You Can't Cheat an Honest Man (27 page)

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In Connecticut, the state filed suit against Nu Skin. Attorney General Richard Blumenthal accused Nu Skin of violating the state’s anti-pyramid law by emphasizing recruitment of new distributors rather than the sale of its products to consumers. “We’re concerned, especially during difficult economic times, that unsuspecting consumers will be lured into believing the company’s claims that they can earn more than $10,000 a month as a Nu Skin distributor,” Blumenthal said.

Nu Skin resolved all of the actions without having to go to court or admit any wrongdoing. In exchange, it agreed to make several changes in the way it did business. It rewrote recruiting materials to emphasize the sale of products more and recruitment of other distributors less. It discontinued the requirement that distributors buy set amounts of product to maintain their positions. And, in most of the states, it agreed to pay fines or reimburse agencies for the cost of their investigations.

“Anytime you talk about multi-level marketing, a red flag pops up immediately, and it should,” said CEO Roney, acknowledging that some people might draw an inference of guilt from the settlements. He admitted that sales and financial figures reported by multi-level companies and their distributors often “sound too good to be true.” But he blamed most of Nu Skin’s problems on over-aggressive distributors—who had no direct ties to the company.

Nu Skin’s growth leveled off for a year or two in the early 1990s. But it rebounded and doubled its distributor base from 150,000 worldwide in 1992 to 300,000 in 1994. Then there was more trouble.

In 1994, Nu Skin paid $1.23 million to settle charges by the Federal Trade Commission that it exaggerated the effectiveness of its products. Among other things, FTC officials took issue with Nu Skin claims that its Nutriol Hair Fitness Preparation was as effective as the prescription hair-loss drug Minoxidil and that its Face Lift with Activator product was just as effective at removing facial wrinkles as the medication Retin-A.

Again, Nu Skin blamed the problem on rogue distributors—and said it had stopped doing business with about 10 of those involved.

In the same case, the FTC said Nu Skin misled potential distributors about how much they could earn by selling Nu Skin products. Nu Skin promotional materials cited by the FTC had mentioned earnings “in excess of $60,000 to $80,000 their first year” and claimed “a lot of other people” earned as much as $168,000 a year.

In addition to paying the big fine, the company agreed to tell prospective distributors what the average earnings were of all distributors—in 1994, this meant reporting that seven out of 10 distributors cleared an average of about $300 that year.

The Blurred Boundry Between Legal and Illegal

MLM is legal. But some MLM companies press the limits of the law— and become, essentially, illegal pyramid schemes. MLM programs are regularly accused by prosecutors of shady practices, including violating anti-pyramid laws and making false claims about “miracle” products.

Other problems: misrepresentation of potential income and “inventory loading,” the practice of encouraging distributors to buy a basement full of products in order to reap a higher sales commission.

Much of that merchandise never gets sold. This practice is illegal and in many states, and attorney generals are eagerly investigating complaints. “Every illegal pyramid is an MLM company,” said Robert Ward, a Michigan assistant attorney general. “But not every MLM is an illegal pyramid.”

Ward says that, in his state, the average multi-level marketer remains in business just 18 to 24 months. This observation is generally true. The turnover rate in MLM sales is high; in most programs, as many people drop out as join up in a given year. Which means, eventually, the MLM is going to run out of distributors.

Jeffrey Babener, an Oregon lawyer who specializes in MLM cases, says that an ordinary person can reasonably expect to make $300 to $1,000 per month from a legitimate program. If he or she works hard at it. He also says that, because MLM relies so heavily on social interaction, the programs work better in some regions than in others: “MLM does not do that well in the Northeast. It does best where people are friendly and are out and about—the Sunbelt, Bible Belt and California.”

Still, MLM’s ability to defy conventional marketing notions and generate eye-popping revenue attracts unscrupulous marketers and Ponzi perps. It will always be a source of concern for regulatory bodies at state and federal levels whose job it is to protect the unwary buyer from tall stories promising outrageous riches.

