Corey Augenstein
MLM Insider
Editor-In-Chief

A Book Educational Development Corporation Doesn't Want You To Read
Published: May 19, 2017

Summary

Using a framework created by pyramid scheme experts William Keep and Peter Vander Nat, we explore how much UBAM must sell at retail.

Despite EDUC not disclosing UBAM’s retail sales, there is evidence to suggest that demand for the product is not what it appears.

Research suggests that UBAM consultants engage in internal sales to each other at a loss and potentially qualification buy, which are red flags.

Additionally, UBAM lacks Amway-like safeguards and may not pass the Koscot Test, two key tests often used in court in pyramid scheme accusations.

We find that there are enough problems that only EDUC releasing the retail sales data of UBAM can make it a legitimate MLM.

We have been examining Education Development Corporation (NASDAQ:EDUC) and Usborne Books & More (UBAM) for over a year prior to publishing this article. Brandon Ferro's phenomenal article covers a wide range of issues relating to UBAM's and EDUC's operations, but did not examine some of the more critical elements of the UBAM MLM we believe make the company prone to an even greater downside.

Overview of Educational Development Corporation

Education Development Corporation is the sole United States distribution company for Usborne Publishing Ltd., a UK company which publishes children's books. Books are sold through two channels: the Publishing Division, which is comprised of Kane Miller publishing and focuses on placing books in typical retail outlets such as bookstores and toy stores. The second division is the Home Business Division called Usborne Books & More, which is a multi-level marketing (MLM) program, that retails books through a network which utilizes various methods such as home shows, book fairs, and more. According to EDUC's 2015 10-K, for the fiscal year ended in February 2015, UBAM accounts for 65% of revenue of EDUC while the Publishing Division accounts for 35%. For the fiscal year ending February 2016, UBAM accounted for 83% of revenue for EDUC while the Publishing Division accounted for 17%.

Sources and Methods

Research in this report utilized open source data and discussions with current and former consultants. The majority of information is sourced directly from EDUC and UBAM websites, materials, and government filings. Other information sources came from distributor created content such as websites, blog posts, YouTube videos, and other similar sources. Discussions with consultants are focused on their experience with UBAM, some of which are republished with permission here anonymously.

The authors started with the company's 2015 and 2016 10-Ks, analyzing it for potential issues and areas of concern. Additionally, the authors gathered materials provided in order to understand what a consultant would see, such as the marketing plan, which would indicate what the company placed emphasis on and any other topics that may be of interest.

Drawing the Line Between MLM and Pyramid Scheme

Before discussing UBAM any further, we must first establish the difference between an MLM and a pyramid scheme. In 2002, pyramid scheme experts William Keep, a dean at The College of New Jersey, and Peter Vander Nat, a retired senior economist at the FTC, published "Marketing Fraud: An Approach for Differentiating Multilevel Marketing from Pyramid Schemes." In the piece, they define pyramid schemes as a type of marketing fraud that "... is a transfer scheme that uses certain marketing tools that illegally achieve financial success for some by imposing a direct loss on others and that are inconsistent with establishing a viable retail base." Retail bases are where the line is drawn between MLM and pyramid scheme. Keep and Vander Nat explain that if participants are paid primarily based upon their retail sales, then they are in a legitimate MLM. However, should participants be paid primarily on their recruiting of new individuals, then they are part of a pyramid scheme.

While the above distinction is fairly well understood, Keep and Vander Nat provide a framework where one can calculate the point where an MLM is a pyramid scheme by looking at the retail sales or the percentage of product that is sold at retail to a person or entity that is not part of the MLM. Keep and Vander Nat identified several critical retail levels when examining an MLM. Retail percentages have three cut points, which we'll call c(1), c(2) or c(*), and c(^). When the amount of product sold is above c(1), less than 50% of upline rewards and consultant gross earnings are founded in recruiting. Retail sales in this range do not warrant a pyramid scheme finding. When the amount of product sold is below c(2) a/k/a c(*), it means both upline rewards and over 50% of a consultant's gross earnings are founded in recruiting. This means that recruiting is what drives the MLM, making it a pyramid scheme. c(^) is the point where the upline rewards are based primarily in recruiting, but a consultant's gross earnings are based primarily in retail sales. A pyramid scheme label at this point or below is possible but not a guarantee.

