Multilevel Marketing and Illegal

Pyramid Schemes: Current

Controversy and Historical Context
WILLIAM W KEEP, PHD
PRESENTATION FOR:
SCHOOL OF MANAGEMENT
FUDAN UNIVERSITY
SHANGHAI, CHINA

AGENDA
1. Motivation for Interest: Current News and
2.
3.
4.
5.
6.
7.

Regulatory Action
Historical Thread: Traditional Direct Selling to
Multilevel Marketing
Fraud Connection: Ponzi Schemes to Pyramid
Schemes
Confluence: Multilevel Marketing & Pyramid
Schemes
Critical Issues in the United States
Present Actions and Inactions
Conclusions and Questions

Motivation for Interest

Nu Skin
Nu Skin and the short-sellers
Fortune

October 26, 2012

Nu Skin fined more than $500,000 over China

sales practices
Financial Times
March 24, 2014
Skincare products maker Nu Skin settles class
action suit
Reuters
Feb 26, 2016

Motivation for Interest

Herbalife
Ackman Outlines Bet Against Herbalife
The New York Times
December 20, 2012

Herbalife Discloses Civil Investigation by FTC

Bloomberg
March 12, 2014

Herbalife Says FTC Settlement Discussions

Include Large Fine And Injunctive Relief
Forbes
May 5, 2016

Motivation for Interest

Amway
Amway India chief, 2 directors arrested
Business Standard
May 28, 2013

Amway India CEO William S Pinckney arrested

The Times of India
May 27, 2014

HC Orders Action if Amway Continues

Unauthorised Business
The New Indian Express
June 12, 2016

Motivation for Interest

Avon
US watchdog fines Avon $135m for China bribes
BBC
December 18, 2014

Lackluster Avon Explores Makeover

The Wall Street Journal
April 27, 2015

Avon Could File For Bankruptcy

MSN
May 30, 2016

Motivation for Interest

Federal Trade Commission (FTC) Actions
FTC Settlement Bans Pyramid Scheme Operators
From Multi-Level Marketing
FHTM Defendants Will Surrender At Least $7.75 Million in Assets

FTC.gov

May 13, 2014

U.S. Appeals Court Affirms Ruling in Favor of FTC,

Upholds Lower Court Order Against BurnLounge
Pyramid Scheme
FTC.gov
June 5, 2014

FTC Acts to Halt Vemma as Alleged Pyramid Scheme

FTC.gov
August 26, 2015

Avon: Direct Selling Pioneer

Avon Products
1886: California Perfume Company founded
1914: First international office -- Montreal
1920:

Sales = $1M; 1926 sales = $2.2M

1931: Named changed to Avon
1946: Company goes public
1967: Most profitable company in US (Forbes, 1968)
1975: the worlds largest cosmetic and fragrance
company (NYT, 1975)

Direct Selling Expansion

Products: brushes, groceries, radios, sewing

machines, phonographs, musical instruments,

vacuums, cosmetics, apparel, chinaware, cooking
utensils, books, televisions, furniture, automobiles
Mid-1920s: estimates of annual direct selling
ranged from $300 - $500 million
Fuller Brush Company (1906) reported sales in
1923 of $15M, dropped to $10.3M in 1929 in the
face of increased competition
Source: Friedman, 2004

Success and Concerns

1st woman millionaire in U.S.: Madam C.J. Walker,

African-American, entrepreneur (Peiss, 1998)

Hair treatments and cosmetics sold through a agent-operator

network to African-American women

1930s: 27 Eastern colleges - including Harvard,

Dartmouth, Princeton, Yale, Williams, Brown,

Columbia, and MIT - signed a statement
discouraging the practice of door-to-door
salesmen trading upon their college connections to
make sales (The New York Times, 1932)

Industry Growth and Stagnation

1950-1963: Industry sales estimates vary from $1B

to $7B, one report claimed 5% of retail sales

Party Plan: Moves direct selling from door-to-door

to social events and workplace relationships

1970s-1980s: Industry sales estimates go from $6B

(1974) to $9B (1980) to $8.5B (1984)

Mid-1980s brings industry-wide stagnation among

traditional, single-level direct selling companies

Sources: Keep and Vander Nat, 2014

Multilevel Marketing (MLM) Direct Selling

Multilevel

Marketing Downline
and Compensation Structure

Commissions/Overrides
Level 1: (15%)
Level 2: (10%)
Level 3: (5%)

Allan
/ |
\
B1 B2
Bill
/
C1 C2 C3, Cathy

Sources: Keep and Vander Nat, 2014

John
|
A2
|
B4.

