14 key points from the FTC’s Herbalife complaint (and conclusion)
Since the FTC’s announcement earlier today confirming Herbalife was operating as a pyramid scheme, I’ve seen a lot of mis-reporting and distortion of the facts.
I suspect much of this arises from most people not having the time to read through the FTC’s 42 page long complaint against Herbalife. Either that or the complaint was simply to complicated in it’s original format for a significant number of people to comprehend.
In an attempt to remedy this, I’ve broken down the complaint into what is hopefully an easier to read format below.
I’ve refrained from publishing anything not in the complaint in all but one instance, in the hope that facts as opposed to interpretations based on flawed analysis might be put to rest.
1. Herbalife operated as an autoship pyramid scheme
Herbalife’s compensation program incentivizes not retail sales, but the recruiting of additional participants who will fuel the enterprise by making wholesale purchases of product.
As a consequence, the small minority of Distributors who receive substantial income through Herbalife are primarily compensated for successfully recruiting large numbers of business opportunity participants who purchase Herbalife product.
Regardless of whether Distributors operate a Nutrition Club, Distributors experience difficulty in selling product to customers outside the network.
Nevertheless, Herbalife’s compensation structure puts pressure on Distributors to purchase large quantities of product in order to qualify for greater wholesale discounts and recruiting-based rewards.
As a result, many Distributors buy product that they find difficult to sell.
Although Herbalife have a buy-back policy, in order to take advantage of the policy, a Distributor must resign his distributorship.
Many Distributors have been unaware of the policy or, for various reasons, have been reluctant to attempt to use it.
Distributors dispose of excess product purchases in numerous ways.
At the simplest level, when Distributors are left with product they are unable to sell they may give it to friends, throw it away, or gradually consume it themselves.
Such self-consumption is not driven by genuine demand for the product, but is the easiest and most convenient way for a Distributor to get some benefit from product that the Distributor would not have bought absent his or her participation in the business opportunity.
In other instances Distributors attempt to sell their excess inventory at a discount on auction websites or at flea markets, although such efforts to mitigate their losses are prohibited by Herbalife’s rules.
Notwithstanding Herbalife’s express and implied representations that Herbalife offers a retail-based business opportunity, in truth the only way to achieve wealth from the Herbalife business opportunity is to recruit other Distributors.
Participants must purchase product from Herbalife, or convince others to join and purchase product from Herbalife.
2. Herbalife’s compensation plan encouraged product-based pyramid scheme activity
Herbalife’s compensation plan gives participants a powerful incentive to recruit more participants, because recruiting a downline entitles a participant to receive multiple different types of payments directly from Herbalife.
The amount of compensation a Distributor receives from Herbalife is not based on retail sales of Herbalife products, but rather is based on the volume of product purchased by the Distributor’s recruits, and by their recruits, and so on.
Thus, the compensation plan contains incentives for Distributors to recruit participants and to persuade them to buy as much product as they can.
3. Herbalife was a terrible MLM business opportunity
Although recruiting is the only path to a high income, very few Herbalife participants earn income from recruiting.
Most Distributors (80%) do not successfully recruit any new participants, and therefore receive no recruiting rewards.
Even among those who do recruit, a substantial percentage receive no reward payments.
For example, as of December 31, 2014, more than 111,000 U.S. Distributors had recruited a downline, but approximately 43% of them (47,714) received no reward payments from Herbalife.
Income from recruiting is low even for many in the top 13% of all Distributors—those who reached the status of “Sales Leaders with a downline.”
In 2014, more than half (57.6%) of the Distributors in this elite group received average gross reward payments from Herbalife of under $300 for the year.
Rewards are highly concentrated among a small number of Distributors.
In contrast to the experience of the vast majority of Distributors who make little or no money from recruitment-based rewards, the top 0.03% of U.S. Distributors (205 individuals) received average gross reward payments of over $600,000 per year.
The overwhelming majority of Herbalife Distributors who pursue the business opportunity earn little or lose money, while those few Distributors who do make a living from their Herbalife business do so by recruiting other business opportunity participants who purchase product, not by retailing the product.
4. Retail sales in Herbalife were not viable
Herbalife’s program does not offer participants a viable retail-based business opportunity.