Key to the above retail points, Keep and Vander Nat analyze what they call the advanced retail commission (ARC). This is a critical component in establishing a legitimate entity versus a pyramid scheme. ARC measures how much money is available to pay upline distributor rewards after satisfying basic costs. It also uses a gross sales figure for products sold at retail to the public. The formula is:

Advanced Retail Commission = gross retail sales - (direct retail commissions + full production costs)

If UBAM's costs exceed ARC, the company must keep recruiting new individuals into the program in order to afford paying out rewards to the upline distributors, as these new recruits bring potentially new sales and new recruits to the program that allow the money transfer scheme to continue.

When costs exceed ARC, Keep's and Vander Nat's framework measures the level of rewards or compensation that does not have a connection to retail sales. Essentially, the framework provides guidance on determining rewards to the upline that are based on recruiting and not retailing. This can be determined by the use of the effective recruiting rewards (ERR) calculation. The formula is as follows:

Effective Recruiting Rewards = Total Upline Commissions Based Upon The Wholesale Price of a Unit - Advanced Retail Commissions

It is also crucial at this point to reiterate and more clearly define what a retail sale actually is. A retail sale is when a consultant sells a book at full retail price to an individual or entity that is not part of UBAM. Anything not sold outside the network could be sold to the downline (ex: inventory loading new recruits), self-consumption (ex: joined to buy books at a discount for personal use) or qualification buying (ex: purchased a certain amount of books in order to qualify for rewards or status qualification). As these sales do not leave the network, they fail to qualify as a retail sale. Remember that if UBAM is not selling enough product outside the network to cover rewards, then the operation is likely a pyramid scheme.

Applying the Framework to UBAM

Because UBAM's parent company EDUC is publicly traded, the company is required by law to make available financial disclosures which are used as in inputs to calculating how UBAM's consultants are paid. Using the framework and starting with EDUC's 2016 10-K, we start with the following.

  • Column A: How many $10 books must be sold at retail (assumed average book cost).
  • Column B: The gross retail sales volume, which is Column A times $10.
  • Column C: Is the commission collected by consultant? We assume that each book sold is approximately 21% commission, which is an average of 17% and 25%, the two most frequently paid commission percentages.
  • Column D: The fixed costs, which are cost of sales, operating, and general administration expenses divided by revenue. As we do not know the exact percentage UBAM is of costs versus EDUC's Publishing Division, we used 100% of the numbers from the filings provided. As these costs go lower, the amount that needs to be sold at retail to the public would also need to be lowered. This number is found by dividing EDUC's costs against its revenue for a percentage.
  • Column E: Is the aggregate upline rewards, which is found by totaling each override commission paid out per level (8.5%+5.5%+4%+1%), equaling 19%? The amount is found by multiplying $7.90 (wholesale book cost) times 19% to get $1.50 in total rewards paid on a $10 book. This will always be a fixed cost due to the marketing plan being a fixed item.
  • Column F: Is the ARC or total amount available after all costs to pay for upline rewards?

A

B

C

D

E

F

Percentage Retailed Outside the Network

Gross Sales Volume ($10 book)

Direct Retail Commission (21%)

Production Costs (63%)

Aggregate Upline Rewards (19%)

Advanced Retail Commission

90%

$9.00

$1.89

$5.01

$1.50

$2.10

85%

$8.50

$1.79

$5.01

$1.50

$1.71

83%

$8.30

$1.74

$5.01

$1.50

$1.55

80%

$8.00

$1.68

$5.01

$1.50

$1.31

75%

$7.50

$1.58

$5.01

$1.50

$0.92

73%

$7.30

$1.53

$5.01

$1.50

$0.76

70%

$7.00

$1.47

$5.01

$1.50

$0.52

65%

$6.50

$1.37

$5.01

$1.50

$0.13

63%

$6.30

$1.32

$5.01

$1.50

-$0.03

Table 1: Analysis of UBAM's 2016 10-K numbers.

This table shows the following:

c(1), our upper cut point, is 83%. Should 83% or more of all UBAM books be sold at retail, then EDUC covers its costs and there's no way it is a pyramid. c(2) or c(*), our lower cut point, is about 63%, meaning that if UBAM only sells 63% or less of its books at retail, then it is undoubtedly a pyramid scheme.

