Herbalife might just want to put that auditor search on hold. There’s a new problem in multi-level marketing land. Former Herbalife Distributor Dana Bostick filed a Class Action Complaint against Herbalife claiming that amongst other serious allegations the company is operating as an illegal pyramid scheme. And in direct violation of the second element of the Koscot test, the claim alleges that “Herbalife’s compensation structure rewards recruiting of new participants over retail sales and leads to abuses”. From the court document:
This obviously wouldn’t be the first claim to be made that HLF is a pyramid scheme (note that we released our first report on the topic before Bill Ackman) but there’s a good chance this case might just put the nail in Herbalife’s formula one shake.
The court document which we have made available on our website – provides some excellent background information on Herbalife and outlines the many facets of its marketing scheme and operations. Here are some of the key points of the case:
- Herbalife has deceived consumers by leading them to believe there is a good probability of attaining success in the program, while the company’s own compensation disclosures outline a slim probability of success. The court paper goes into details of some of the egregious earnings claims made by Herbalife and its distributors. (We covered this in depth here.)
- There is little chance for a Herbalife Distributor to earn a profit since Herbalife “sets the “Suggested Retail Price” (“SRP”) at a price so high that few if any Herbalife distributors can earn retail profits”. This is compounded by very high shipping and handling costs which are charged on the SRP. (Something we covered extensively in our first report).
- “An undisclosed fact (from at least April 2009 to February 2013) is that a large majority of all distributors (approximately 71%) make few if any retail sales and are forced to self-consume the Herbalife products.”
- “To avoid being a pyramid scheme, a multi-level marketing plan must have effective provisions to ensure that its distributors sell most products to consumers not a part of the marketing system. Herbalife does or did not employ or enforce such provisions.” (Something we also covered extensively in our first report—and something that puts Herbalife in violation of a 1986 California Court order requiring them to have a system in place which documents retail sales)
- “Because so much money is paid upline in recruiting bonuses so that Herbalife can retain its “most active and productive distributors,” Herbalife’s SRP is an inflated price that bears no relation to the actual market price distributors can get for Herbalife’s products in sales to retail customers.” (A point that was a big focus of Bill Ackman’s presentation)
- The documents speak of how Bostick was more or less forced to “pay to play” in order to reach the Supervisor status, which requires certain volume purchases each month. New distributors are encouraged by their upline sponsors to make a big upfront purchase in order to qualify for the better commission rate. A great note from the documents—they point out a video in which Herbalife Director and Chairman’s Club member John Tartol explains how a distributor can “qualify right away” for a 35% discount “with just one order” and “enjoy a substantial 42% discount immediately.”
- Bostick ended up having to unload unsold inventory on Craigslist—a common dumping ground for Herbalife’s shakes, vitamins ,etc. Remember, when Ackman spoke of the huge amount of product on EBAY? More proof here that distributors making that initial purchase order simply to qualify for Herbalife’s higher commission structure turn online to dump their inventory. As of this article, there were nearly 3000 listings for Herbalife product on EBAY, with many of the listings offering a significant amount of product for sale.
The complaint has been filed and Herbalife has been served with the complaint. Next steps: Herbalife needs to file a response to Bostick’s complaint. As soon as Herbalife has filed a response, we will provide an update on the case.