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Now We Can’t Trust the FTC to Protect Consumers?

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CNBC has a very good 20 minute investigation on the whole "Is HerbaLife a Pyramid Scheme" question. What I found most interesting is the interview with the David Vladeck who was until recently the Director of the Bureau of Consumer Protection of the FTC. At the 17 minute, there is this exchange between Hank Greenberg of CBNC and Vladeck:

" HERB GREENBERG: Well, if 90% of the distributors are failing, what does that say? If--

DAVID VLADECK, former Chief of Consumer Protection, FTC: It doesn't mat--

HERB GREENBERG: What kind of a business is it if 90% of 2.7 million every year-- right now we're talking 2.7 million distributors for one company.

DAVID VLADECK: It doesn't mean that-- that-- that doesn't mean that the company made misrepresentations. And it doesn't mean that the people who-- who bought these-- franchises or participated in these schemes necessarily feel that they were injured. I-- look, I don't know what the failure or success rate of new businesses are in the United States. But it is not high.

And when we get consumers who are willing to tell that story, and the sufficient number of them who are willing to stand up and be counted, then we can do something about it.

And that's the way we work. We work precisely because consumers like that, instead of talking to reporters, come talk to us."

There's a lot to break down there, so here goes in order of importance as I see it

The FTC's Chicken and the Egg Problem Hurts Consumers

The first thing that stood out to me is the way Vladeck puts the pressure on consumers to complain. Why can't the FTC take a proactive approach to protect consumers before they are harmed? Notable in Vladeck's response is that is that people might not "necessarily feel that they were injured." So the implication here is that the FTC is fine with consumers being victimized by a pyramid scheme as long as they don't know it.

Consumers are told by MLMs that if they fail it is because they didn't work hard enough (which is wrong failure is a mathematical certainty). They are also told that the system works, and the only variable is them. The MLMs will point to a guy who has a downline of 1,000 people and say, "See, it worked for him." They ignore the fact that many of the 1000 people below the "successful" person are losing money, to support this person's "success."

I've heard it from MLMs over 100 times... "If it were illegal, the FTC would shut it down." Fortune Hi-Tech Marketing's President said, it himself to USA Today: "If it were illegal, I wouldn't be standing here." Two and a half years later the FTC, after being urged by some states' Attorneys General shut down Fortune Hi-Tech Marketing (FHTM) saying, "In its decade of operation, FHTM has defrauded hundreds of thousands of customers out of hundreds of millions of dollars."

Consumers are under the assumption that the FTC would shut down an illegal pyramid scheme. Thus they assume they were in a legit MLM, and have no reason to complain to the FTC about being a victim. The FTC is under the assumption that consumers are educated enough to know the difference and will actively seek out the FTC to complain.

It's a stalemate. The result is what you see with Fortune Hi-Tech Marketing defrauding hundreds of thousands of customers out of hundreds of millions of dollars over ten years.

I know I'm Lazy, but come on FTC, read your own mission statement: "prevent business practices that are anticompetitive or deceptive or unfair to consumers." What's wrong with acting proactively to protect consumers before they are defrauded out of their money?

90% of People Failing = Pyramid Scheme?

In 1997, The FTC went after JewelWay, another MLM, and shut them down. In their report they explained some differences between legitimate MLM and pyramid schemes:

"Legitimate multi-level marketing plans are a way of making retail sales of products or services to consumers through a network of representatives. However, in an illegal pyramid scheme the main focus is not on sales, but on recruiting new representatives into the program. Typically, each new representative must buy a certain amount of products and must recruit a specified number of new participants in order to earn money in the program. In a pyramid scheme there is almost no emphasis on making retail sales of products to persons who are not participants in the program. According to an FTC expert, earnings claims made in conjunction with promoting a pyramid scheme are false because pyramids inevitably collapse when no new participants can be recruited and approximately 90% (or possibly more) of the participants consequently lose their money."

I thought it was interesting that more than 15 years the FTC points to 90% of people losing money when no new participants can be recruited, but when CNBC asks about the 90% of people failing in HerbaLife, they get the brush-off. At a minimum, shouldn't the FTC's response be something like, "We are definitely going to look into this right away!"

Failure Rate of New Businesses vs. MLMs

I understand that Vladeck might not have the failure rate handy, but we can look it up. The U.S. Small Business Administration has this handy PDF of information. It seems that "7 of 10 survive the first two years" (30% failure rate over two years), "half at least 5 years", "a third at least 10 years", and "a quarter stay in business 15 years or more."

