Friday, September 6, 2013

Are You Aware of Your Own Bias? How About MLM Lawyers?

Human beings are remarkably adaptable creatures. However, sometimes, this adaptiveness works against us. One way this happens is we become unaware of our own biases. It is simply the way it is. And this is especially apparently in the MLM world. And it often takes a bit of outside information or criticism to make one aware of one's own bias.  (If you think I have a bias leaning one way or another, let me know in the comments!)

Anyway, with the Brouhaha between Ackman and Herbalife, one of the few MLM lawyers in the country, Jeffrey Babener, wrote an article on his about what he believed Ackman missed.

Previously I've analyzed John Hempton's position on Herbalife. Hempton is a fund manager and is opposed to Ackman's position and found Hempton has his own bias that he doesn't seem to realize (or not apparent from his writing), but he's a money manager, not a lawyer. A lawyer should cover all angles, right?

In this case, not quite. Mr. Babener showed quite a bit of bias too.

First, a disclaimer. I am not a lawyer, nor do I play one on TV. I'm just a junior skeptic. So my observations on Mr. Babener's bias will not be about his legal analysis... but his biases.

Mr. Babener discussed the caselaws that lead to the Amway safeguard rules, and before that, how FTC and SEC closed two of Glenn W. Turner's scams (one of which is Koscot Interplanetary). Then he jumped forward 40 years to Herbalife, and claimed that Ackman missed two big things:

1. Federal prosecution history of scams
2. Trend in allowing self-consumption

Let us analyze each in turn.

Prosecutory History of Scams

Mr. Babener listed every large scale MLM-type scams in the past 20 some years, but he also included most SEC prosecuted scams (such as Ad Surf Daily and Zeek Rewards) which are more Ponzi schemes than pyramid schemes. His hypothesis basically claimed that there *is* a clear divide between what is a pyramid scheme / scam vs. a legal direct selling / network marketing, and he claimed that these scams shows a clear pattern on what's illegal which is very different from "established direct selling companies".
As a general matter, the facts of these federal prosecutions look nothing like the programs of established leading direct selling companies. They are often “inherently fraudulent” and often represent “egregious” abuse.
He conclusion, which reasonable, shows a bias /.assumption that is not readily apparent upon first read: that the Feds will only ever prosecute the "egregious" abuse cases. To borrow this horribly corny joke involving randy boys...
A: Stop masturbating, young man, or you'll go blind!
B: Can I do it until I need glasses?
To put it a different way, that Mr. Babener thought he proved was "established MLM companies do not abuse, Scams do abuse, thus MLM is not Scam". What he actually proved was "established MLM companies do not abuse to the same extent as egregious scams".  It doesn't prove that MLMs are not scams. It just means they may be "less obvoius" scams.

Self-Consumption Trends 

What about self-consumption? Here Mr. Babener takes an interesting angle on the Webster vs. Omnitrition case. He noted that this decision about "ultimate consumer" is dicta (incidental ruling), not a formal decision. However, dicta decisions are some of the most influential decisions in the US history. I think most of you know that all babies born in the US, even by illegal residents, are US citizens. Did you know this is not law, or formal court ruling, but dicta? But enough about dictas. What about his interpretation?

Mr. Babener interprets Omnitrition ruling as a ruling against inventory loading, not against self-consumption. In his conclusion, he wrote:
In other words, this case was not really about "retail sales," nor "personal use," it was about inventory loading that defeated the goal of sales to the ultimate user. 
To give a short rehash, Omnitrition requires their "supervisors", who earns MLM commission, to achieve $1000 sales for 2 consecutive months to stay qualified. And it actively encouraged the supervisors to just "buy stuff and give them away" to participate in the profit sharing. The court ruled that
This compensation (by Ominitrition to supervisor) is facially "unrelated to the sale of the product to ultimate users" because it is paid based on the suggested retail price of the amount ordered from Omnitrition, rather than based on actual sales to consumers.
And thus it would fit the Koscot test for pyramid scheme, and thus Omnitrition is a pyramid scheme. Furthermore, the court also ruled:
In addition, plaintiffs (Omnitrition) have produced evidence that the 70% rule can be satisfied by a distributor's personal use of the products. If Koscot is to have any teeth, such a sale cannot satisfy the requirement that sales be to "ultimate users" of a product.[5]
There are other rulings and comments in the case but here are the two big ones. Together, they suggest that Omnitrition, which encourages its own "supervisors" to buy $1000 worth of products every month and give them away as "proven formula for success" to qualify for multi-level commissions is indeed a pyramid scheme. But what did the court mean about "if Koscot is to have any teeth"?

FTC vs. Koscot, which defined the pyramid scheme test i.e. Koscot Test, specified that when one joins a company, one buys the right to refer/recruit additional members, and is compensated by something OTHER THAN directly based on sales to ultimate consumers. If one can be one's own ultimate consumer, i.e. sell to one self, then clearly Koscot pyramid definition is being violated in spirit if not the letter.

To look at it from the "inventory loading" point of view, one of the more dangerous aspects of MLM is inventory loading, where the affiliate is loaded up with more inventory one can possibly sell (or consume, if you also count self-consumption) just so his upline can qualify for the commission. But in this case, inventory loading is a SYMPTOM of not retailing to ultimate consumer, not a cause.

Furthermore, in this case, an affiliate is loaded up with more inventory one can sell or consume so he HIMSELF can qualify for the commission. This is NOT the conventional definition of inventory loading any more. While the company may not "encourage" such, the compensation plan is clearly tilted to reward such... esp. if "self-consumption" is allowed and not limited to "reasonable amount"!

The solution here is to pay affiliate commission on RETAIL SALES of products, not on their ORDER of products. If they give the stuff away, they get nothing. This was specifically referenced by the court.

By not recognizing inventory loading as the SYMPTOM of pyramid scheme, Mr. Babener have shown a bit of bias against Ackman's interpretation of Omnitrition case.

Mr. Babener then tried to build a case about how Self-consumption is being recognized on a state level and even to a limited extent by the FTC. He, however, failed to note that it was the DSA's own lobbying effort that is pushing that agenda. And what constitutes "reasonable self-consumption" was left up in the air. A trend is not always right, and this is strangely suggestive of bandwagon fallacy.

Personally, whatever's "reasonable" would be a company's own "recommended dosage" for ONE individual. And I honestly don't see how one can reasonably consume $1000 worth of vitamins in a month. Though I agree that if "reasonable" amount of self-consumption, along with enforcement of 10 retail customer rule, as well as pay people on RETAIL SALES instead of "ordered amount from corporate", should not trigger the Koscot test in any way shape, or form.

All in all, while Mr. Babener's article is not outright wrong, being an industry insider gave him a bit of bias that he may have not realized as he wrote it. I have no idea if he will ever read my little blog post, but I welcome comments from lawyers and other skeptics.
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