The area between c(1) and c(2) is a key area. Since not all the costs are covered strictly by retail sales, then recruiting becomes an important focus. The question is how important is the focus on recruiting? With each decreasing percentage of retail sales, a greater percentage of upline rewards and consultant earnings are founded in recruiting.

  • Column A: The two cut points and area between them from Table 1.
  • Column B: The Effective Recruiting Reward, which is Column E minus Column F from Table 1.
  • Column C: Gross earnings, which is Column C plus Column E from Table 1.
  • Column D: Percentage of upline rewards not funded by retail sales, which is Column B from Table 2 divided by Column E from Table 1.
  • Column E: Percentage of Gross Earnings is Actually ERR, which is Column B divided by Column C in Table 2.

A

B

C

D

E

Percentage Retailed Outside the Network

Effective Recruiting Reward (ERR)

Gross Earnings

Percentage of Upline Rewards Not Funded by Retail Sales

Percentage of Gross Earnings is Actually ERR

83%

-$0.05

$3.24

-3.34%

-1.55%

80%

$0.19

$3.18

12.45%

5.87%

75%

$0.58

$3.08

38.76%

18.91%

73%

$0.74

$3.03

49.29%

24.38%

70%

$0.98

$2.97

65.08%

32.88%

65%

$1.37

$2.87

91.39%

47.86%

63%

$1.53

$2.82

101.92%

54.17%

Table 2: Analysis of UBAM's grey area for 2016 10-K.

This table shows the varying grey areas between the two cut points. For each level, we can see the percentage of upline rewards that have no basis in retail and the percentage that gross distributor earnings are recruiting. c(^) is just under 73%, half of upline rewards have no basis retail, and about 25% of each consultant's gross earnings are based in recruiting. It is possible for UBAM to be a pyramid scheme should retail sales fall below this number, but that would solely be at the discretion of the government.

Repeating the same exercise on the 2015 10-K numbers, we get the following:

A

B

C

D

E

F

Percentage Retailed Outside the Network

Gross Sales Volume

Direct Retail Commission at 25% retail

Production Costs

Aggregate Upline Rewards

ARC

100%

$10.00

$2.10

$6.11

$1.50

$1.79

99%

$9.90

$2.08

$6.11

$1.50

$1.71

97%

$9.70

$2.04

$6.11

$1.50

$1.55

90%

$9.00

$1.89

$6.11

$1.50

$1.00

88%

$8.80

$1.85

$6.11

$1.50

$0.84

85%

$8.50

$1.79

$6.11

$1.50

$0.60

80%

$8.00

$1.68

$6.11

$1.50

$0.21

77%

$7.70

$1.62

$6.11

$1.50

-$0.03

Table 3: Analysis of UBAM's 2015 10-K numbers.

That is correct. 97% of UBAM's product would have had to leave the network to at least cover costs. At about 77%, the company can be considered a pyramid scheme.

A

B

C

D

E

Percentage Retailed Outside the Network

Effective Recruiting Reward (ERR)

Gross Earnings

Percentage of Upline Rewards Not Funded by Retail Sales

Percentage of Gross Earnings is Actually ERR

97%

-$0.05

$3.54

-3.21%

-1.36%

90%

$0.50

$3.39

33.63%

14.89%

88%

$0.66

$3.35

44.15%

19.79%

85%

$0.90

$3.29

59.94%

27.38%

80%

$1.29

$3.18

86.26%

40.70%

77%

$1.53

$3.12

102.05%

49.13%

Table 4: Analysis of UBAM's grey area for 2015 10-K.

At about 85% is where we find that half of upline rewards aren't funded by retail sales.

There's an eyebrow-raising 14% reduction from 2015 to 2016 attributed mostly to lower production costs at EDUC. Recall, however, that the production costs are large factor here since we do not know how much UBAM's costs are versus the Publishing Division. As production costs drop, the amount sold at retail will also go down. Here are some comparisons using less than 100% for the 2016 numbers:

If UBAM is ___ of Productions Costs

c(1) - All costs covered

c(^) - Over 50% of upline rewards based in recruiting

c(2) or c(*) - 100% of upline rewards are based in recruiting

90%

76%

66%

57%

80%

70%

60%

51%

70%

64%

54%

45%

Table 5: Select percentages of EDUC's production costs and the impact on retail sales for UBAM for 2016.

