You Can't Cheat an Honest Man (26 page)

In the 1970s, the frowning started to fade though. MLM began gaining credibility in mainstream business circles. From a corporate perspective, the strength of MLM is that it shortcuts the traditional retail distribution mechanism with all of its attendant support costs—marketing, sales, inventory and distribution.

MLM networks can be run and maintained with limited overhead— no expensive offices, large staffs or marketing support, just an inordinate amount of energy and a heavy long-distance phone bill.

Finally, MLM offers companies a level of plausible deniability if any distributor does something illegal or unethical. People who get involved in MLM are not employees of the producing company; they are independent business owners.

Several interlocking trends have contributed to the growth of network marketing, including technology advances, economic changes, job insecurity and the twin desires for financial security and control of one’s destiny. (Frankly, some of these trends have also encouraged Ponzi schemes.)

There’s no doubt that technology has made MLM more appealing to potential recruits who would otherwise be reluctant to handle the chores of sales, recruiting, inventory, deliveries and recordkeeping. In the age of Windows, these things can be managed in ten minutes a week, using any of numerous $99 software packages.

But the economic motives are more powerful. “We’re seeing a much more highly educated group of people coming in,” said Neil Offen, president of the Direct Selling Association, an MLM lobbying group. “We’re seeing a lot of middle-management executives who’ve been laid off because of corporate downsizing. The American reality of ‘you work hard, play by the rules and your talent will get you to the top’ is not true anymore in the corporate world.”

But not all of the growth is simple economics. People recruiting MLM distributors know who’s most likely to join. “When you’re unemployed, you’re most vulnerable,” said Jim Lyons, a financial investigator for the Florida Attorney General’s office.

As experienced managers are downsized or forced to take early retirement, they take with them tidy retirement packages. They also have expanded networks of business acquaintances and friends...and the entrepreneurial determination never to be downsized again.

A caveat: According to the DSA, 90 percent of MLM distributors earn less than $5,000 a year.

Another—bigger—caveat: MLM is a ripe hunting ground for Ponzi perps. The lines of demarcation between legitimate MLM and illegitimate pyramid schemes have always been...and remain...fuzzy.

The Tempting Mechanics of an MLM Program

MLM companies sell products into the distributor system at a discount deep enough to make the products or services inexpensive, compared to competing products. But this usually leaves enough margin to fund the commissions and bonuses that drive the system.

The company will also fund the commissions and bonuses by charging new distributors a nominal amount—usually less than $500—as a franchise fee for joining.
Not only does the MLM distributor receive accumulated commission on the sales made from his or her recruits, but also from the commission on the sales made by each recruit’s recruits—and on down the line.

An often-made analogy is to a family tree, with roots extending down six—and sometimes nine or 10—multiple levels. You recruit five distributors, who recruit five distributors, who recruit five distributors....

A few percentage points of override commission on the sales made by everyone below you in the scheme can result in some big monthly sales commissions.

But the fat-check math that drives most MLM schemes is often calculated selectively to make the strongest impression. Consider another, disinterested, calculation: If one person recruits six distributors, each of whom recruits six others, the total number of people in the program is 43 by the third level. It’s 9,331 by the fifth. And more than 10 million by the ninth.

That’s the exploding hunger of geometric progression. It’s the same thing that makes all Ponzi schemes eventually fail.

To overcome the hard numbers, most MLM programs appeal to recruits’ hearts rather than their brains. Informational and motivational meetings are one of the most common methods for introducing potential recruits to an MLM program. This is where the evangelism comes into play. The meetings use many of the same motivation devices that religious revival meetings use.

Meetings often include songs and testimonials, stressing dedication to the business. Some companies go further, encouraging their distributors to follow an approved way of life. For some people, “MLM is close to religion,” says Thomas Hayes, an expert on multi-level marketing and chairman of the marketing department at Xavier University in Cincinnati. “They want to believe in something. They are looking for a reason to believe in something. And here it is. It says, ‘I, too, can be wealthy.’”
Most distributors—particularly at the lower levels—will not make a fortune from the programs. Many of the lower-level distributors sign up simply to buy products at a discounted price. For this reason, the most effective MLM programs are those that distribute products that require continual replenishment—detergent, cosmetics and vitamin supplements.

