Nocera,
Joe
Sep 15, 2015
"I
have nothing for you," said Frank Dorman, a spokesman for the Federal
Trade Commission. "Lots of reporters have asked that question. Our final
response is, We're not going to answer it."
What had I asked that was so sensitive that the F.T.C.
wouldn't respond? I had requested that the agency explain what distinguished an
illegal "pyramid scheme" from a legal multilevel marketing company.
What had prompted my question were two recent events. In
late August, the F.T.C. had gotten an injunction issued against a multilevel marketing
company called Vemma Nutrition, claiming it was in fact a pyramid scheme.
And last week, Fortune magazine published a lengthy story by
Roger Parloff about William Ackman's nearly three-year battle to force the
government to make the same declaration about Herbalife. The company, of
course, has fought back hard against the hedge fund manager's allegations,
insisting that its business practices are above board.
Indeed, the F.T.C.'s move against Vemma has caused both
sides in the Herbalife battle to claim vindication. Although the F.T.C. has
been investigating Herbalife for some 17 months, Timothy S. Ramey, a stock
analyst and Herbalife bull, raised his price target for the company, saying
Vemma's business model was clearly different from Herbalife's. Meanwhile,
Ackman prepared a 29-slide deck with side-by-side comparisons of all the ways,
in his view at least, Herbalife's business model was exactly like Vemma's.
So which is it?
As Parloff notes in his article, "The Siege of
Herbalife," there is no law defining a pyramid scheme, nor are there even
any regulations on the books. The simple common-sense definition is that a
pyramid scheme is a business in which recruits make a payment for the right to
recruit others into the network, and whose revenues are more dependent on
recruitment than on selling a product.
But it turns out to be so much more complicated. In 1979,
the F.T.C., after investigating Amway, a multilevel marketing company with a
vast product line, decided that the company's business model passed muster --
even though recruitment was at the heart of it -- because it claimed to take
certain steps that (among other things) supposedly showed that its recruits
were selling the company's products to real customers, not just to other
recruits. Very quickly, other multilevel marketing companies adopted the
"Amway rules" to stay on the right side of the F.T.C.
Yet the Amway rules have never been codified into regulation
-- they're really more like suggestions -- nor have they ever been proved to mitigate
the harm pyramid schemes do in taking advantage of recruits or lying to them
about the potential to get rich. (A vast majority of those who sign up for
pyramid schemes lose money, sometimes lots of money.)
For a while, the courts and the F.T.C. seemed to say that a
truer test of a pyramid scheme was how much of its products was bought outside
its recruitment network (meaning they had real customers who were not involved
in the pyramid) versus how much was bought by those inside the network, who were
buying precisely to remain part of the network.
But in a recent court decision involving a pyramid scheme
called BurnLounge, the appeals court ruled that it didn't really matter whether
the customer was inside or outside the network, and that the test was actually
whether a company's "primary" purpose involved recruiting rather than
"meaningful opportunities for retail sales."
William Keep, dean of the College of New Jersey's School of
Business, and a pyramid scheme critic, told Bloomberg earlier this year that
"in terms of sending clear signals to the industry, the F.T.C. has done
worse than nothing since 1979. It sends confusing signals that have in no way
helped us understand how to identify a multilevel marketing company that may be
a pyramid scheme."
In the Herbalife dispute, this lack of federal guidelines
animates much of the controversy.
Ackman says Herbalife is a pyramid scheme because the only
way people can make any money is by recruiting others, not by selling the
company's protein shakes. Herbalife says its business model is on the up and up
because it is selling a real product to consumers who sign up more to get
product discounts than to become part of a recruiting network. Parloff, after
months of investigation, came down more on Herbalife's side than Ackman's,
though in truth, that's just his best guess. The F.T.C. wouldn't talk to him,
either.
"Here we are three years into [the Herbalife battle]
and it's no clearer than it was at the beginning," Keep told me when we
spoke. If the government had rules about where the line was between an illegal
pyramid scheme and a legal multilevel marketing company, there wouldn't be any
such dispute. It's ridiculous that we have to guess what's illegal.
The F.T.C.'s refusal to define a pyramid scheme -- and to
act aggressively on that definition -- is a dereliction of duty.