One MLM Program Crashes into the Law

Missouri-based Consumer Automotive Resources, Inc. (C.A.R.) was a clear case of an illegal pyramid scheme that tried to pass itself off as a legitimate MLM program. William Herbert and Robert Warren promoted the scam as a program for helping people buy cars inexpensively. In exchange for a steady flow of customers ready to buy, participating car dealers would offer deep discounts and good financing packages. Then, the dealers would pay a 5 percent commission to C.A.R. on the car sales resulting from references it made.

In the early 1990s, C.A.R. was looking for distributors who would— theoretically—earn commissions for locating the people who wanted to buy cars.

Like the worst MLM programs and most Ponzi schemes, C.A.R. was full of jargon and complex commission guidelines. To participate in the program, a distributor (called a “member”) created a personal income center (PIC) by completing an application form and paying a $190.00 enrollment fee. The PIC was “activated” when the member recruited at least one other person in the program. The member earned maximum commissions when he or she recruited two people.

The initial member received a one-time commission of $70 for each person he or she recruited and a “network management commission” of $6 a month for each person enrolled in his or her downline group. C.A.R. executives claimed lamely that these commissions were advances against the 5 percent fees for car sales—rather than for recruiting dupes. (The monthly commissions paid to the members, however, depended only on the number of people enrolled in a downline pay group.)

As unlikely as it seems, the pitch worked. In December 1992, C.A.R.’s membership included approximately 1,400 distributors from 20 states.

C.A.R. offered members various tools for recruiting people. It scripted public informational meetings, provided a video and brochures, and gave distributors pointers for recruiting. However, in more than two years of operation, C.A.R. only sold two cars.
In December 1992, the scheme started running into trouble. The Missouri attorney general sought an order freezing C.A.R.’s assets, charging that it was an illegal pyramid scheme. The state filed for preliminary injunctions against C.A.R., CEO William Herbert and president Robert Warren.

The attorney general’s office had used a decoy investigation to discover how the program worked. “We had this guy in there, and the things he saw were amazing,” says one investigator involved in the case. “These guys were draining hundreds of dollars out of the poorest people around. They promised new cars—for free or close to it. It was like a lottery. And they were lining up to hand over the two hundred bucks.”

The State charged Herbert and Warren with selling the right to participate in a pyramid sales scheme in violation of Missouri law. Under Missouri law, a pyramid sales scheme was defined as:

any plan for the sale or distribution of goods, services or other property wherein a person for a consideration acquires the opportunity to receive a pecuniary benefit, which is not primarily contingent on the volume or quantity of goods, services, or other property sold or distributed for purposes of resale to consumers, and is based upon the inducement of additional persons, by himself or others, regardless of number, to participate in the same plan[.]

In the spring of 1993, a Missouri court issued a summary judgment granting the attorney general’s requests—and effectively closed down the scheme. While it considered the details of the case, the court ordered C.A.R. and its principals to stop selling memberships in the program and from promoting it in any way.

In May 1993, the same court concluded that the C.A.R. program was a pyramid sales scheme. This made its preliminary ruling permanent.
Cautionary Steps

From the Ponzi perp’s perspective, there are many things that are appealing about MLM. A couple are psychological.
People who get ripped off by MLM programs are often unwilling to go public. They aren’t likely to complain about a scheme full of their friends and relatives. Also, because of the entrepreneurial and patriotic rhetoric that marks recruiting meetings and MLM literature, people often assume that they’re to blame if they aren’t able to recruit enough people to make money.