If we are to compare this against a business where 90% are failing every year, it is drastic. If we start with a 100,000 people and 90% fail each year, you have 1000 people after two years. That's a 99% failure in MLM vs. 30% in traditional small businesses. After 5 years, you are left with a single person in MLM instead of the 50,000 that you'd have with a traditional small business.

Mr. Vladeck, the success rate of new businesses in the US is sky high in comparison with MLM and in particular HerbaLife.

What You Can Do About It

There's a petition to get the White House more involved with stopping pyramid schemes before consumers get defrauded out of tons of money. Sign it and spread the word and let's see if we can get some positive action to help consumers.

Last updated on March 20, 2013.

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11 Responses to “Now We Can’t Trust the FTC to Protect Consumers?”

  1. It sounds good in principle to say that this should have been shut down long ago (and I agree that I don’t see any value in the product or the business). But by that standard a lot of hosting companies might have to be investigated because of the failure rate of new bloggers. How can the government know enough to find all of these schemes without people at least reporting suspicious claims?

    If they ignore information they receive that’s another matter but I don’t see anything wrong with this kind of practice for getting the information.

  2. Lazy Man says:

    Hosting companies don’t pass the muster as being MLM or potential pyramid schemes. There’s not an endless chain of recruiting going on. They simply provide a service and deliver what it is expected.

    The FTC could read the compensation plan of these and look to see if the reward for recruiting is greater than the reward for selling product. They can require that such companies undergo a compliance audit (of course paid for by companies who choose to use the MLM distribution model). The scheme mentioned in this article, Herbalife, is a 4 billion dollar company. How can the FTC “not” investigate it when it gets information that 90% of the distributors are failing each year?

    I’ve submitted to the FTC secret leaked financials on One24 that shows it is a pyramid scheme, and they appear to have ignored it. They haven’t even reach out to me for clarification.

  3. Jeff says:

    Even when the FTC does act, as with Fortune Hi-Tech Marketing, what’s the point? Their high level distributors just jump to other MLMs and are probably paid to do so. Every couple of years the FTC shuts one down, but like a hydra, many more spring up. They need to regulate the entire industry. For example, they could require that MLMs are not allowed to have sales quotas or required purchases to continue in the business opportunity. They could clamp down hard on income misrepresentation, make all MLMs to provide clear income disclosures and tell every prospect their chances of making money.

    All top MLM distributors should be forced to release statements showing exactly how much income they make and from exactly what source (from retail sales, from the sales of tools to their downline, speaking fees, etc..) and which of those sources of income are available to people just joining.

    Having read the court documents against FHTM, it’s plain the FTC has MLM’s number, they are not fooled by their misdirection or BS semantics. They get it. Which makes it all the more frustrating they choose not to regulate industry wide.

  4. Lazy Man says:

    You are right that the FTC shutting down one doesn’t really stop much, but it does significantly cast doubt on the industry. If it shut down something like Herbalife it would be significant in getting it in front of the public eye.

    That said, you are right that further regulation has to be made. I put a post on two easy thing that MLM compensation plans could implement overnight that would absolve them from nearly anyone calling them a pyramid scheme: How An MLM Can Show It Isn’t an Illegal Pyramid Scheme:

    1. No minimum purchases to qualify for commissions.
    2. Commissions are not paid on products ordered by other distributors only by people outside the company

    These two would ensure that there’s no point in recruiting people just to get them to buy into the business model. For one the person could just join the business, not buying like a product like an affiliate relationship. That means that you aren’t selling them something that looks more like a terrible business opportunity than a product. Also with commissions being made on sales to the outside, it encourages distributors to recruit people interested in making actual sales. If I want to build a sales team, I can still do that, but I actually have to focus on getting the team to sell, not just transfer money internally up the line.

    I like your thing about how all top MLM distributors needing to disclose income and sources clearly and accurately. That would work too.

    I don’t know how much power the FTC has in regulating the industry. Could they do these things if they wanted too? Maybe they’d have to get Congress and Judicial branches involved.

  5. […] but if you have to pay your customers to praise your products, it’s similar to bribery. The FTC has a spotted history of pursuing the worst of the pyramid schemes, but perhaps they should look at this new form of […]

  6. Evan says:

    LM,

    With the FTC obviously failing in your opinion why do you believe the FDA is untouchable?

