MLM Dictionary: Omnitrition Case

The term "Omnitrition Case" refers to "Webster vs. Omnitrition" class action lawsuit that was argued in 9th Circuit Court (of Appeals) in 1996.

Explaining the Case

(editor's note: I am not a lawyer, so you can read the full case, and summaries by several MLM attorneys and MLM critics near the end.)

Omnitrition was started by Roger Daley, who had previously worked at Herbalife in the 1980's, and may have known Mark Hughes, founder of Herbalife, quite well. When Herbalife hit a rough patch, Daley went off on his own with a few close Herbalife fellow sellers and created OmniLife 4, a liquid supplement formula that became the foundation of Omnitrition International. Later, when Omnitrition hit a rough patch,  in the 1990's, he was served with multiple lawsuits, including the Webster vs. Omnitrition.

Shaun Webster and Robert Ligon worked for Omnitrition until they, in 1992, decided to sue Omnitrition International, a MLM selling vitamins and such supplements, charging it as a pyramid scheme. The case gained "class action' status, as it sought relief for all similar reps who had allegedly been cheated by Omnitrition. Webster also charged Omnitrition with violations of securities law as well as violations of California's "endless chain" (pyramid scheme) laws, as well as various other laws such as RICO (racketeering), wire and mail fraud, etc.

At the time, Omnitrition's comp plan has distributors (no multi-level commssion), and various ranks of supervisor. Lowest rank, "bronze supervisor" requires $2000 order in one month, or $1000 orders over two consecutive months. The order goes to Omnitrition.  (Omnitrition's comp plan is very similar to Herbalife's comp plan, because Daley used to work at Herbalife)

Omnitrition's defense is that it had followed Amway Safeguard Rules and thus it cannot be a pyramid scheme if Amway was ruled not a pyramid scheme by the FTC (per FTC vs. Amway).

District Court ruled in Omnitrition's favor in 1994, granting it a summary judgement ("Not pyramid scheme") and thus essentially dismissing the lawsuit. Webster appealed.

The 9th Circuit Court of Appeals reviewed the case in 1996 and found that the district court have ruled the summary judgement in error in not considering sufficient evidence. However, it had also ruled that some additional charges brought against Omnitrition's lawyers and such are not valid and the summary judgement issued by lower court for those are affirmed.

MLM Dictionary: Pyramid scheme

A pyramid scheme is a type of financial fraud that usually disguises itself as a business, but the participants earn compensation by first paying into the system some sort of fee, in exchange of right to recruit additional participants and sell the product / service, and will be compensated primarily by the number of additional participants they recruit (who also pay the fee). Little if any of the compensation will be based on actual sale of the product or service.

The earliest pyramid schemes, and modern HYIP matrix schemes, are investment frauds, in that you pay in (buy a position), recruit others, then when enough people joined, you are "cycled out" and get the big payout. This has lead to much confusion in modern times where scammers insist on using the original definition of pyramid scheme and insist their business cannot possibly be a pyramid scheme (by the old definition).

In the US, pyramid scheme is defined by the Koscot Test.

Pyramid scheme is related to Ponzi scheme, but pyramid scheme requires participants to recruit in order to be compensated, whereas the Ponzi scheme do not require recruiting.  There are many other differences between pyramid scheme and Ponzi scheme.

Pyramid schemes are known by several names to law enforcement, including franchise fraud, chain referral / endless chain, matrix scheme, and pyramid selling.

Franchise Fraud 

Franchise fraud is mainly used by the US Federal Bureau of Investigations (FBI), it stated:

pyramid schemes — also referred to as franchise fraud or chain referral schemes — are marketing and investment frauds in which an individual is offered a distributorship or franchise to market a particular product. The real profit is earned, not by the sale of the product, but by the sale of new distributorships. Emphasis on selling franchises rather than the product eventually leads to a point where the supply of potential investors is exhausted and the pyramid collapses

Basically, this sort of pyramid scheme sells the opportunity itself, rather than the products. Thus, it is a disguised pyramid scheme.

Note that franchises are governed by franchise laws, under the purview of the Federal Trade Commission (FTC), which also prosecutes pyramid schemes on the Federal level as consumer fraud.


Chain Referral / Endless Chain

In many US states, including California, "endless chain" is the same as pyramid scheme. The California Office of the Attorney General (OAG) writes:

Millions of Americans have lost money participating in pyramid schemes which are also known as "endless chains" - - because they cannot work unless the chain is endless and, of course, it cannot really be endless because at some point there are no more people willing to join the scheme.... An "endless chain" or an unlawful pyramid is a plan in which a person pays money or buys merchandise for the chance to receive money when additional participants are introduced into the scheme.

