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Is the FTC ready to take on multi-level marketing?

Is the FTC ready to take on multi-level marketing?


A case against a fraudster could have implications for the $30 billion industry

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It’s been more than a year since Bill Ackman publicly made a billion-dollar bet that Herbalife — a nutritional supplement company based in Los Angeles that’s traded on the New York Stock Exchange and brought in more than $4 billion in revenue in 2012 — is an illegal pyramid scheme. As The Verge outlined last month, Ackman’s billion-dollar bet has not gone well for the controversial hedge fund manager; Herbalife’s stock price has increased by about 230 percent in the last year, and Ackman is at least $500 million in the hole as a result.

But in a court filing on Friday, the US Federal Trade Commission (FTC) took a step toward clearly defining a pyramid scheme. That filing could put every multi-level marketing (MLM) company in the United States — including Herbalife, as well as Avon, Amway, Vemma, ViSalus, Nutrie, and a host of others that contribute to the $30 billion-per-year industry — at risk of a major lawsuit from the nation’s foremost consumer protection agency.

If the FTC had taken the advice from Ackman’s three-hour, 342-slide presentation last December to shut Herbalife’s doors, the company’s stock would’ve plummeted, Ackman would’ve made a bundle of cash, and every other MLM operating in the US would’ve been in trouble, too. With regard to Herbalife, the FTC remained silent.

But on Friday, it made a clear statement in the ongoing case of Kevin Trudeau.

The FTC is finally defining pyramid scheme

A notorious and prolific fraud, Trudeau has been tracked by the FTC since at least 1998, when the consumer protection agency filed a sprawling lawsuit against the author and late-night infomercial pitchman who claimed, among other things, that his "Sable Hair Farming System" would "finally end baldness in the human race." Though Trudeau has somehow managed to continue hawking his weird and obviously fake "solutions" in between stints behind bars, the FTC keeps an exhaustive record of his products, filing court action against him when regulators feel he’s attempted to market something newly counterfeit.

That’s what happened Friday: the FTC alleged that he’d been running a pyramid scheme called Global Information Network (GIN). The company sold discounted products (including a "Success Mastery Course") along with a business opportunity (which amounted to the privilege of selling such products to others). To define GIN as a pyramid scheme, the FTC needed to define what exactly a pyramid scheme is.

For years, that’s been a problem. In 2004, the FTC released a "staff advisory opinion" about pyramid schemes. But it was vague. Lawyers and scholars argued that it did more to muddle a pyramid scheme’s definition than clarify it. The opinion said, for example, that "for each person who substantially profits from the scheme, there must be many more losing all, or a portion, of their investment to fund those winnings." It didn’t say, however, what it meant by "many more." Dr. Jon Taylor, a pyramid scheme scholar, estimates that 99.92 percent of Herbalife’s participants lose money. Does that count as "many more"? Until this year, the FTC hasn’t said.

Bait and switch

But Friday’s FTC filing did. It says Trudeau's company, GIN, was "almost certainly operating as a pyramid promotional scheme" because it involves "perpetual recruitment" that "dooms the vast majority of the participants (well above 90 percent) to financial losses by the very design of the compensation plan."

What makes GIN and Herbalife similar is "a form of ‘bait and switch’ where the ‘bait’ is the potential for life-changing wealth, and the ‘switch’ is the reality of an improbable opportunity," says dean of the College of New Jersey’s business school, William Keep.

"The success stories on their websites are heavily skewed toward telling the stories of the very few who do achieve life-changing income," he says. "Ironically, in the case of MLMs operating pyramid schemes, the very strength of trust developed through face-to-face selling gets perverted for the purpose of endless recruiting."

Since Herbalife provides discounted products along with a business opportunity (which amounts to the privilege of recruiting and selling such products to others), the company certainly seems to fit the FTC's definition of a pyramid scheme. But Trudeau is an easy target — an obvious fraud with decades of overt violations to his discredit. What we don't yet know, though, is whether the FTC will be willing to apply the same definition to harder targets like Herbalife.