    While I LOVE your MLM posts (and subscribe to almost every single one) I never understood your defending of that organization. Ever read up on how Aspartame got approved?

    http://www.collective-evolution.com/2013/01/19/the-shocking-story-of-how-aspartame-became-legal/

    Shocking at best, nauseating at worse. Does that justify an MLM? NOOOO, just saying that the FDA is infallible never sat right with me

  7. Lazy Man says:

    That’s a great question.

    I don’t think I’d say that the FDA is untouchable. In fact, I place a lot of the blame on the FDA for not acting on a lot of the MLM stuff that falls in their domain. I’m talking about the numerous companies like Protandim open making claims that their supplements prevent cancer (I have videos of it), which is a clear violation of the Dietary Supplement Health and Education Act of 1994. It has gotten to be an epidemic that has spread to dozens of MLM products leading me to write this article on why the MLM product isn’t a miracle cure.

    About once every 2 or 3 years, the FDA does seem to act with a warning letter like this one or this one. It doesn’t do much.

    In fact, it’s been going on for 25+ years with the FDA. Here’s an excerpt from a Money Magazine article from 1987:

    “Stephen Barrett, editor of the monthly newsletter Nutrition Forum and recipient of a 1984 award from the FDA for exposing nutritional quackery, ^ says: ‘I’ve told the FDA of 300 illegally marketed products, many of them from multilevel companies, but the agency has taken no action on them.’ An FDA spokesman responds: ‘A good number of nutritional products fall into the area of puffery claims, rather than representing a direct health threat. While these products may be in technical violation of the law, we won’t spend our resources to challenge the claims.'”

    Now why do I defend the FDA? For the most part they are like the FTC, a very good organization. Not having the FDA or the FTC would be chaos for consumers. We can find many individual mistakes that the FDA probably wish they could take mulligans on (Vioxx, Fen-Phen come to mind), but mistakes will be made in any large organization. In this article, I point out a very specific process issue with the FTC that requires fixing. If there’s something at the FDA, with the scientific process of approving a drug is similarly broken (i.e. like drugs being assumed to work unless proven otherwise), then that would get my attention. The FDA takes an extra step in making sure that each product and company has been tested (not always well, but tested nonetheless), while the FTC refuses to look at the data in front of their face. It’s complete opposite ends of the spectrum.

    I don’t research the FDA’s history with aspartame, because there has never been a for me to do so. I’m not confronted with an intriguing question like, “Why is someone trying to sell this $45 bottle of juice as with MLM?” I think anyone who has been to a grocery store would realize that something there isn’t right and is need of further investigation. I’d need a lab to run my own aspartame tests (not to mention the minor detail of a scientific background), but when it comes to MLM, I haven’t found one yet that ISN’T a pyramid scheme by the FTC’s definitions. This, to me, is like finding that every medicine on the market didn’t pass the FDA’s clinical trials for safety.

    Since you follow the MLM posts, you’ve probably noticed that the organizations stress to the distributors that the FDA is not trustworthy. The idea is create a lot of fear, uncertainty, and doubt in the FDA. They specifically point out user-fees that fund the FDA and suggest that because the FDA is funded by the drug companies they are trying to keep natural cures from the public. This is complete BS: 1) It’s not like the FDA employees split the proceeds of a new drug getting approved. There is no extra money in their wallet. 2) The alternative to being funded by the drug companies is to be funded completely by the tax payers, so would you rather have the drug companies kicking their fair share or give them a free ride? 3) If the FDA wanted to maximize its money, it could give approval to the supplement companies and require them to pay the same fees as the drug companies opening up a whole new revenue stream.

    As you have noticed by following the comments in the MLM posts, the people do use the logic of “Well the FDA is evil, so the only alternative I have is [fill in the MLM product]”. They absolutely attempt to use the “FDA is evil” as justification for their MLM product. They are incapable of seeing that the two aren’t related. The FDA could be run by Hitler and it doesn’t have a bearing on whether the MLM product works, but they’ll never see that point of view. Instead they just see, “Hey the MLM company told me that the FDA is evil. Now I see this aspartame article, and it clear that the MLM company was right. They must be correct about everything they say too.”

    I have a large problem with that kind of faulty “logic” (can’t even call it logic). The other thing is that you could look at almost every organization and see enormous problems. In 2008, we found out about massive banking problems, subprime mortgages, CDOs and the like. There is corruption at the corporate level (Enron) and at the underwriter level for IPOS. Are you going to pull your money from the banks or the stock market? Don’t we write about how these financial institutions can help us accumulate wealth?