If UBAM is ___ of Productions Costs

c(1) - All costs covered

c(^) - Over 50% of upline rewards based in recruiting

c(2) or c(*) - 100% of upline rewards are based in recruiting

90%

89%

79%

70%

80%

81%

71%

62%

70%

74%

64%

54%

Table 6: Select percentages of EDUC's production costs and the impact on retail sales for UBAM for 2015.

You can review all the calculations here.

So what percentage of UBAM's salesis at retail? As that number is not disclosed in EDUC's filings, we cannot answer that question. Furthermore, there is no way to deduce what the percentage may be. However, taking a deeper look at consultant activity online as well as some of EDUC's practices can shed a light on what kind of retail activity is taking place in order to help us come to a conclusion about this MLM.

Consideration 1: Consultants Participate In Large Facebook Groups That Sell Exclusively To Each Other At A Loss Or Create Synthetic Demand

The groups are not one-offs, with a few dozen or few hundred consultants: there are thousands of active consultants constantly seeking to sell or obtain inventory. The two largest groups are UBAM Buy * Sell * Trade (Consultants Only) and UBAM EC (Educational Consultants). As these are secret groups, you will not be able to access them, but the links are provided.

Source

The second group, UBAM EC, is a much larger community, with nearly 5,500 members.

Source

And a third group, Usborne Books Buy Sell Trade, which is also open to non-consultants and has approximately 1,700 members.

Source

Although we cannot get an accurate count for the number of unique individuals in these Facebook (NASDAQ:FB) groups, the sum for the current groups is just over 10,000 individuals. If 5,000 are unique, that would mean that nearly 18% of their 27,000 consultant sales force potentially engages in internal consumption, or transacting with other consultants. The fact that these groups exist and are this large is unfavorable for EDUC in arguing their retail sales numbers.

The selling taking place in these groups is disheartening. For example, UBAM Buy * Sell * Trade (Consultants Only) is so tightly maintained that it has its own rules about what can be charged for books, shipping, sales tax, and more. The part highlighted below reads as follows "...in this group you are prohibited from selling BOOKS at full retail value! All sales of books in brand new condition will begin at 25% off the retail value of the book!" This means that books must be sold to other consultants at cost, though likely at a loss after shipping, and the consultant selling the book stands to lose more money if the 25% off isn't enough. None of the sales taking place in this group would count towards the required amount needed in retail sales for EDUC to not be a pyramid scheme.

Source: UBAM Buy * Sell * Trade (Consultants Only)

The examples of consultants selling their books at a loss are plentiful within these groups. Those who seek to exit UBAM completely typically take the largest losses.

Source: UBAM Buy * Sell * Trade (Consultants Only)

Source: UBAM EC

Source: UBAM Buy * Sell * Trade (Consultants Only)

Source: UBAM Buy * Sell * Trade (Consultants Only)

EDUC claims that UBAM's Facebook Parties are a source of massive growth; increases in the hundreds of percentage points. First, if such a thing is true, then EDUC knows where the retail sales are going and could provide data that would answer the retail question we are exploring. However, now that we know about the existence of these groups, what percentage of the Facebook Party sales comes from the above groups and is strictly to other consultants seeking to build out their own inventory or meet demand that EDUC cannot meet due to various logistic issues on its end? These sales would not count towards retail.

Consideration 2: High Level Consultants Have Inexplicably Large Amounts Of Inventory In Their Homes

Before going into detail, it is important to understand a bit about UBAM's structure and qualifications, starting at the first notable level: Team Leader. If someone achieves Team Leader status, the individual must meet the following requirements to maintain status:

  • Achieve personal sales of at least $1,000 within the previous three months.

  • Have central group (personally recruited individuals and the individuals they recruited and the individual's sales) total $4,000 per quarter.

To achieve Team Leader, an individual must achieve $2,000 in personal sales in two consecutive months and recruit at least two people, but once the individual is a Team Leader, he or she must make $1,000 in personal sales over three months and make sure that there are enough people below him or her that $3,000 in additional sales in achieved over the same three-month period.