To avoid these traps—and others—there are some basic steps anyone considering joining an MLM program should take before signing up:

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determine how much of a distributor’s income comes from sales rather than recruiting other distributors. One common standard is that 70 percent of a distributor’s income should come from selling product;

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ask how many levels of recruits a distributor has to bring in before making money. The geometric progression of recruitment tends to burn out by the third or fourth level;

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be cautious of large start-up fees. Sleazy MLMs charge as much as they can. Since many states require reporting for franchises that cost more than $500, a lot of MLM’s charge $499 to join;

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get a written guarantee that the company will buy back unsold product. Some state laws require a 90 percent buy-back;

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resist the temptation to invest just because you know the person selling the program. Most MLM programs rely on recruitment of friends and family. This gives people an unrealistic impression of the company’s size and market presence;

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ask how long it typically takes to get payment from the company. A legitimate MLM company should take no longer than 90 days to pay commissions and bonuses—and good ones will pay even sooner;

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find out what expenses you’ll have to pay. Sleazy MLM programs require that you attend sales conventions at your own expense in order to receive overrides and bonuses;

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don’t believe a promoter who says the venture has been approved by the state attorney general’s office or any other regulatory agency. These offices don’t approve of or endorse
any
business ventures.

In the end, the difference between legit and bogus schemes is simple: an illegal pyramid focuses on recruitment of new members to make money; a legitimate MLM program focuses on selling product.

The problem is that, in the heat of a dramatic recruitment meeting, the difference may be hard to see. “The whole concept of multi-level marketing is that they feed on people’s emotions and greed,” says Xavier University marketing professor Thomas Hayes. “Especially in hard economic times, people are looking for something easy, something that will make them rich. The only pure guarantee in a multilevel marketing scheme is that you will lose friends.”

Case Study: Amway

No company has been investigated—and sued—for being an illegal pyramid scheme more often than Michigan-based Amway Corporation. As a result, Amway has emerged as a kind of dividing line for the legitimacy of multi-level marketing schemes. Its structure and methods have survived legal scrutiny. But any MLM firm that operates beyond the bounds of the Amway model may have trouble with the law.

Amway makes and sells home care products, such as laundry detergent and household cleaners; health and beauty products, such as cosmetics, vitamins and food supplements; “home tech” products, such as air and water treatment systems; and some commercial products, such as janitorial and food service items.

It moves these products and services exclusively through a network of some 300,000 independent distributors.

The company started in 1949. About 10 years later, Jay Van Andel and Richard DeVos—two successful distributors—decided that some of their suppliers were in danger of collapsing and that they should go into the business themselves, making their own products and selling them through the sales organization.
Within five years, they controlled the entire organization. As they grew the business, Van Andel and DeVos decided to look for products which were readily consumable, relatively low-priced, and competitive with those found in retail stores—all of which would lead to repeat sales. This product profile has become standard for MLM programs.

When a person becomes an Amway distributor (typically for an upfront investment of about $150) he or she receives an identification number to use when ordering anything from the company. That number tells Amway everything it needs to know about the distributor, including the identity of upliners—the people who recruited him or her.

Amway distributors generally sell products to friends and neighbors at parties or other informal gatherings. People who join Amway are urged to change their buying habits. One common pitch is: “Every time you buy from a retail outlet, you are sending someone else’s kid to college.” Newly sponsored distributors—the downliners—normally purchase their products from the distributor who personally sponsored them.

For each sale above a certain minimum, the Amway distributor makes a percentage computed under a graduated schedule.The percentage of sales volume the Amway distributor receives is called the
discount
and averages between 15 and 35 percent of the cost of each item sold. One Amway distributor explained the system:

Say you become a distributor and order $200 worth of products a month. You’d have a gross income of $66—that’s a $60 discount from retail price, plus a $6 commission. Your annualized “income” is $792, nothing to quit the day job over.

But if you recruit six people who also order $200 a month, you now are generating monthly group sales of $1,400 for Amway, and a monthly income of $150 for yourself ($90 in commissions, $60 in discounts for products you consume). If your six recruits duplicate themselves four times each, you’ll take down $816 a month. If those 24 new recruits duplicate themselves twice, you’ll have a network of 78 distributors and a monthly income of $2,138.