Corey Augenstein
MLM Insider

Multilevel Marketing: Ethics And Business Model Persistently Heading Due South
Published: Sep 03, 2017

Multilevel Marketing: Ethics And Business Model Persistently Heading Due South

Aug. 23, 2017 9:31 AM ET


 Includes: AVPHLFNUS




DSA and MLM industry seek to handcuff the FTC.

Legislation is a poor substitute for sound business practices.

MLM industry in relative decline as a retail channel in the US.

Congress protecting the MLM industry is inconsistent with the FTC record of protecting consumers and recovery losses from pyramid schemes.

In describing the MLM industry, the Direct Selling Association (DSA) inevitably references the history of direct sellers as retailers; "Direct selling is the vibrant retail channel that offers consumers the ability to buy goods and services in the comfort of their own homes from friends, family members, and neighbors." Remember the parts about "vibrant retail channel" and "friends, family members, and neighbors."

How successful was traditional direct selling as a retail channel? In the 1930s store retailers resorted to politics to counter the competitive threat by getting communities to adopt "Green River" ordinances. The ordinances forbade door-to-door solicitations without direct sellers first making an appointment. But direct sellers persisted and by the early 1960s party plans and product innovations propelled the industry forward. In 1967 Avon, now a mere shadow of its former self, was the most profitable company in America.

While many investors apparently could care less, similarities between the modern MLM and traditional direct selling, inclusive of corporate ethics, began to fade many years ago. An investigation of DSA members by "found that out of 62 member companies selling nutritional supplements, 60 have distributors who are making (or have made) claims that their products can diagnose, treat, cure, prevent, alleviate the symptoms of, and/or reduce the risk of developing a multitude of diseases, which means they are making illegal disease-treatment claims." Previously, I have questioned the veracity of income statements of some DSA member companies (here and here). Prohibiting false claims was an important concern of the Federal Trade Commission (FTC) in its Settlement with Herbalife(NYSE:HLF) and any continued use begs the question: If false claims aren't important to the business model then why resort to them? Naturally, the DSA claims its members, including Vemma, operate under the highest ethical standards.

Okay, industry ethics may have some holes (yet to be fully explored), but what about the business model? Each year the DSA publishes "Industry Fact Sheets." As I have no independent way to verify the "Fact" part, for now I accept the facts as true. Over time the DSA reports a continuous upward trend line in the number of industry participants and the amount of industry sales. For example, in 2003 the DSA reported $29.55B in industry sales and 13.3 million industry participants, and in 2016 $35.54B in sales and 20.5 million participants-increases of 20.3% and 54.1%, respectively. Now for the retail implications. In fact, the relative importance of direct selling declined significantly during that period. From 2003 to 2016 the direct selling share of all U.S. Retail Sales (excluding motor vehicle and parts dealers) declined by 22%, from 1.22% to .95% (source data: herehere, and here). In other words, despite a 54.1% increase in direct selling participants over thirteen years, direct selling has become a less economically significant retail channel. Why? What does this say about the current efforts to handcuff the FTC, a regulator charged with protecting consumers?

Investors who thought the Herbalife Settlement would end systemic risk failed to appreciate the continuing fault lines in the MLM business model. Even small regulatory pebbles can produce big ripples. Herbalife's stock price ranged from $81.81 to $30.48 in a bit over a year (January 10. 2014 - January 30, 2015) as investors worried about its fate in the hands of the FTC. In China, bluster against behaviors that appear to be at the fringe of how any industry would operate, caused MLM stocks to quickly tumble. It should be noted that despite claims to the contrary, China's regulation of the MLM industry is much more bark than bite (e.g., China fined Nu Skin $540,000 for behaviors that ultimately led to a class action settlement in the U.S. that cost the firm $47M).

Adrift from a distant past, ongoing systemic regulatory risk both plagues and motivates the industry to seek a long-term remedy not by re-committing to selling products to the general public but by telling lobbying stories inside the Beltway. According to numerous public statements, the DSA and some leading MLM companies no longer want the burden of what the BurnLounge court called "consumer demand. They argue that participant purchases for the proposed opportunity are enough. So much for the retail channel to friends and family! It turns out the joke was on those store retailers of old who actually thought direct selling posed a long-term retail threat.

Evidently, the real threat comes from regulators prosecuting more product-based pyramid schemes. These endless-recruitment chains endure, sometimes for years, on fees and/or product purchases made by a churning base of recruits pursuing an unknowable and improbably path to success. Against twenty years of case law, most recently Vemma and BurnLounge, the MLM industry argues that customers interested in buying only the product (and not the income opportunity) are now immaterial to the business model.

The industry's search for a long-term political solution dates back at least fourteen years, and presently comes in the form of an amendment to an appropriations bill, and a separate bill, HR 3409. FTC Commissioner McSweeney correctly describes the DSA-backed Moolenaar (R-MI) amendment as designed to "handcuff the FTC and enable deceptive and unfair MLM schemes to continue to victimize consumers." The proposed language regarding a "bona fide inventory repurchase agreement," laughable to anyone who has taken the time to study MLM company policies and practices, simply provides protection to an industry heading due south, and certainly not to consumers.

Similarly, HR 3409, a rehash from last year's equally poor HR 5230, both sponsored by Blackburn (R-TN), mirrors the industry's fear of being held accountable for making sales to the public; i.e., consumers who are not pursuers of the "business/income opportunity." A former FTC senior economist describes in detail the language that would relieve the industry of the burden of actually establishing and satisfying "consumer demand," as well as the many ways an MLM company can satisfy a "bona fide inventory repurchase agreement" with zero improvement in consumer protection. Worse, in the name of having done something positive for consumers, passage of the Moolenaar amendment or HR 3409 would provide effective protection for practices that the FTC and federal courts have consistently held to comprise a pyramid scheme operation.

By way of case law for more than twenty years, the FTC has maintained that MLM companies need to recruit their independent sales force through honest dealings and to demonstrate that compensation to representatives derives primarily from sales to non-participant customers; i.e., the general public. The BurnLounge and Vemma courts pointedly highlighted this message. Both decisions shook the MLM community. Subsequently, in direct communication with the DSA (here and here), the FTC further reinforced the importance of both "consumer demand" and the elimination of misleading product and income claims. Is this really too much to expect from an industry that presents itself as a vibrant retail channel? Apparently it is, for an industry that fears what I previously described as an "honest conversation" about its business model and its ethics.

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. I have no business relationship with any company whose stock is mentioned in this article.