Chain referral scheme can also describe a fraudulent sales plan, where you order an item at the given price, but if you can make friends and family to also buy the same item, your price of the item will be reduced (possibly all the way up to free).  However, in reality, the item is vastly overpriced, and the demand for the item is vastly exaggerated. This was prosecuted many times by Postal Inspectors as mail fraud in the 1970's.

Please note that referral sales is ILLEGAL in the US, and if a company offers such a plan... It may be in legal trouble.

MLM Dictionary: Amway Safeguard Rules

English: Honda- Amway（AVCL）Hồ Chí Minh (Photo credit: Wikipedia)

Amway Safeguard Rules represents a set of "rules" (actually concessions) implemented by Amway when it was sued by the Federal Trade Commission (FTC) in 1975. With the reform of the compensation plan where the IBOs (independent business owners, i.e. sales affiliates) are only paid for what they sell and what their downlines well, and the provisions in these rules, FTC reluctantly agreed that Amway does NOT fit the Koscot test for pyramid scheme. This was finalized in 1979, and became the basis for the entire "multi-level marketing" industry.

In the successful 1975 FTC prosecution of "Koscot Interplanetary" and earlier prosecution of "Dare to be Great", FTC specified the four specific problems they have with the pyramid scheme:

• a) Large membership fees (Dare to be Great can cost up to $2000 or more in 1970's!)
• b) Front-end loading (buying a huge "starter kit") and inventory loading (buying so much inventory just so your upline can get the commission)
• c) Programs in which distributors were misled as to the amount of commission they might reasonably earn (misleading income claims), and
• d) Programs in which commissions were not based on the sale of product to the ultimate consumers. (no true retail customer means it's a money circulation game)

SEC had also previously joined in the prosecution of "Dare to be Great" in 1973, as it considered a pyramid scheme similar to a ponzi scheme...  you put in money, and you expect to get more out of it with rather minimal effort, via the rule known as the "Howey Test".

In fact, many states as well as the US Postal Service have also joined in the prosecution of misleading direct sales, esp. those sent through the mail. Some argued that this patchwork of regulations, different from state to state, created such a hostile atmosphere for direct sales that it would have perished...

An infamous player of this era is called Cambridge Plan International, founded by Jack and Eileen Feather. Some of their most infamous products are "Mark Eden Bust Developer" (diet supplement to make women's boobs bigger), "Astro-Trimmer" (diet supplement that shrinks your tummy fat), and their namesake, the "Cambridge Diet", powdered drinks, soup, and such, only 350 calories, developed by Cambridge professor!  Cambridge eventually went bust when it tried to shift from mail order model (prosecuted multiple times for mail fraud) to direct sales, then the direct sales went bubble and burst. It started with 25 reps in 1981, to 150000 reps in 1982...  and declared Chapter 11 bankruptcy in 1983.

Direct sales basically would not have survived had Amway not survived the FTC lawsuit, and it did not survive unscaped. The ruling, 1979 FTC vs. Amway, resulting in a consent decree where the company agreed to several fundamental changes, that became known as the "Amway Safeguard Rules". (Incidentally, Amway also agreed to tone down income claims, and agree not to restrict the power of affiliates to set prices, i.e. price-fixing).

So what are the Amway safeguard rules? It's quite simple... 3 simple steps.

MLM Dictionary: Autoship

Previously a commenter asked me if I can put up a glossary page where some of the terms I often use are defined. I haven't thought about it for a while, as at the time adding to a page over and over sounds a bit... boring. Then I realized... why not define the term as a blog post, and link to relevant articles if I already discussed it?

Meet the new segment: MLM Dictionary

Today's term:  

Autoship (n)

Autoship refers to the periodic "subscription" of products shipped from company to you and your account is automatically debited. The amount is usually just sufficient to meet the minimum sales quota to stay qualified for certain amount of sales commission or rank level.

DSA code of ethics require DSA members to honor cancellation of autoship as well as accept returns of merchandise with a clearly defined return policy (usually it's 90% of price paid within 6 months). 

Usage: New affiliates are highly encouraged to enroll in "fast start", which includes autoship of 1 unit of product XYZ every month, thus qualifying you for rank of "supervisor" immediately.  

Analysis: Autoship is a somewhat controversial practice that has attracted attention of critics.