of "leads" schemes. Buying the "leads" led only to increased financial loss .
- Nutrition Clubs : The Herbalife-nutrition clubs, as Christine Richard ably documented, are not local clubs, and are not about nutrition. They are commercial recruiting centers organized and controlled by Herbalife, in which Herbalife-awarded points that lead to Herbalife-recruiter status are sought by the operators and constituents. They are not operated by anyone trained in nutrition, and have no program for health other than the recommendation of consumption of Herbalife protein powder drinks, incentivized by Herbalife's "unlimited" income promises.
- Education : "Graduation" in the nutrition club's program of consumption that is presented as a " Universidad " and includes cap-and-gown ceremonies, has no relation to real education (other than the university of hard knocks), and the promise of high income for "graduates" has no relation to actual results. 99% of "Supervisors, " which is the recommended goal for nutrition club participants and for which they gain "education, " earn only about $20 a week, on average, before all costs are deducted.
This dissection of fundamental elements of the Herbalife narrative illustrates the first and perhaps the main cause of widespread denial, bewilderment and the incapacity to imagine Herbalife as fraud thesis advocates portray it. It is that there is no declarative language in general use for describing what Herbalife is. The dissection only describes what Herbalife is not . To replace Herbalife's fictional account of direct selling, unlimited income opportunity, endless sales chains and magical powder drinks, with an understandable, fact-based, business model analysis, an appropriate vocabulary is required. Yet, the terms that are almost universally used to describe Herbalife, including by the fraud thesis advocates, sabotage the message.
How does one speak about an enterprise that sells products almost entirely and only to its own salespeople, who are not actually salespeople because they have no customers, and who are described even by the company not as salespeople but as "members," but are legally the opposite of members, and those products which they allegedly sell are not the company's true products, but rather its own salespeople are the actual tradable commodities, except that they are not really salespeople?
How can one find an effective voice while using terms such as "income" and "opportunity" and "sales" to describe an enterprise that offers no income opportunity, has no true sales force, and inflicts financial harm on a vast scale? Herbalife is wrapped in the language of conventional business, but if, as Pershing Capital's fraud thesis asserts, it gains money from people by making a promise it cannot and does not deliver, how could that be called a "business" at all? Utopian promises that cannot be fulfilled are the stuff of religion, political ideologies and cults, but businesses are entities that can be quantitatively measured and facilitate equitable exchanges of value.
Pseudo-Business and Mythical Terms
The difficulty of fraud thesis advocates to convincingly reveal Herbalife's true nature is contained in the language used. The sabotage of truth begins with the legally meaningless, indefinable, self-made-up term, "multi-level marketing, " (already used several times in this essay). This term refers to hundreds of enterprises, such as Amway, Nuskin ( NUS ) and Usana ( USNA ), all indistinguishable from Herbalife, except for logos and some products. Their models, policies, sales contracts, marketing activities, rhetoric and compensation plans are fundamentally identical to Herbalife's. Most of the larger ones belong to the same trade and lobbying group, the Direct Selling Association. Participants in the enterprises can and do move seamlessly from one company to another in their quests for the promised "unlimited income , " product differences notwithstanding.
Note : To my knowledge, the only person in the world who has specifically developed a vocabulary for describing "multi-level marketing" as a distinct social and economic phenomenon is David Brear, an English writer, cult expert and popular European blogger. He calls his terminology and conceptual framework a "deconstruction" of MLM. An example of his linguistic treatment of MLM, in contrast with how it is covered in the news media, can be foundhere.
The Federal Trade Commission, the Better Business Bureau and the Chamber of Commerce all assert that MLM is a "legitimate business." None, however, will unequivocally identify and verify a single MLM enterprise as legal and legitimate. Would it be the oldest, largest and best-known MLM - Amway? That company was recently sued as a pyramid fraud in a class action lawsuit in the USA, and settled for over $100 million. The claims of the suit closely mirror those now made against Herbalife in a current class action lawsuit , and those made by against Herbalife by fraud thesis advocates.
