Herbalife pyramid scheme case to go to trial
Barring any unforeseen events, it the next chapter in the Herbalife pyramid scheme saga will take place in a US Federal court.
Back in April Dana Bostick filed a lawsuit against Herbalife, ‘accusing the company of being an “inherently fraudulent pyramid scheme.”‘ Bostick’s 68 page complaint was filed under Federal corruption and racketeering laws.
Bostick, who became a distributor in April 2012, is suing Herbalife under California’s “endless chain” law that prohibits pyramid schemes, as well as under federal racketeering laws, which allow for triple damages.
Bostick, a 68-year-old retired general contractor, claims he failed to make money because “he was doomed from the start by an Herbalife marketing plan that systematically rewards recruiting over retail sales.”
The company makes “outlandish statements” about potential earnings, but the marketing plan, he charges, “pays millions to those few at the top at the expense of many at the bottom.”
Bostick said he bought and used Herbalife products, set up three websites and paid for coaching sessions where he was taught how to recruit others.
But “the only recruit he made was a long-time friend.” He spent $3,000 in products not consumed by himself or given to family, he claimed.
Bostick’s lawyer, Philip Dracht, said Bostick spent thousands of dollars to purchase Herbalife products but failed to earn much money by selling them. “The retail profits are not there because of all this discounting,” Dracht said.
He added that Bostick was urged by other Herbalife distributors to spend more money to buy leads that would help him earn more money but that he could not afford it.
The suit, which also seeks class-action status, claims around 88 percent of Herbalife’s 500,000 US distributors do not make any money.
Sounds to me like your typical case of self-qualification via purchases, which is evidently rampant in Herbalife affiliate circles and somewhat of an open secret in the MLM industry.
Whereas Herbalife has quietly settled such lawsuits in the past with payoffs, this time around, no doubt due to the increased public scrutiny over Herbalife’s business model, they’ve decided to fight the case.
That resulted in the filing of a motion for dismissal by Herbalife, which was subsequently denied last Tuesday.
U.S. District Judge Beverly Reid O’Connell denied Herbalife’s request to dismiss the case, saying former Herbalife distributor Dana Bostick’s allegations were significant enough to proceed toward trial.
Herbalife appears to have argued that Bostick’s claims were not significant enough for the case to proceed, which Judge O’Connell disagreed with.
“While the court concluded that Bostick had adequately alleged a claim against Herbalife, it expressed no view of the merits of that claim,” a Herbalife spokeswoman said.
She said the company has policies in place to discourage inventory loading and that “Herbalife will establish these facts for the court and seek dismissal of the complaint at the appropriate time.”
High on PR rhetoric and low on substance, the company’s tincan response doesn’t exactly inspire confidence. Least of all when one accepts that, despite not having evaluated the merits of Bostick’s allegations, to certify them “significant” Judge O’Connel has obviously on some level evaluated their merit.
Even if that merit was restricted solely to ascertain whether or not the case was a waste of time it still undermines Herbalife’s blasé explanation.
Furthermore the single defending factor the spokesperson mentioned was Herbalife’s supposed ‘policies in place to discourage inventory loading‘. I personally reviewed the Herbalife business model back in January and found nothing stopping an affiliate from self-purchasing to qualify for commissions, and then profiting off recruiting others who do the same.
Infact if anything, Herbalife’s compensation plan all but tries to hide the source of revenue within the company by failing to differentiate between retail customers and affiliates (distributors).
This is done by counting affiliates who fail to recruit and build their business as retail customers, despite them being able to earn commissions via the compensation plan and having signed on as affiliates.
Herbalife announced they were going to address this issue back in February by creating a preferred customer “wholesale class” in April of this year, however given we’re now in October it’s probably safe to assume the company backflipped on the issue.
One can only conclude that Herbalife’s announcement was made prematurely, before company management realised the creation of a wholesale customer class (and the lack of affiliates who join it), would conclusively reveal revenue wise Herbalife was overwhelming affiliate-funded.
A wholesale customer class of course also dismissing the argument that Herbalife’s failed affiliates are wholesale customers only in it for the products and not the business opportunity.
If I was Bostick I’d be making sure this is a core issue brought up by his lawyers when the case goes to trial. Surely affiliate revenue pumped into the company over the past 12 months and retail revenue for the purposes of comparison would be easy enough to obtain via discovery?
Oh and don’t forget to ask for global commissions paid out on the purchase of products by affiliates versus retail too. Those two figures alone being revealed would bury Herbalife under a mountain of pyramid scheme tainted gravel.
Slap the FTC’s definition of a pyramid scheme (generating more commissions from recruited affiliates over retail customers) on top of both of those figures and away you go.
To Philip Dracht and the rest of Bostick’s legal team, you’re welcome.
The problem is partly from Herbalife (and DSA) blindspot toward inventory loading, a position advanced by Jeff Babener, another MLM attorney who wrote a long piece for DSA not that long ago (indirectly defending Herbalife).