The overwhelming majority of Distributors who attempt to retail the product make little or no net income, or even lose money, from retailing the product.
For the fewer than 1% of Distributors who receive substantial income through Herbalife’s business opportunity, their compensation for recruiting large numbers of new business opportunity participants dwarfs whatever they might make from retail sales of the product.
5. The “overwhelming majority” of Herbalife affiliates lost money
The overwhelming majority of Herbalife Distributors who pursue the business opportunity make little or no money, and a substantial percentage lose money.
6. Top Herbalife affiliates scammed their downlines
Savvy Distributors have figured out ways to use the recruiting reward structure to reap rewards, even without profitable retail sales.
For example, during the years 2009–14, one top Distributor paid over $8 million for product (with a total Suggested Retail Price of over $16 million) which the Distributor purchased in the names of various downline members, thereby generating additional rewards and qualifying for higher payments from Herbalife.
This Distributor then donated all of this product to charity, rather than attempting to sell it.
The Distributor generated enough rewards through these purchases to make a net profit, without even selling the products.
Similarly, other Distributors have used unprofitable retail sales of product to generate large reward payments.
These Distributors have created specialized websites offering products at discounts of up to 50% with no tax and free shipping.
Although the net profit earned from these online retail sales has been de minimis, by manipulating Herbalife’s compensation system, these Distributors have generated significant “recruiting” reward payments from the large volume of product purchases made by their purported downlines.
7. Herbalife’s promotion and marketing activities were “misleading”
Herbalife promote their business opportunity in both English and Spanish through a variety of channels, including videos, live presentations, and print materials.
Through each of these channels, Herbalife represent, expressly or by implication, that consumers who become Herbalife Distributors are likely to earn substantial income, including significant full-time or part-time income by purchasing and re-selling Herbalife products.
Herbalife use videos to promote their business, making them available to Distributors through Herbalife’s websites.
Herbalife’s videos include representations that Distributors are likely to earn substantial income through Herbalife’s business opportunity; images of expensive houses, luxury automobiles, and exotic vacations; and income testimonials.
Herbalife also sponsor numerous events for Distributors in both English and Spanish.
Many of these events include live presentations at which speakers boast about the high incomes they earn as Herbalife Distributors.
These events have names such as “Extravaganzas,” “Leadership Development Weekends,” and “Success Training Seminars.”
Herbalife strongly encourage Distributors to attend these events, which often require Distributors to pay an attendance fee and/or purchase a minimum amount of product from Herbalife.
Herbalife craft the agendas and select the speakers who present at these events.
Speakers are usually chosen from among the very small percentage of Herbalife participants who have reached the highest status levels of the Herbalife organization.
The presentations made by the selected top Distributors repeatedly emphasize that Distributors are likely to earn substantial income through Herbalife, and that Distributors’ income potential is limited only by their own efforts.
In addition to the spoken content, the live presentations at Herbalife events often involve images of expensive houses, luxury automobiles, and exotic vacations.
Herbalife have recorded many of the live presentations given at Herbalife’s sponsored events and have formally integrated the presentations into their own resources, making the recordings available to Distributors through Herbalife’s websites.
Like Herbalife’s videos and sponsored-events, Herbalife’s print publications include representations that Distributors are likely to earn substantial income through Herbalife’s business opportunity.
To help Distributors recruit new participants, Herbalife have provided Distributors with several tools and training materials, including the videos and print materials discussed above.
Herbalife encourage Distributors to use these materials in attempting to recruit new participants.
8. Herbalife’s representation of profits from retail sales were “misleading”
Many of Herbalife’s representations that Herbalife participants are likely to earn substantial income expressly or impliedly represent that Herbalife participants earn significant full-time or part-time income from selling Herbalife products at retail.
The overwhelming majority of Herbalife Distributors who pursue the business opportunity do not make anything approaching full-time or even part-time minimum wage because the promised retail sales to customers simply are not there.
Analysis of Herbalife’s own Distributor purchase data shows that, even under favorable assumptions about Distributors’ market reach and sales price, the overwhelming majority of Herbalife Distributors who pursue the business opportunity make little or no money from retail sales.