In 2007, The Department for Business Enterprise and Regulatory Reform in England charged that Amway is " inherently objectionable " and must be "wound down" ("shut down" in USA English). The government claimed that Amway violates England's Fair Trading Act 1973, among other laws. A UK judge subsequently ruled that Amway could continue, upon making major structural and operational changes in the UK. The final ruling noted among the findings that, of Amway's current "active" distributors in the UK, only about 90 out of more than 33,000 earned enough bonus to cover the costs - a 99.7% loss rate; for the period 2001-2006, 75% of all Amway bonuses were earned by 1.5% of IBOs (distributors); over a five-year period, there was a near-100% turnover rate among the "distributors." Do those findings about the archetype of the "legitimate" MLM industry sound familiar? So which MLM company is the model to measure all others by?
Beyond the pseudo-identity of the "legitimate" multi-level marketing "industry, " Herbalife is shielded by a thought-stopping dictionary of myth-language - distributors, members, downlines, direct selling, commissions, distributor allowance, royalties, leaders , supervisors , etc. Herbalife's mythical business language - the dissection showed that those terms and others are erroneous or the opposite to reality - keeps the speaker and thinker trapped inside a fictionalized narrative, preventing a recognition or an expression of plain facts.
Despite this linguistic labyrinth, the truth of Herbalife can be grasped, and some have seen it in full light. Some have even placed enormous financial stakes on those facts. Yet, when they attempt to speak about what they know, they inevitably find themselves using the loaded and misleading language assigned by Herbalife itself. The result is that many people find the fraud thesis incomprehensible or irrelevant, lacking a context, a justifiable purpose or an over-arching reason for targeting Herbalife. Lacking that, they ascribe malice.
Trying to describe - as the advocates of the fraud-thesis do - an inherent fraud (endless chain scheme), yet defining the scheme in terms of conventional business and then directing the indictment at a ranking member of an "industry" that is generally presumed (including by some fraud thesis advocates themselves) to be "legitimate" becomes contradictory. Are all MLMs frauds, or just Herbalife? Why Herbalife? Why has Herbalife not been prosecuted, or all the others like it? How would a person know which MLM is fraudulent, if this large and long-running one is? Surely, the entire industry could not be fraudulent? Surely, the largest and oldest among them are legal?
The fraud thesis depiction of Herbalife as merely a rogue "business," that has somehow been allowed to operate for 30 years by regulators and is unwittingly supported by some of the world's most notable financiers and political figures - dilutes the monumental, global questions raised by the thesis. The thesis is, thereby, dismissed by many people, without further inquiry, as not serious or driven by ulterior motives. It just does not seem possible - beyond belief - that the largest and one of the oldest icons of MLM is a fraud, when it is the model emulated by all the others.
Business Engaging in Fraudversus Fraud Engaging in Business
Enron, at one time the seventh-largest company in America, was later revealed as a business engaging in fraud , as was WorldCom, the second-largest long distance phone company. The use of conventional business terminology for such firms and many others that resorted to fraud is appropriate and understandable. Their prosecutions did not indict every other electric energy provider or telephone service company. They were not inherently fraudulent, just functionally.
Bernard L. Madoff Investment Securities LLC, on the other hand, was
But the clear and unequivocal realization of Madoff as a pseudo-business came only after he voluntarily turned himself in. Never during its many years of operating was there ever a public discussion of Madoff's enterprise in terms of its true nature, a calculated Ponzi. Until his arrest, Madoff enjoyed linguistic safety ensconced in the vocabulary of "hedge fund, " "investors" and "trades," and was protected as a respected member of the "financial industry." To have spoken the truth about his enterprise was "defamation" against a Wall Street icon. Implying illegality of his enterprise carried great risk to the speaker. When whistle-blower Harry Markopolos tried to say the truth, and wrote the word "Ponzi" in his reports to the SEC, and then, to his amazement, the SEC did nothing, he realized his extreme personal vulnerability. He began carrying a gun for self-protection. The truth about Madoff was literally unspeakable .