UBAM still has several other levels in its marketing plan. In ascending order, the level and requirements are as follows:

Level

Requirement

Senior Team Leader

$1,000 in personal sales over three months

$4,000 in central group sales per quarter

2 First Level Team Leaders

1 Second Level Team Leader

Executive Leader

$1,000 in personal sales over three months

$4,000 in central group sales per quarter

3 First Level team Leaders

1 Second Level Team Leader

1 Third Level Team Leader

Senior Executive Leader

$1,000 in personal sales over three months

$4,000 in central group sales per quarter

4 First Level Team Leaders

2 Second Level Team Leaders

1 Third Level Team Leader

Director

$1,000 in personal sales over three months

$4,000 in central group sales per quarter

6 First Level Team Leaders

1 Executive Team Leader

Source

What we believe is happening with consultants at all levels is that their personal sales and/or central group sales fall short at the end of each three-month mark. Therefore, the consultants pay for the difference out of their own pocket because either 1) doing so is beneficial because the consultant will still make a profit or 2) the consultant is afraid of losing his or her level, as consultants are only allowed missed month. This leaves the consultants with large amounts of inventory in their homes and no retail customers for them. Ultimately, qualification buying by consultants does not count towards retail sales. To illustrate this, refer to the exchange between the two former consultants (repeated below):

Source: Former UBAM Consultants

Ann is referring to the following comment by Jim York, the husband of Beth York, a director (one of the highest levels in the marketing plan at UBAM):

Source: Former UBAM Consultant

Jim York claims that at any moment he and his wife have at least $5,000 to $10,000 in books in their "life-time library" (it is not clear what this is, but it sounds like personal inventory) and another $2,000 to $4,000 in a revolving inventory, although that number has been higher. That's nearly $7,000 in inventory at any moment and that does not include their consignment ("we use consignment as well… all the time."). There are only a few plausible explanations for a director in UBAM to have this much in inventory:

  1. The Yorks actually run a library or physical bookstore out of their house.

  2. The Yorks really love PreK-12 Books.

  3. The Yorks engage in qualification buying.

Physical stores are typically not allowed in MLM format and some consultants reported to us that UBAM does not allow this, ruling out one. The Yorks have children, so there's a degree which we can forgive some on-hand inventory, but the numbers here are alarmingly high. That leaves us with what appears most likely in option 3: qualification buying. That is because in order for the Yorks to receive their royalty and commissions on their downline, they must meet certain sales requirements each month, as shown in the marketing plan at the beginning of the section. At a level like theirs, this amount is fairly small compared to the size of the check they likely receive from their downline. This would leave them with lots of excess inventory that they cannot sell or do anything with that is likely to pile up in their garage, around their house, and anywhere else.

It appears the Yorks may not be alone in having large personal inventories. Consider the snapshot from the YouTube video posted by UBAM Director Laura Schoeggl:

UBAM Director Laura Schoeggl

Source

As a book saleswoman, we expect her promotional material to feature books, so the fact that there are so many in the background is not surprising. The question and issue is: what books are they?

We cannot confirm what they are from the video. At the very least, we believe many of the books are Usborne. This is for several reasons. First, recall Jim York's comment that they have $5,000 to $10,000 in a "life-time library." As Ms. Schoeggl is the same level as the Yorks, it is reasonable to believe that she, too, has some sort of personal collection. Next, if Ms. Schoeggl is also engaging in qualification buying, she, too, would have excessive amounts of inventory, possibly reaching hundreds or thousands worth of books in a quarter. Placing it on shelves to act as the backdrop to a video might suggest that she is a successful saleswoman. However, inventory that is bought with for the purpose of qualifying for rewards or to maintain status does not qualify as retail sales and is in fact a warning sign of a pyramid scheme. Then again, we concede that it is possible that those books are not Usborne books at all.

Ms. Schoeggl is not alone. Videos posted to YouTube by Directors Tabitha Roach and Dusty Shell feature similar backdrops with large numbers of books. We believe these directors are in a similar predicament as Ms. Schoeggl.

If the top level directors of UBAM cannot sell their inventory at retail, what chance do lower levels, especially entry level consultants, have at selling these books? And when EDUC cannot fill orders, how often do these top directors sell to their downline to meet demand, which are sales that do not qualify as retail?