\
A3
B9
C26, C27

The Rise of Multilevel Marketing

1945: Nutrilite multilevel marketing model (MLM)
1951: U.S. FDA injunction prohibiting 15,000

door-to-door salesmen from making extravagant

therapeutic claims for Nutrilite (The New York Times, 1951)
1956: Shaklee adopts MLM model
1959: Van Andel and DeVos found Amway
1980s-1990s: Sunrider, Herbalife, Advocare, Nu
Skin, Melaleuca, USANA, ACN, Mannatech, etc.
Sources: Keep and Vander Nat, 2014

1991-2014: Industry Size and Growth

U.S. Direct Selling Sales/Total Retail Sales;
# Direct Selling Sales People;
Direct Selling Sales/Sales Person
0.0140

20
18

0.0120

16
0.0100

14
12

0.0080

10
0.0060

8
6

0.0040

4
0.0020

0.0000

0
1991

1993

1995

1997

1999

Sales/US Retail (excludes automobile related sales)

2001

2003

2005

2007

# Sales People (in millions)

2009

2011

2013

Sales/Sales Person (in thousands)

Fraud Connection
1920: Charles Ponzi nets $5K in February from

investment scheme ($59.8K in 2016), in May he

nets $420K ($5M in 2016)
November 1920: Ponzi pleads guilty to fraud
March 2009: Bernie Madoff pleads guilty to
running massive Ponzi scheme over 20 years
Chain Letter: send a certain amount of money-usually $5--to the person at the top of the list, and
then eliminate that name and add yours to the
bottom (U.S. Postal Service)

Basic Pyramid Scheme

Source: Wikipedia

Multilevel Marketing & Pyramid Schemes

Pyramid salesthat work on the chain-letter

principle, involving an ever increasing number of

participants are currently the number one
consumer fraud in the metropolitan area (NYT,1973)
1970s: Holiday Magic, Koscot, and Dare to be Great
Koscot (1975): participants pay money in return for

which they receive (1) the right to sell a product and (2)
the right to receive in return for recruiting other
participants into the program rewards that are
unrelated to the sale of product to ultimate users

Product-Based Pyramid Scheme

Investment
Pyramid
Scheme

Product-Based
Pyramid
Scheme

Wealth Transfer:
Recruitmentdriven investments
fund rewards to
current participants

Wealth Transfer:
Recruitmentdriven fees and/
or purchases fund
rewards to
current
participants

Legal Multilevel
Marketing
(MLM)

Single-Level
Direct Selling

Recruiting and rewards for recruitment were integral to BurnLounges business

structure, and there was ample evidence that Moguls were meant to be, and were,
primarily motivated by the opportunity to earn cash rewards for recruitment.

An MLM Not A Pyramid Scheme

FTC v. Amway (1975-1979)
150

witnesses
1,000 exhibits
7,000 pages
4 years
Amway found not to be a pyramid scheme
Amway Safeguards
70%

rule
10 customer rule
Inventory Buy Back

MLM Pyramid Schemes Actions Post-Amway

1996 - 2016: Equinox, Five Star Auto Club,

Fortuna Alliance, Gold Unlimited, JewelWay

International, International Heritage Inc.,
Webster v. Omnitrition, Fortune Hi-Tech
Marketing, BurnLounge, Vemma, etc.
FTC actions since 1996: 24 pyramid scheme

complaints, 3 wins, 21 settlements (each

operation dissolved)

Multilevel Marketing & Pyramid Schemes

Modern pyramid schemes generally do not

blatantly base commissions on the outright

payment of fees, but instead try to disguise these
payments to appear as if they are based on the sale
of goods or servicescommissions are funded by
purchases made to obtain the right to participate in
the scheme. (FTC, 2004)

FTC Fraud Survey Report 2004:

# incidents 2.55M (1.2M 3.85M); Mean loss = $100
By far the least likely among victims of ten forms of
consumer fraud to complain

Critical Issues in the United States

Recent Cases:

FTC v. FHTM (2013)

FTC v. BurnLounge (appellate decision, June 2014)
FTC v. Vemma (2015, ongoing)

FHTM operated 10 years with two former Attorneys

General and a former Associate General Counsel of

Direct Selling Association (DSA) on advisory board
Vemma, award-winning member of DSA, operates 10
years: court accepts FTC recommendation that
bonuses be paid only to an Affiliate whose
organizations sales to Customers [non-Affiliates] are
at least 51% of total sales for the organization

BurnLounge Appellate Court

rewards BurnLounge paid were primarily for

recruitment
when participants bought packages in part for internal
consumptionthe participants were the ultimate users
rewards BurnLounge paid for package sales were not tied
to the consumer demand for the merchandise in the
packages
Quoting FTC expert: pyramid scheme is an organization
in which the participants obtain their monetary rewards
primarily through enrolling new people into the program
rather than selling goods and services to the public.

Present Actions and Inactions

TruthinAdvertising.org documents complaints:

Consumer complaints on 60 MLM companies, including numerous

members of DSA (e.g., Vemma, Advocare, Jeunesse)
https://www.truthinadvertising.org/tinas-list/

ESPN magazine expos of Advocare

Advocare spokesperson Drew Brees defends business model

http://espn.go.com/espn/feature/story/_/id/14972197/questionssurround-advocare-nutrition-empire-endorsed-saints-qb-drew-brees

Herbalife:

2 year-old FTC investigation of continues

Ackman short position continues
Questions regarding Distributor Earnings Statements
Top

Earners Persistence Opaque

Present Actions and Inactions

H.R. 5230 introduced in House of Representative
Industry-sponsored bill removes need for direct selling
representative to sell outside distributor network
Aggressive lobbying effort by DSA, Amway, Herbalife, Mary Kay
Bill opposed by: National Consumer League, Consumer Action,
Consumer Federation of America, Consumer Watchdog, U.S.
PIRG, and League of United Latin American Citizens

Conclusion and Questions

Conclusions: Investor, media, and political interest

in MLM industry and pyramid scheme problem

higher than in many years. Legislative action
possible. Presidential election may have impact
(Trump associated with the MLM company ACN)
Questions?

Thank You!