Under these assumptions, and assuming no costs other than an individual’s total payments to Herbalife, half of Distributors whom Herbalife designate as “Sales Leaders” average less than $5 per month in net profit from retail alone, and half of these Distributors lose money.
9. Herbalife actively discouraged affiliates from generating a “large customer base” of retail sales
In order to restrict sales to the direct-selling channel, Herbalife have adopted rules that effectively prevent Distributors from being able to sell to a larger customer base.
Herbalife’s rules prohibit the sale of product in retail stores and impose many restrictions on online selling.
Nonetheless, Herbalife foster an illusion that Distributors can make significant full-time or part-time income from retail sales.
10. Herbalife lied about retail sales volume
In 2014 Herbalife President Dan Walsh claimed:
Research by Lieberman Research Worldwide and Nielsen shows that Herbalife has millions of customers in the United States and that 78% to 87% of our customers are not within our network of Members.
The reality, as per the FTC, is that
although Herbalife represent, expressly or impliedly, that Distributors will be able to sell Herbalife products at a profit, Herbalife do not track either the existence or profitability of Distributor attempts to retail Herbalife products.
11. Herbalife lied about their failed affiliate numbers
Although Herbalife heavily promote their business opportunity, in recent years Herbalife have begun to claim that most consumers who sign up to be Distributors are merely customers who purchase the product only for their own consumption and are not interested in pursuing the Herbalife business opportunity.
Herbalife do not offer a separate “customer” or “discount buyer” status for consumers who are uninterested in pursuing a business opportunity and thus do not systematically track or distinguish Distributors who might be “discount buyers” from Distributors who are pursuing a business opportunity.
Herbalife’s rules provide that all consumers who sign up with Herbalife must enter into an agreement that includes the business opportunity.
Since 2013 Herbalife has publicly claimed or implied that a mere 27% of their Distributors are pursuing the business opportunity either full-time or part-time, and that a “substantial majority” (73%) are simply interested in buying Herbalife products for their own personal consumption.
Herbalife’s express or implied claim that a “substantial majority” of their Distributors are not pursuing the business opportunity is based not on Distributor behavior, but on surveys commissioned by Herbalife beginning in July 2012 that are flawed and unreliable.
When observable Distributor behavior from Herbalife’s data is analyzed, the percentage of Distributors who are attempting to earn income from the Herbalife business opportunity readily exceeds the 27% in Herbalife’s claims.
In short, many of the Distributors whom Herbalife would expressly or impliedly characterize as solely “discount buyers” are, in fact, pursuing the business opportunity.
Regardless of the number of so-called “discount buyers,” it is clear that collectively they could account for only a small percentage of the volume of Herbalife products sold in the United States.
Even using a grossly overstated measure of “discount buyers”—that is, counting as “discount buyers” the roughly 80% of participants who are not “Sales Leaders”—such Distributors collectively account for less than 25% of the volume of Herbalife products sold in the United States.
The remainder, over 75%, is purchased by Distributors at the “Sales Leader” level, who are clearly pursuing a business opportunity.
12. Herbalife’s income disclaimers were ineffective and useless
In some but not all instances, Herbalife accompany misleading income representations with purported “disclaimers.”
These purported disclaimers, which often appear in small print, do not alter the net impression created by Herbalife’s misleading representations, namely, that Distributors are likely to earn substantial income.
13. Herbalife Nutrition Clubs were recruitment tools and not profitable
According to Herbalife, the Nutrition Club is supposed to be a neighborhood gathering place to promote health and wellness, and to provide income for the Nutrition Club owner.
In practice, Nutrition Clubs operate primarily as a tool for recruiting new members rather than as a method for profitably retailing Herbalife products.
While only a small percentage of the roughly half-million U.S. Herbalife Distributors report operating Nutrition Clubs, Herbalife claim that club owners purchase a disproportionate amount of volume of Herbalife product.
Although Nutrition Clubs would appear to be retail establishments, Herbalife’s rules provide that Nutrition Clubs are not retail stores or outlets, nor are they restaurants or carry-out establishments.
Nutrition Clubs are not intended to attract “walk-in” traffic; Herbalife’s rules prohibit signs that state or suggest that Herbalife products are available for retail purchase on the premises.