MLMs that make "endless chain" income propositions, dooming virtually all their investors to inevitable loss, do so in plain sight. They rely almost entirely on the linguistic immunity factor to shield them from being recognized for what they are. And they enjoy the safety of membership in the "multi-level marketing industry."
To say otherwise about them carries risk for the speaker. The last major MLM prosecuted by the FTC, Fortune High Tech Marketing , operated for more than 10 years without prosecution. It never concealed its model. Recruits made money only if they recruited other people who would have to do the same ad infinitum . The products and all the other aspects were trappings. FHTM said it was just an ordinary multi-level marketing company. It had no need for falsified reports, a second set of books or a secret trading room, as a Madoff-style Ponzi would. It merely disguised its operation with the pseudo-language of "multi-level marketing, " presumed by the public and the authorities to be "legitimate." When one whistle-blower did say publicly that the FHTM enterprise was a pyramid scheme, he was sued by the scheme almost into bankruptcy. Later, all his claims were verified and vindicated.
The fraud thesis asserts that Herbalife is a "fraud engaging in business, " that it harms people by its pyramid scheme design, making its commercial transactions not market-based, but "unfair and deceptive , " and therefore illegal.
The entrenched and entrapping jargon of MLM, involving terms such as "sales, " "commissions" and "distributors" which the fraud thesis employs, partially explains why Pershing Capital's presentations on Herbalife have more than once led to investors arriving at conclusions opposite to the presentations' intended messages. Some listeners cannot hear a claim of such sweeping magnitude when it is presented in Herbalife's own business terms. The assertion is "unthinkable," because the very words that are used make the thought implausible .
Beyond the linguistic protection of an identity as a "legitimate MLM, " there is one other factor that reinforces the denial of facts about Herbalife. It is the protective web of business boosters, financial backers, legal defenders, celebrity endorsers, negligent or compliant regulators and political supporters of Herbalife, many of whom share in Herbalife's booty. They serve as defenders of the myth, with their own interests now attached to Herbalife's fairy tale. For decades, this web was left undisturbed to widen and strengthen, except for the occasional private lawsuit or class action cases.
Can today's voices calling for prosecution penetrate or break the tight web that protects and upholds Herbalife's version of reality? Consider the ramifications. Former Secretary of State, Madeleine Albright, now a paid speaker at Herbalife recruitment rallies, would have to explain and back out of her endorsements. How would a prosecution of Herbalife affect the Albright Group , her international consulting firm that lists Coca-Cola among its clients. Would it affect Albright Capital Management , her private fund related to investments in emerging markets? The survival of Madeleine Albright's credibility now potentially aids the Herbalife myth.
Would Carl Icahn be able to explain away his aggressive support of
How could the FTC and SEC explain to Congress that they somehow missed the Herbalife scheme's realities for three decades, when the entire case had been laid before them in two previous class action lawsuits, a California AG prosecution decades ago and a whistle-blowing lawsuit brought by a former top Herbalife distributor? The survival of the regulatory agencies' integrity and authority potentially aids the Herbalife myth.
A far longer list of institutions, individuals and organizations - did I reference the Direct Selling Association? - have vital stakes in upholding what some surely know to be outrageous fabrication.
The court-appointed receiver in the recently SEC-prosecuted MLM company, Zeek Rewards , has sued nearly 10,000 "winners" in that Ponzi in "clawback" suits. How many Herbalife upliners would be similarly sued in a pyramid scheme prosecution scenario? Would the clawback extend to shareholders on the inside who are well-positioned to know about 99% loss rates, even as they trumpet the "greatest income opportunity in the world?" The sheer number of people that have been involved in Herbalife after all these years, and the vast amount of money that has changed hands potentially serves to aid the maintenance of the myth, even as reality is ripping and pulling at the web.