Because MLM programs are usually regulated at the state level, attorney general and consumer protection agencies from various states will sometimes cooperate in investigating suspicious ones.

In April 1993, attorney generals offices from nine states forced one MLM company, Tennessee-based National Safety Associates, to buy back thousands of water filters from struggling distributors.

The company let distributors recruit others with get-rich-quick promises that delivered garages full of unsold water filters. In a common move, National Safety argued that its distributors—who were indepednent contractors and not employees—were the ones who fell out of line.

Under the coordinated pressure of several states, National Safety had little choice but to change its policies. The company agreed to buy back 90 percent of products from distributors who wanted to get out within a given period of time.

The company also agreed to monitor that its products were being sold to consumers who actually used them—rather than piling up in distributors’ garages. Finally, it agreed to review distributors’ promotional activities, checking that claims about products and earnings potential were realistic.

The package of changes followed the standard guidelines recommended by DSA and several other MLM trade groups.

“More people are interested in it now because of the economy,” said Terri Norton, education coordinator for Florida’s Division of Consumer Affairs, in 1996. “Maybe one of the couple is out of a job, or there was no cost-of-living raise this year.”
She offered this advice: If you go to an MLM presentation, take someone with you who isn’t interested in the business and leave your checkbook at home. “You get caught up in the mood and excitement,” Norton said. “You sign up right then and there without reading what you’re signing. If they’re really legitimate and want your business, your money will be just as good later.”

Many MLM firms lure participants and investors by telling them they have to sign up right away or they’ll lose the opportunity.
A Fast-growing Company Tests the Law’s Limits

Utah-based Nu Skin International Inc., was founded in 1985 by Blake Roney, his sister and a childhood friend. The company sells skin care, hair care, and nutritional products through an MLM system. Its independent distributors make an initial investment to acquire a distributorship and inventory. Then, they can sell product—keeping about half of the suggested retail price—and recruit other distributors.

For every additional salesperson he or she recruits, a distributor gets 5 percent of that person’s wholesale purchases from the company. There are six levels of salespeople in Nu Skin’s organizational plan, each named for a precious metal or gem. At the top is the Blue Diamond Executive—who’s recruited at least 12 other salespeople directly and draws commissions from at least six downline groups. A Blue Diamond’s downline can include up to 15,000 people.

Most companies in the cosmetics business spend heavily on advertising. Nu Skin doesn’t—and forbids its distributors from doing so. It relies exclusively on MLM.

In addition to cosmetics and some nutritional products, Nu Skin sells motivational audio tapes to help distributors recruit new salespeople. The tapes, which include subliminal messages encouraging success, are controversial. “This is one of the greatest examples of snake oil currently being sold in the marketplace,” said Gerald Rosen, a Seattle psychologist who chaired the American Psychological Association’s 1990 task force on self-help products.
“Independent and business consulting firms are calling this the greatest business opportunity in the last 25 years,” the narrator of one audiotape says—in a non-subliminal passage. He describes how Nu Skin distributors can earn $168,000 per year by recruiting five people, who recruit five more...and so on. (The numbers assume each recruit sells $100 of Nu Skin product a month—and that 25 percent of the recruits stay with the program a year. Both assumptions are optimistic.)

Roney, Nu Skin’s founder, combats the skepticism by giving recruits a cosmic pitch. According to one distributor, he avoids talking about products or the money distributors can make. Instead, he talks about having “harmony in your family life and...high standards and morals.”

Of course, Nu Skin distributors also use more traditional recruitment tools—namely, greed. They tell prospects that top distributors can earn commissions of up to $400,000 a month.