Club owners are not permitted to post signs indicating whether the club is open or closed, and the interior of the club must not be visible to persons outside.
Club operators may not post, list, or charge prices for servings of prepared products such as shakes, teas, or aloe.
The only permissible charge in connection with the provision of these products is the “membership fee.”
Provision of the shake, tea, and aloe generally costs a Distributor a few dollars, leaving little of the “membership fee” to cover the various operational expenses associated with the club.
Although Herbalife create the impression that Nutrition Club owners will make significant full-time or part-time income from retailing Herbalife products to customers at their clubs, many Distributors find it all but impossible to make enough money from retail sales of product to cover the overhead of the club and also generate income for the owner.
Many club owners incur thousands of dollars in expenses—including but not limited to product purchases, rent, utilities, supplies, and licensing fees—that they are unable to recover through the operation of their clubs, and end up losing money.
In fact, Herbalife’s own telephone survey of 433 current and 69 former Nutrition Club owners in February 2013 paints a discouraging picture of the experience of many Nutrition Club owners.
Fifty-seven percent of Nutrition Club owners reported that their clubs made no profit or lost money. Club owners reported spending an average of about $8,500 to open their club.
Some Nutrition Club owners continue to operate their clubs for little or no profit —or at a loss—for years, in the hope that things will turn around and their investment will eventually pay off.
However, the promised retail-based business opportunity is simply not there.
Because Nutrition Clubs are expressly not retail establishments and are often unprofitable, they are principally of value to a small minority of financially successful Herbalife Distributors as a location from which they can recruit new participants.
As one top Distributor explained in a PowerPoint presentation:
[Nutrition Club] Operators need to realize that the end goal is not how many $4.00 services they sell each day as that is not the way for them to achieve their financial goals.
Rather, it’s upgrading a Consumer to become a Customer and eventually a Distributor and ultimately having Distributors become Operators who will duplicate the Nutrition Club method.
“Successful” Nutrition Club owners make money not from retailing product, but from recruiting other participants who are encouraged to open their own clubs, buy more product, and recruit more participants.
When recruited participants purchase product to sell at their clubs, these purchases generate recruiting rewards for the sponsor, even if the clubs themselves lose money.
These recruiting rewards are the only pathway to achieve the high incomes touted in Herbalife promotional materials.
14. Herbalife affiliate attrition rates are horrendous
In light of their poor financial results, many Distributors either stop buying product or leave the organization altogether, resulting in a high turnover rate.
Despite Herbalife’s efforts to promote retention of Distributors whom it characterizes as “Sales Leaders,” in 2014 nearly 60% of first-time Sales Leaders did not purchase sufficient product to requalify as Sales Leaders.
Retention for non-Sales Leaders, many of whom are pursuing the business opportunity, is even worse.
An analysis of Herbalife’s data shows that the majority of Distributors stop ordering Herbalife products within their first year, and nearly 50% of the entire Herbalife U.S. Distributor base quits in any given year.
Roughly half of all Herbalife Distributors at any given time are in their first 12 months of membership, and roughly 40% of the volume of Herbalife products sold by Herbalife each year is sold to participants in their first year.
During 2009–13, an annual average of approximately 242,000 new Distributors signed up in the United States.
On average, 89% of those newly recruited Distributors, however, simply replaced U.S. Distributors who left that same year, with an annual average of approximately 216,000 Distributors leaving during this time period.
In sum, Herbalife’s compensation structure incentivizes Distributors to purchase thousands of dollars of product to receive recruiting-based rewards and to recruit new participants who will do the same.
This results in the over-recruitment of participants and the oversupply of Herbalife products and exacerbates participants’ difficulty in selling Herbalife products for a profit.
Participants in a business opportunity should have some reasonable prospect of earning profits from reselling products to customers.
However, most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products.
In the absence of a viable retail-based business opportunity, recruiting, rather than retail sales, is the natural focus of successful participants in Herbalife’s business opportunity.
Thus, participants’ wholesale purchases from Herbalife are primarily a payment to participate in a business opportunity that rewards recruiting at the expense of retail sales.