    I think my point here is that you can criticize an organization with deficient in one area without throwing the whole thing in the trash. Perhaps I went a little overboard in this article in throwing the FTC in the trash. I am a bit emotional about such an obvious procedural oversight costing people billions and billions of dollars. I would happily volunteer to patch it for a small percentage of that money. It’s the proverbial low-lying fruit. If I can help 15 million people a year by fixing this process, it’s a pretty good lifetime’s work, I’d say, wouldn’t you?

    As for the article on aspartame, that definitely seem corrupt. I question the article a bit. For example there was this, “By 1980 the FDA bans aspartame from use after having 3 independent scientists study the sweetener. It was determined that one main health effects was that it had a high chance of inducing brain tumors. At this point it was clear that aspartame was not fit to be used in foods and banned is where it stayed, but not for long.” If aspartame has such a high chance of inducing brain tumors that showed up in some lab test (presumably over a pretty short span of time, because it isn’t like these scientists had 5 years to run the tests), then with a billion people sample size (I’m presuming that a billion people drink Diet Coke with it world-wide), over a span of decades, why isn’t everyone getting brain tumors? Take the small chance and multiply it out and it would be enormous, right?

    What other countries have banned aspartame? According to a well-cited Wikipedia article, “Aspartame has been deemed safe for human consumption by over 100 regulatory agencies in their respective countries,[61] including the UK Food Standards Agency,[62] the European Food Safety Authority (EFSA)[63] and Health Canada.[64]” If there’s a conspiracy involving aspartame and the FDA, how is it that it has passed the muster in 100+ other agencies? Is there a 100 different Arthur Hayes Hull, Jr.’s pushing it through?

  8. Evan says:

    I completely understand why the FTC would be on your radar over the FDA. Makes sense, but I don’t think the answer of the FDA employees have nothing to gain is correct whatsoever.

    I may have a general distrust of gov’t, but I 100% believe that maybe it isn’t your low level paper pusher that is being influenced I really do believe that the higher up you go there is RX drug company involvement. Maybe it is indirectly done from a donation from PFE to a Senator who then makes a friendly call?

    Notwithstanding, the point that doesn’t justify MMLs is unarguable. Just b/c there may be some corruption doesn’t mean that some silly ass juice should be accepted as a gift from God.

    The diet pepsi point is REALLY interesting. If I remember the article I cited it was done on rats, and as we both know not all things translate over. Just like if the MLM de jur cures cancer in a test tube doesn’t mean it will work in our bodies.

    Side note: I believe that one day in 30 or 40 years we will finally figure out why autism and allergies have tripled (if not more) in a generation. Personally, I believe it has to do with something that some of us are taking into our body. How long did it take before everyone just generally recognized that taking cigarette smoke into your lungs (w/ or w/o a filter) was TERRIBLE for you? How long were we lied to by those that we trust? Again, does this make some silly shake alright…no, but I think this conversation has morphed past that into more or less me rambling lol

  9. Allhoneyqt says:

    I tried to sign the petition but I’m from Canada. Include Visalus in this debate too! I’ve emailed you their compensation plan. They get around it by telling their promoters and customers they have to remain on autoship to get bonuses.

  10. Dona Collins says:

    The dividing line between a pyramid scheme and a legit MLM opportunity is pretty unclear, in most cases. I’ve been involved in a couple of MLM opportunities and the sad part is that I really did love the products – they were great. But the way the company went about “helping” the “marketers” build their “businesses” was very odd to me. And they ALL started out by saying you could run your business the way you wanted to, but then ultimately said that if you don’t follow their plan (including being a product of the product every month), it just wouldn’t work. Lesson learned.

  11. Lazy Man says:

    The FTC gives pretty clear guidelines:

    “Not all multilevel marketing plans are legitimate. If the money you make is based on your sales to the public, it may be a legitimate multilevel marketing plan. If the money you make is based on the number of people you recruit and your sales to them, it’s not. It’s a pyramid scheme. Pyramid schemes are illegal, and the vast majority of participants lose money…. Avoid any plan where the reward for recruiting new distributors is more than it is for selling products to the public. That’s a time-tested and traditional tip-off to a pyramid scheme.”

    So if the MLM showing people on a stage who made most of their money from a downline, you can firmly put it in the pyramid scheme category. I have yet to see an MLM put someone on stage who has no downline and just sells the product extremely well.

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