Consideration 3: UBAM Does Not Fully Pass Analysis of Common Safeguards and Tests of Amway and Koscot

Lacking Amway-Like Safeguards

Some of the common self-imposed rules MLMs use to protect themselves and argue their legitimacy comes from the 1979 Amway case, FTC v Amway. In this case, Amway protected itself from pyramid scheme accusations by having in place three safeguards:

  1. Each distributor must have 10 customers outside the network to qualify for rewards.
  2. Distributors must sell 70% of their product to customers before ordering more product.
  3. The buyback policy prevents inventory loading.

Though not a legal standard and only a self-imposed rule, the courts found that these rules were sufficient enough to help rule that Amway was a legitimate MLM company and not an illegal pyramid scheme. Today, many MLMs adopt these rules in order to illustrate that their practices are legitimate. However, simply having these rules in place does not mean that the operations are actually legitimate, as later demonstrated in FTC v. Omnitrition. The following reviews UBAM for each of these practices:

Each distributor must have 10 customers outside the network to qualify for rewards.

Research suggests that UBAM does not have a 10 customer rule in place; in fact, retail sales are never discussed for UBAM in a EDUC regulatory filing. For example, if a consultant sells books at a book fair, which could easily garnish far more than 10 customers, the consultant would have to record at least 10 of those customers to show that he or she sold to people outside his or her network. However, it appears that keeping such a list is not mandated. In theory, if a consultant did not achieve 10 customers that month, he or she would not be eligible for commissions.

Distributors must sell 70% of their product to customers before ordering more product.

This rule is somewhat of a "scout's honor," but also goes in tandem with the number of customers rule. No evidence could be found in UBAM's Consultant Agreement or New Consultant Guide that indicates that must sell a percentage of their product to customers before ordering more. Without having such a safeguard in place, distributors could easily inventory load or encourage their downline to purchase large amounts of product without ever having customers to sell to.

As we have explored in great detail in this article, it appears likely that many consultants are sitting on some amount of inventory that they simply are unable to sell at retail. If UBAM is unable to sell or return product, it sells it on places like Facebook groups, eBay (NASDAQ:EBAY), Craigslist, or Amazon (NASDAQ:AMZN). Searches in common retail outlets such as eBay and Amazon show large numbers of books being sold at or below retail cost. Selling on these outlets is prohibited according to the Consultant Guide and New Consultant Agreement. However, quick searches show that they are abundant and readily available often below the prices that a UBAM consultant would sell the book at in a retail environment.

Consider the following (note: searches may be different and listings may be inactive due to eBay's dynamic nature).

Source

Examination of some of the people have multiple Usborne book listings. Below is one such example, where 71 of the individual's listings match the word Usborne. The sheer quantity of books at reduced rates makes it very possible that this is a former consultant looking to exit the business.

Source

EDUC claims to have stopped selling books on Amazon in December 2015 as it was hurting UBAM sales. Subsequently, UBAM sales soared. However, the books are readily available on the site from marketplace sellers (not officially sold by Amazon) despite the fact that selling through this channel is prohibited according to the Consultant Guide. It is possible that these books are being sold by retail customers just as easily as former; however, face difficult competition from Amazon because many of the books are likely priced below UBAM's retail and some do not have a shipping fee either, making it a better priced alternative to UBAM. This would ultimately hurt the total number of retail customers through UBAM.

Source

A Buyback Policy For Consultants With Unwanted Product

Despite lacking the two safeguards above, UBAM does have a buyback policy which appears in the Consultant Agreement when an individual signs up. Paragraph 4 of the agreement reads as follows:

I may terminate this agreement at any time by giving the Company ten (10) days written notice. When written notice of termination is given, the Company will buy back product of marketable inventory within twelve months of the salesperson's date of purchase at not less than 90% of the salesperson's original net cost less appropriate set-offs and legal claims, if any, which was purchased by that salesperson for resale prior to the date of termination of the salesperson's business relationship with the Company. Products shall not be considered for return if not commercially marketable or if the Company clearly discloses prior to purchase that the products are seasonable, discontinued or special promotion products and are not subject to repurchase obligation. Your rights are subject to the Company's right to require the payment of all sums paid or credited to you as a bonus in respect of any such product.