In their minds, there is no reason to load up on inventory when one can simply seek refund/buyback as per DSA’s Code of Ethics on company level. DSA’s code of ethics also prohibits company from “require or encourage an independent salesperson to purchase inventory in an amount which unreasonably exceeds that which can be expected to be resold and/or consumed within a reasonable period of time. ”
However, DSA / MLM simply ignore the problem, as Oz pointed out, that the rep will do inventory loading if it’s to qualify HIM- OR HERSELF for commission, rather than his/her upline. While the company did not require or encourage such behavior, the comp plan is shaped in the way the REWARDS such behavior, no requirement or encouragement is needed.
The solution is very simple, audit retail sales, and only pay commission on retail sales (and reasonable amount of self-consumption). However, AFAIK, no MLM currently audit retail sales. Not Amway. Not Herbalife. Not any one. They only count wholesale and ASSUMES that it’s all being resold or self-consumed, as per that ethics code.
MLM apparently is afraid to see whether they are actually pyramid schemes by auditing retail.
Not sure what your definition of audit is, there is at least one company that requires reps to legally document a minimum dollar amount of sales to a minimum number of REAL customers on a quarterly basis.
So, there is auditing at the distributor level (again, depending on what you mean by audit). Then, the company tracks sales at a higher level and also shows a ratio of over 10 million active customers to less than 200,000 distributors.
Retail customers or “customers” (including recruited affiliates)?
He was talking about Herbalife and the DSA, not about MLM in general.
DSA *have* “Code of Ethics”, but it doesn’t have any system in place to enforce those rules. Member companies will only need to *have* the rules. It’s a type of “pseudo ethics” specifically designed to meet certain needs and wants.
M-Norway, I was referring to K.Changs statement that NO company audits sales to customers.
OZ: Retail customers are completely separate from “recruited affiliates”. Customers are customers, Distributors are distributors. There is no blending of the two in any manner. Nor is there any other methods used to try and skew the actual performance or success rates of the business model.
Sounds good to me. The MLM industry needs more of it.
HLF Stock rises on the news…..
Well, I did said AFAIK, so I’m glad to be proven wrong (which is it, BTW?), but most companies rely on distributor self-proclamation, i.e. “I swear I have ten retail customers, etc.”
And Webster vs. Omnitrition had proven that the safeguard rules, unless audited and enforced periodically, will NOT protect a company from being charged as a pyramid scheme.
Actually I was talking about MLM in general. 🙂 But I may have painted that stroke a bit too broadly.
MLM can easily be designed in a way that gives them full insight into the number of customers vs the number of distributors. Herbalife isn’t a TYPICAL method to organize a company.
MLM is a DISTRIBUTION METHOD (marketing is a part of the distribution chain, so Multi Level Marketing is simply a part of an organized distribution chain from manufacturer(s) to consumers).
A distribution chain should normally be focused on FUNCTIONALITY and COST EFFECTIVENESS, e.g. if I want to order something via internet from a retail store in another part of Norway, the retail store might decide to use other solutions to send it to me than sending it themselves (e.g. order it from the importer, and let the importer send it directly to me). And so on and so forth.
MLM doesn’t need to be about distributors buying goods for resale. Normally it would have been much more FUNCTIONAL if distributors did the marketing and the sales job, not the DELIVERY of goods.
“Straight from Herbalife’s own warehouse within 2 business days” is a much better sales argument than “straight from your local distributor’s garage within 1 business day”, for MOST products. For autoship orders, that should be the TYPICAL solution (it doesn’t make much sense sending orders like that via a local distributor).
For other types of products and orders, small local “warehouses” may have a function.
Herbalife’s business model revolves around distributors in a downline ORDERING products each month, rather than around distributors SELLING products. It doesn’t revolve around FUNCTIONALITY and COST EFFECTIVENESS, but around the compensation generated when distributors are ordering monthly supplies to qualify for compensation themselves.
Herbalife’s model is based on the idea that if anyone is ORDERING a product, it can legally generate a sales commission the the upline “selling” the product. DSA is trying to legalize that idea.
A distribution chain is typically about these parts.
LONG CHAIN (EXAMPLE)
B. Wholesale agent / exporter (Country of origin)
C. third party shipping (can be many different parties)
D. Importer / wholesale agent (Country of destination)
E. Local transport to local wholesale warehouses.
F. Local transport to retail stores (or MLM distributors)
G. Local distribution to local end users.
It was only an example. SONY is the manufacturer (A) in Japan, but it probably produce products in other countries too. It acts as its own wholesale agents (B exporter and D importer) in both countries (Japan and Norway). It has a centralized warehouse (E), and it will organize the main marketing of the brand locally in the destination country.
The products are sold through retail stores (F), with only minimum of goods stored in own warehouses (they typically don’t store any product, all products are available for sale, the functionality of the warehouse is only for internal distribution in the shop. The goods have to come IN somewhere to the shop).
If I order anything from one of those retail shops, I can either pick it up directly (standard product), pick it up within a couple of days or weeks (special product), have it sent to me from the shop, or have it sent to me from SONY’s warehouse.
* It’s more COST EFFECTIVE if SONY is sending it directly to me, rather than via a local retail store.
* It’s more COST EFFECTIVE if I can pick up the product directly, rather than having it sent to me.