Herbalife's Absent Legal Defense
Notice that an examination of the factors that uphold the Herbalife myth does not include a powerful legal argument. Herbalife never did sue Pershing Capital for calling it a fraud, as many Herbalife backers expected and hoped it would. Indeed, the need for a legal argument is often dismissed by Herbalife backers on the grounds that the FTC simply does not have the prosecutorial will or the administrative capacity to enforce the law against the giant Herbalife and all its heavy-hitting backers. It is too big to jail.
This is surely a risky assessment. If it proves wrong, the collapse of the House of Herbalife would bring down many with it. In the recent MLM/Zeek Rewards prosecution by the SEC, the court-appointed Receiver has also named as a defendant the scheme's attorney who administered its "compliance test" to all the MLM's participants. He is charged with adding up to $100 million in losses. According to the Receiver's lawsuit, the attorney, Kevin Grimes, and his law firm, Grimes and Reese , assured the public and regulators of the scheme's legality, and leveraged their credentials in the MLM industry to put a halo of credibility around the Zeek fraud.
If that short-lived, minor-league MLM does not seem relevant to the fabled MLM giant Herbalife, remember that Kevin Grimes was considered the most famous "MLM" lawyer in America. His firm counts Herbalife among its MLM clients, along with Take Shape for Life (Medifast), Usana and Donald Trump's "Trump Network." Grimes previously was the in-house attorney for the MLM company, Melaleuca. The firm claims to have advised hundreds of new MLMs about the status of laws and the regulatory environment.
In 2010, Grimes & Reese received the Direct Selling Association's "Partnership" Award. The DSA stated, " Grimes & Reese's expertise in the industry is highlighted by the fact that in all of the major FTC pyramid scheme actions brought against direct sellers in the past decade the defendants have sought out their firm for representation."
The Amway Protection
Herbalife's current legal team, Boies, Schiller, Flexner ( BSF ), has apparently played no such role as a public promoter of the Herbalife myth. However, it was surely not lost on investors that Herbalife hired that particular firm as soon as Pershing Capital's pyramid scheme thesis was presented, and just after BSF had successfully sued Amway , the mother of all multi-level marketing companies, in a class action lawsuit, winning more than $100 million in damages and restitution. Who better to defend Herbalife's legality than the firm that had successfully attacked the pillar of the MLM industry as a pyramid scheme, with charges that mirror those now leveled against Herbalife by Pershing Capital? On behalf of Herbalife, Boies, Schiller, Flexner is also sitting across the table from attorneys who are suing Herbalife in a class action case closely paralleling the one BSF itself brought against Amway . That suit claimed the Amway business is an illegal pyramid scheme selling a false income promise, just like the Herbalife case's claim.
Long Life and Sudden Death
The 30+ year longevity of Herbalife's growing enterprise is frequently cited as evidence of its legality and sustainability, and may be included as part of the protective web supporting the Herbalife myth. Yet, this longevity might also be viewed as an ominous indicator of an inevitable catastrophe that only grows worse over time.
For a jolting look at the devastating consequences of continuing to ignore or believe in a destructive fraud that is presented as financial legitimacy, I recommend the book " The Club No One Wanted To Join - Madoff Victims In Their Own Words ." It recounts the experiences of 29 victims after the 2008 arrest of Bernard Madoff, told in their own words. For many of them, the disaster spelled the end of college careers, home ownership, retirements and medical care. The sudden revelation that the Madoff Hedge Fund was a Ponzi scheme, which some had placed full faith and all their lives' savings in, led to suicides, early deaths, illness and untold harm extending far beyond direct investors.
The stories in that book offer a variety of accounts from a diverse group of people, each coping with shock and loss. There was, however, one unifying theme. They all said that before the 2008 arrest of Madoff, it had been literally unthinkable and unimaginable to them that Bernard L. Madoff Investment Securities LLC could have been a fraud.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has 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.