Friday, March 30, 2007

USANA & MLM Schemes -- Pyramid Scheme Alert Speaks Out

The 10Q Detective is publishing in its entirety an articulate and educational letter that we just received on Usana Health Sciences & MLM schemes by Pyramid Scheme Alert, a non-profit consumer organization dedicated to exposing and rooting out the (alleged) abuses and chicanery of pyramid scheme perpetrators.

I read your blog yesterday on Yahoo finance. Thanks for alerting me about it.

Since I have worked in this area of multi-level marketing for some time, I might add a thought to your analysis. I believe you have grabbed only the tip of a much larger issue that extends well beyond Usana.

Multi-level marketing, as practiced by Usana and most of the largest MLMs like Nuskin and Mannatech, is largely not understood in the financial markets. The analyst reports on Usana that I examined revealed that the analysts thought Usana was something like the Fuller Bush Company of 50 years ago, selling "through" distributors. Strangely none wondered why one of Usana's hundreds of thousands of reps had never knocked on their door.

Regarding reactions to the FDI report, as Thomas Paine, wrote, "Perhaps the sentiments contained in the following pages, are not YET sufficiently fashionable to procure them general favour; a long habit of not thinking a thing WRONG, gives it a superficial appearance of being RIGHT, and raises at first a formidable outcry in defense of custom. But the tumult soon subsides. Time makes more converts than reason."

Paine referred to the habit of accepting the domination of a foreign monarch. I am referring to the habit of viewing pyramid recruitment schemes as legitimate businesses, as we have largely done in the US for the last 20 years or so.

Since the 1980's when Pres. Reagan came to office, the US government has mostly allowed these blatant pyramid scams to operate. We did have a brief period between 1996 and 2000 when the FTC began to enforce the law and brought down some large MLMs. The largest and best known, Equinox International, was specifically prosecuted for building an endless chain business based on sales to distributors, with little or no retail sales. This was deemed an “unfair and deceptive trade practice.” Others would likely have been brought down too, including, I believe, Usana, had proper law enforcement continued. Cases were building and consumer awareness was rising. Then, Pres. Bush was elected, having received millions in contributions from Amway, and he appointed Timothy Muris to head the FTC in 2001. Muris' law firm represented Amway. For the next six years, the FTC was muzzled with also no congressional oversight. Schemes like Usana's went wild.

Their ability to generate enormous cash quickly which translates to sales tax revenues and political contributions; their ability to build up followings of cult-like adherents (Approximately 70% quit within the year after suffering financial losses, despite their early enthusiasm and credulous support); and their ability to quash, deceive or bully critics and victims have enabled them to evade law enforcement and the eyes of journalists for the most part. Only class action suits and a few private lawsuits indicted them for what they are and shed light on the large-scale harm they cause.

In more recent years, blogs, books, email networks, MLM-exposé websites, the formation of the consumer group, Pyramid Scheme Alert, and China's extraordinary decision take a stand against MLMs indicate a shift toward consumer awareness and, we think, a coming renewal of law enforcement in the USA.

Most MLMs—like Usana—operate in obvious violation of state laws – the CA Penal Code 327 is an excellent example, and ironically was signed by then Governor Ronald Reagan.

CA Penal Code 327. "Endless chain" schemes:

Every person who contrives, prepares, sets up, proposes, or operates any endless chain is guilty of a public offense, and is punishable by imprisonment in the county jail not exceeding one year or in state prison for 16 months, two, or three years.

As used in this section, an "endless chain" means any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant. Compensation, as used in this section, does not mean or include payment based upon sales made to persons who are not participants in the scheme and who are not purchasing in order to participate in the scheme.

In short, a sales scheme based on rewards tied to recruiting other participants who are similarly rewarded – and “endlessly” recruited – is illegal. The law does not restrict legitimate sales programs in which the rewards are tied to purchases made by non-participants (retail customers).

A the time most of these laws were passed in the states it was widely understood that endless chains were inherent frauds and could only reward a few at the top. The employment of the endless chain trick to sell products was seen as fraudulent. Deception was understood to be their MO. They were viewed as a corruption of the legitimate marketplace and unfair competition. That understanding has greatly diminished in recent years, especially inside the financial community.

For the reasons cited earlier, the state laws are seldom enforced, except on small-time operations. And, these types of schemes now even claim to be ambassadors of American business and American values. They are spreading worldwide, sometimes with the aid of the US Dept. of Commerce and Trade Representatives.

The political force and insider influence behind the MLM industry is Amway, which is now the target of a class action lawsuit that alleges the very same facts as Fraud Discovery Institute's report on Usana.

California’s—and most—other state’s anti-pyramid statutes, all past FTC and SEC prosecutions of Usana-type MLMs and several very explicit federal court rulings use the levels of retail selling as the dividing line between legitimate direct selling and MLM recruitment fraud.

The plain fact is that there is no retail sales opportunity in Usana-type recruitment MLMs. “Direct selling” is the official disguise, a ruse. The business is entirely based upon endless chain recruiting of "Associates" (distributors), a model that must cause 90+% loss rates among all distributors, even if the entire sales force were the equals of Donald Trump and Warren Buffet. It is a money trap, utterly based upon deception. For a full picture and a statistical analysis of the loss rates these endless chain recruitment schemes inflict on their revolving door groups of "associates" see: a clinical study by Pyramid Scheme Alert released in January 2006.

That these schemes generate profit and can manipulate their stocks upwards, through false, incomplete or misleading reporting, has caused some analysts to take them seriously as publicly traded businesses. This is a delusion and an error.

Though you clearly grasped the essence of the facts enough to say you were "skeptical", I would urge you to look more closely. I believe the proper response is outrage and amazement.

I leave you with a quote that I think captures the right view of a Usana-type enterprise. It was written by New York Supreme Court in 1966 in the State v. ITM Inc. case (a similar pyramid scheme), before these types of scams gained their political clout, built up their aura of legitimacy and gained the power and guile to face down regulators and intimidate critics in gang-like fashion as they do today.

"It is difficult to conceive of a more deliberately fraudulent and maliciously dishonest pattern of doing business with the public. [The defendants] gorged themselves on their ill-gotten gains from highly credulous consumers. They engaged in practices in which duplicity was the keynote and fraud the keystone of a commercial enterprise designed to pillage the public. None has the right to earn his livelihood in this fashion"

The employment of a pyramid reward plan to induce purchases by distributors, who cannot resell them on a retail basis—and then to report them to shareholders as "sales"—and to annually replace the 70% of distributors who quit the recruitment scheme after losing money—while withholding the huge failure and collapse rates from shareholders—have no place in the legitimate marketplace.

Usana's is the face of an "unfair and deceptive trade practice," based on my knowledge of FTC and SEC prosecutions of the past, state laws prohibiting pyramid schemes, and federal court rulings on distinguishing a legitimate direct selling business from a pyramid scheme.

Thanks again for your interest and your fine reporting to your readers.
-- Robert L. FitzPatrick, President



The 10Q Detective has a Full Disclosure Policy and holds no political or financial ties in Pyramid Scheme Alert.

1 comment:

Anonymous said...

oh I get it now, you and Fitz are friends, some un-biased reporting you've got here, lol!