Distribution chains are about a combination of many different solutions, but they should primarily revolve around the ideas of COST EFFECTIVENESS and FUNCTIONALITY.
I haven’t analysed Herbalife’s distribution chain in detail, but it obviously have hundreds of thousands of unprofessional “local warehouses” spread around the world = the distributors themselves.
“Straight from your local distributor’s garage” isn’t a very good sales argument for ANY product. That distribution chain will not stimulate retail sales to external customers. I’m pretty sure most of the products ends up in the lower levels of distributors if that method is the primary distribution method.
Functionality wise, that distribution method will allow for internal distribution from upline to downline. The upline will have someone they cn push their own monthly “qualifying purchases” onto. They will make some profit on internal sales. They will only need to convince people in their downlines about that “qualifying purchases” is the best method for success in Herbalife.
Cost effectiveness wise, that distribution method will eliminate some of the distribution costs for Herbalife / push some of the distribution costs onto the distributors. Cost effectiveness is about the total costs, not about pushing costs onto someone else in the same chain.
Herbalife’s distribution method seems to be mostly focused on distributing costs downwards in the system, while distributing recruitment rewards upwards in the system.
K-Chang. I completely understand why you would say there is no auditing. For me it was a fluke that I came across the company that did. I dont know any others that do.
Direct sales companies can easily diferentiate between customer and distributor. In fact its easier to keep them seperate than it is to combine them. The ONLY reason they combine them is to be able to play games with the average success rates and incomes.
As far as the distribution chain is concerend, If you are in a direct sales company that is a manufacturer, WATCH OUT. In this case the job of the sales force is to keep the manufacturer and shareholders profitable. YOU as a rep are beholding to them.
ONE: Not one manufacturer can make the best of everything. TWO: You have to say you have the best product whether it is or not because you cant move with the market place fast enough. If someone comes out with something better you have to re-tool and hope to keep up while trying to dump a warehouse full of product.
Most MLM whether they are a manufacturer or not are buying systems, NOT selling systems. Once you find the company that is a SELLING system, because they only deal with products that are in the highest demand and they let someone else take on the burdens of manufacturing, you will also find the one that is beholding only to the sales force rather than corporate entities.
You will also find an average success rate that is MANY MANY times higher as a result.
If memory serves, Herbalife maintains about a dozen large warehouse ‘stores’ around the world. There’s one in the LA area and many local “distributors” (esp. latinos) pick up big batch of products there.
The problem here is even Herbalife themselves are confused as to what products they offer. They are supposed to be selling the shakes (raw powder form) and other supplements. However, the “diet clubs” (that John Hempton likes) are ILLEGAL retail food prepping operations selling prepared shakes and teas that are not even officially sanctioned by Herbalife.
In other words, the proponents of Herbalife can’t even keep their own story straight.
Rising tide floats all boats. Most stocks rose that day.
The “Nutrition Clubs” are supposed to be “members only clubs”, or actually recruitment centers where members can bring in prospective customers or new recruits, meet other distributors in the same downline / upline, buy and pick up goods, and drink 3 different shakes per day (a type of membership offer, not retail).
I don’t think they are illegal. They are clubs rather than retail stores. They can potentially be a solution to something, e.g. consumption through clubs can potentially count as some type of retail sale.
Good analysis. You’ve highlighted a key issue.
Not really sure if I’m understanding this, but both Herbalife and Dana Bostick filed a join request that information they share with eachother during discovery be protected.
Firstly I don’t get why Bostick would want information protected? Pershing Square and Ackman say it’s a pyramid scheme, so does Bostick, so uh…?
Secondly one can only wonder what the information exchanged will reveal… the true number of retail customers perhaps?
What would be really interesting is if Bostick drops the suit now that he can’t have his secrecy. That’d be worrying.
It was Herbalife that went a step further, not Bostick.
A protective order is rather common, but Herbalife’s extended version is rather uncommon. Herbalife is trying to prevent Dana Bostick from getting personal insight into some (or all) of the documents, they will only be available for his lawyers.
Why would Bostick consent to a protective order (meaning the information obtained via discovery couldn’t be shared if I understand correctly)?
And did Herbalife go the extra step to prevent anyone but Bostick’s lawyers looking at the information or was that part of the join-filed protective order motion? Also how on Earth does Bostick fight a legal case when only his lawyers can review information obtained via discovery. I know a party can sit back and let their lawyer handle everything but it seems a bit silly?
Wonder what Herbalife are so desperate to hide? My guess would be those retail figures, unless there’s some other deep dark secret they don’t want getting out…
A protective order is quite normal, but Herbalife’s suggested version wasn’t.
It’s Herbalife’s strategy, not Bostick’s. A legal strategy doesn’t need to be directly related to the current case, it can have been designed to prevent information from being shared indirectly rather than directly.
The suggested protective order specifically names lawfirm Sullivan & Cromwell LLP. A legal strategy doesn’t need to be about what it looks like, it can be about almost anything
Perhaps herbalife convinced Bostick that Bostick may be next on the Ackman’s expose list if the information was made public.