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Jul 18, 2018

Q&A: Robert FitzPatrick

Are multilevel marketing firms good investments? A pyramid scheme expert weighs in.

Robert FitzPatrick’s first glimpse of pyramid schemes came 30 years ago, when a New Age group he had been introduced to known as “The Airplane Game”—described to him as “a financial system based on sharing rather than competition”—was suddenly shut down by the local sheriff’s office in Florida. A former Saul Alinsky-trained community organizer, FitzPatrick began looking into the matter and learned about a similar, but much bigger phenomenon that preyed on the same “dreams and beliefs” as pyramid schemes: the multilevel marketing industry.

Since then, FitzPatrick has become a leading expert on MLMs and pyramid schemes and runs a blog called Pyramid Scheme Alert. In addition to educating the public, serving as an expert witness in lawsuits and consulting with government officials in the U.S. (and as far abroad as China), FitzPatrick also consults with investors looking at MLMs—companies where individuals sell a variety of products, from vitamins to diet shakes to leggings, by recruiting a network of people below them to do the same thing. By the MLMs’ own disclosures, few profit and a debate still rages over whether it’s products or business opportunities that are being sold. Regardless, MLMs have become multi-billion-dollar companies that are publicly traded and have garnered significant investor interest.

MLMs became big news in 2012, when well-known hedge fund manager Bill Ackman, CEO of Pershing Square Capital Management, started what turned into a five-year battle against Herbalife, one of the biggest MLMs. Ackman claimed Herbalife was a pyramid scheme, betting $1 billion against it. His fight led to a Federal Trade Commission investigation and settlement that forced Herbalife to pay $200 million, restructure its business, quit deceiving people and put its business under a federal monitor.

Since then, however, Herbalife’s shares have rebounded, as have those of other publicly traded MLMs. Earlier this year, Ackman covered his short at a loss. At the same time, the U.S. industry has fallen in both sales and recruits. In 2017, 18.6 million people joined an MLM, according to the industry’s lobbying group, the Direct Selling Association. That’s down 10 percent from a peak of 20.5 million in 2016—the year of Herbalife’s settlement with the FTC.

The DSA claims industry “retail sales” of $34.9 billion in 2017, which is also a slight decline over the past two years. FitzPatrick is skeptical. “How in God’s name would somebody actually retail these products when you have 18 million sellers of them out there?” he asks. “And every one of them is churning at a minimum of 50 percent a year. You have almost 9 million people a year quitting and joining. What we’re looking at here is a social phenomenon of millions of people joining and quitting, and joining and quitting.”

FitzPatrick’s early experiences led him to write a book, False Profits: Seeking Financial and Spiritual Deliverance in Multi-Level Marketing and Pyramid Schemes. He’s now working on a kind of sequel, called Ponzinomics: A History of Multilevel Marketing and How Direct Selling Became an American Swindle.

Worth recently talked to FitzPatrick about the state of MLMs after the Herbalife FTC decision, the political powers at play and why investors are still drawn to them.

Q: What is the state of the mutlilevel marketing industry today? It seems to be everywhere. Is it growing or shrinking?

A: The larger, older MLMs, such as Amway, Herbalife, Usana, Tupperware, Avon and Mary Kay, are shrinking. Some of them have declined dramatically in the United States, and even globally, over the last few years.

But it seems new, small ones are cropping up all the time, like LuLaRoe and Rodan Fields.

What is occurring is a proliferation of these companies. There are vastly more of them. This gives a bit of an impression that multilevel marketing is growing, which is really not the case.

What does it say about the economy?

It’s an indicator of economic insecurity. People who maybe have a spouse working, and they have a child, and maybe they’re living in a high cost area, so economically, they feel insecure. What’s the remedy? You have this MLM story out there floating around, like an urban myth, that somehow there’s this other economy out here, this other industry.

It seems people are drawn to MLMs because they tie into Americans’ entrepreneurial spirit and this feeling that we can create our own destinies. Why are investors drawn to MLMs?

Just as the myth appeals to an individual, it also appeals to investors because it sounds like something that ought to be real in America. An investor can also see that these things really do generate cash.

In your role as a consultant, what kind of investors come to you asking about MLMs?

Some of them are looking at private equity placements, but the majority are people looking at stocks.

What are they looking for?

Cash flow. They want to know, “Is the cash flow growing?” The second thing is, “Will the government prosecute them?”

If they are worried about a government prosecution, they must think there’s something untoward going on.

I think privately they’re horrified at what they’ve seen. But that’s not why they’re calling me. Some of them have done a bit of homework on this before. They see what appears to be a bogus income proposition. They’ve already looked at some of the disclosure data and see that nobody actually makes money.

So the next question always becomes, “This thing is a fraud, this is a scam. Why doesn’t the government do something?” And then we get into a discussion of the FTC, and at the end of the day, they often ask, “Do you think the government’s going to do anything?”

And what do you tell them?

My answer is, “No, I do not.” That’s not a moral judgment. You’re asking for an educated opinion. And the other question is, “How long has this scam got?” Herbalife’s churning through 2 million people a year, and how long can that keep going? Well, longer than you might think.

Ultimately, they don’t care. They say they have a fiduciary responsibility to their investors. If this thing makes money and the government’s not going stop it, many of them have told me, “We have an obligation to our investors to participate.”

Bill Ackman’s effort to take down Herbalife certainly brought criticisms of MLMs to the attention of the broader public—and to Wall Street. Eventually the FTC settled with Herbalife, made it pay $200 million and forced it to change its business practices. What do you make of it?

I’ve been tracking this for years, and the FTC stopped doing anything in 1979 after they determined Amway was not a pyramid scheme. Since then, the FTC never prosecuted a large MLM because, as far as we can conclude, multilevel marketing had an enormous lobby. Now, along comes Bill Ackman in December 2012. This is the first time that anybody had ever spent a dime lobbying against multilevel marketing.

He lost a lot of money doing that.

Yes. What the FTC did to Herbalife was certainly new and unprecedented. Ackman was able with his megaphone to bring attention to some outrageous information about Herbalife, and so the FTC was put in a corner. They had to do something eventually, but they certainly tried to wait him out. And then, when they finally did announce their findings, they announced that they had a complaint, FTC vs. Herbalife, and it was already settled. And we know that the party advising Herbalife was none other than the former chairman of the FTC, Jon Leibowitz.

So what does that say about the political power of MLMs?

All these MLMs are politically protected; they are outside the law, the FTC does nothing. What the FTC did do toward Herbalife, it was absolutely forced into doing. And what it ultimately did do was to screw the hell out of Bill Ackman. I mean, there’s no other way to look at this. Everything he said about the company was true, according to the FTC. There was no retail selling, the income proposition was false and falsely portrayed. The stores, the so-called nutrition clubs, were not nutrition clubs, they were recruiting centers. But they refrained from calling it a pyramid scheme, which is a way of saying it’s not so bad. Whatever it is, we’ve got no name for it and it’s not so bad.

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