More simply put, a consultant must first notify the company of his or her intentions to quit being a consultant and then UBAM will buyback any purchases made within 12 months of their sales date for no less than 90% of what the consultant paid for it unless it is not marketable or clearly disclosed that the books purchased are not subject to repurchase. Then, if a consultant chooses to do a buyback, the consultant may have to return any bonuses paid on the product. The consultant must also pay shipping to return the books.

While UBAM and EDUC may buy back from a consultant 90% of the value of the book they paid, the consultant must pay to return consignment. On top of this, shipping is not covered, adding to the expense a consultant must bear. However, UBAM technically has a buyback policy, and so we must give credit where it is due.

Overall, UBAM appears to have inadequately implemented safeguards that protect both EDUC and its consultants. As discussed in detail, we do not know how many retail customers there are, and there appears to be no tracking in place for how much consultants are selling outside the network. Although EDUC's buyback policy may be somewhat costly to the consultant it is technically in place. This, however, is likely not enough to spare the company pyramid scheme accusations.

Possible Koscot Test Failure

In 1975, the FTC sued Koscot Interplanetary, claiming it was a pyramid scheme. This trial gave birth to the long standing Koscot Test, which courts still use today in determining if a company is a pyramid scheme. It has four parts (as summarized by MLM Skeptic Blog):

  1. Payment of money to the company;
  2. the participant receives the right to sell a product (or service);
  3. the participant receives compensation for recruiting others into the program; and
  4. the compensation is unrelated to the sale of products (or services) to the ultimate user.

Source: Blogspot

Let's look at each of these and compare it to all the research in this article:

Numbers 1 and 2 of the test are straightforward. In this case, consultants that join UBAM pay either a $75 or $125 for a kit which gives the individual the right to sell books as a consultant as well as recruit others into UBAM. Number 3 is true because an upline is rewarded for their sales that their downline makes, as shown in the image below from the consultant manual. The higher the individual and the bigger the downline, the larger the compensation is for the recruitment taking place.

Number 4 focuses on the whole premise of this research from the very beginning, and that is the retail sales question. Depending upon the amount that is sold at retail, compensation may not be related to the sale of products. The problem that we have is that there is plenty of evidence available to question where the retail sales of UBAM may stand. There is evidence of lacking retail sales and qualification buying, activities that erode retail sales and make income recruitment focused. If the government proves that UBAM fails the Koscot test in court because the money comes from recruitment and not from retail sales, then UBAM would be shut down.

What good is EDUC's equity if the overwhelming amount of its revenue disappears overnight?

Conclusion: There Is Enough Evidence To Doubt UBAM's Validity As An MLM

On a recent conference call, Randall White asserted that UBAM "is not a multilevel scam." Scam is a harsh word defined as "a fraudulent or deceptive act or operation" according to Merriam-Webster. We agree with Mr. White that UBAM is not a scam, as we did not find any real evidence of fraud or deception in our research.

However...

Our research examined the UBAM MLM using quantifiable techniques and qualitative research against long-standing legal measures and expert methodologies in an attempt to answer if UBAM is operating as a valid MLM or if it qualifies as a pyramid scheme. Without retail sales figures, we cannot definitively answer that question. But, given the large amounts of internal sales, potential qualification buying, large personal consumption inventories, and lack of safeguards, UBAM contains too many pyramid scheme indicators to be definitively considered as a valid MLM at this time.

These problems leave EDUC susceptible to a major catalyst event such as SEC or FTC investigation and intervention, which could be sparked by anything from a class action lawsuit to a flood of consumer complaints. Knowing when such an investigation may occur is hard to predict, but the announcement of one is enough to send a stock plummeting. Outcomes vary wildly and while they may find nothing, the result often ranges anywhere from minor fines to a complete shutdown of the company (see Vemma and Herbalife (NYSE:HLF) for a comparison). If the company avoids a shutdown but faces fines, it typically must also take certain corrective actions in order to continue operations. EDUC could have to go through painstaking measures to improve sales tracking, legal protections, and other changes that the long-term viability of the MLM could be jeopardized.

Given all the risks and challenges EDUC has with UBAM and the fact that UBAM is nearly 90% of EDUC's revenue, the only safe bet on it is a short one.

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Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a lawyer, nor am I pyramid scheme expert.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.