Nu Skin doesn’t miss many opportunities because a number of key people have experience with aggressive MLM companies. Since Nu Skin’s beginning, Roney has been dogged by allegations that he was part of Cambridge Plan International—a notorious MLM company that went bankrupt in the early 1980s. (Cambridge sold diet plans and powdered supplements that went with them. In September 1983, the Food & Drug Administration received reports alleging that seven people had died as a result of the company’s 330-calorie-a-day diet. Cambridge shut down soon after.)

Roney was not involved directly with Cambridge. But several people close to him—and involved in Nu Skin—were. The connection, disturbing to some, seems to have worked well for the company. Through the late 1980s and early 1990s, earnings financed a 200,000-squarefoot distribution center, a multimillion dollar lab and a 10-story corporate headquarters in Provo.

Early in 1991, Nu Skin hosted 7,500 distributors at the huge Salt Palace Convention Center. The convention theme: Dare to dream. Bill Cosby and former President Ronald Reagan stirred up excitement in the crowd.
But not everyone who worked for Nu Skin shared this enthusiasm. In August 1991, distributor Patricia Arata filed a class action lawsuit in federal court in California. Arata, a widow who lived in rural Gilroy, California, had started selling Nu Skin products part-time in the late 1980s to make some extra money. Instead, she said she’d lost money due to the unscrupulous practices of Nu Skin distributors above her. “Everyone at the top made money,” Arata complained. “I lost thousands.”

Legally, the crux of her complaint was this:

Despite the lip service to “products,” Nu Skin is a classic pyramid scheme in which members/distributors focus their efforts on recruiting new distributors rather than on selling products, and must maintain “personal volume” of wholesale purchases in order to remain members of the distribution chain and reap commissions from the efforts of their “downline” distributors....

Arata’s lawyer said the widow had invested $4,000 in Nu Skin products and marketing materials. He guessed that 100,000 other participants—the rest of the class action plaintiffs—had invested at least $75 million.

Nu Skin tried to have the complaint dismissed immediately. When the court wouldn’t do that, Nu Skin held settlement discussions with lawyers representing Arata and other class members. In November 1991, a short four months after the suit had been filed, the court approved a settlement.

In one of its responses to Arata’s charges, Nu Skin pointed out that she had inaccurately stated that the State of Michigan had issued a cease-and-desist order against Nu Skin. “There has never been such an order,” Nu Skin lawyer John Shuff said. “In its seven-year history, no regulatory complaint has ever been filed against Nu Skin.”

Shuff was right, technically. But his objection denied a more general truth. The California lawsuit had come during a tough period for Nu Skin. Throughout late 1991 and early 1992, the company was fighting off a number of states agencies—and the Federal Trade Commission—who were investigating its practices. Among these investigations:

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In Michigan, Attorney General Frank Kelley said in reference to Nu Skin: “The emphasis is on the sale of distributorships. The sale of a product is secondary. ...Many people who signed up with the hope of getting rich instead just got basements full of Nu Skin products.” His office had fielded complaints from Nu Skin dealers who’d spent thousands of dollars on promotional materials, motivational tapes and Nu Skin products, only to find their neighborhoods saturated with other Nu Skin distributors. (While he didn’t issue a cease-and-desist order, Kelley did file a notice of intent to sue Nu Skin.)

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In Pennsylvania, the state Bureau of Consumer Protection sued Nu Skin for operating an illegal pyramid scheme that was focused more on collecting up-front fees from new distributors than selling products. “My [department] began an investigation into allegations that some Nu Skin distributors were promising fantastic financial profits for prospective recruits and using possibly illegal pyramid-scheme tactics,” said Pennsylvania Attorney General Ernie Preate Jr.

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In Ohio, Robert Hart, consumer protection assistant to the state attorney general, said his office had investigated concerns that Nu Skin “emphasized sales to distributors over the sale of retail product to people. ...Our primary concern was that there was an overwhelming emphasis on getting new distributors into the program. Distributors were stockpiling inventory just to keep their place in the program with no way to sell it.”