Forsage and Herbalife—How Multi-Level Marketing, Pyramid Schemes, and Ponzi Schemes Differ
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode 396. It's titled, How Multi-Level Marketing, Pyramid Schemes, and Ponzi Schemes Differ. The Case of Forsage.

When I was about 10 years old, my uncle came to our house to visit my recently divorced mother and introduced us to a new business opportunity that he had. It was selling cleaning products, soap. The company was Amway. Amway was founded in 1959. It is the world's largest direct selling company.

Amway distributes and manufactures nutrition products, beauty, personal care, and home products. My mom didn't join. She became a Tupperware distributor instead for several years. I recall us having thousands of dollars of inventory in our basement. She did okay with Tupperware, but eventually transitioned to real estate and other products.

opportunities. When I was at university, a friend approached me about a business opportunity. He wouldn't say what it was. I had to go to a recruiting meeting. This was in the late 80s, and again, it was Amway. They talked about the potential to earn cars, trips, money. I don't recall much focus on the product. I wasn't interested. Then in 2007, another family friend came to visit

again to pitch me on a business. It was called Quickstar, which was the name of Amway. They had changed it. Now they've changed it back. I bought a discount card. I wanted to help out some. I had more means to do so. I just didn't want to be an Amway distributor. I, like you, have seen friends, acquaintances, family members get involved in direct selling businesses, which are sometimes called multi-level marketing. Think Amway. Tough

Tupperware, Mary Kay Cosmetics, different essential oils companies, numerous drink companies made from exotic berries. Here in Idaho, we have lived in Idaho Falls. One of the largest companies, or at least one of the wealthiest companies in Idaho Falls is Melaleuca, a company founded by...

Frank Vandersloot in 1985. This company is also a direct sales company, a multi-level marketing company with cleaning products, personal care products, supplements. They built their world headquarters in Idaho Falls. It's a Disney-like castle. It's huge. The

The company, VanderSloot and his senior partners have invested hundreds of millions of dollars in Idaho Falls in commercial and residential real estate projects. They fund the annual Independence Day fireworks show. Our children have attended a Montessori school that was partially funded with Melaleuca money.

Multi-level marketing companies sell products and services through person-to-person sales rather than through a retail store. It could be through home parties. It can be online.

If you work with a multi-level marketing company, you become a distributor or a participant. Sometimes it's called being a member or contractor. Here's the thing though, I don't know anyone who has been successful at a multi-level marketing business, but they have to exist. Multi-level marketing companies are controversial. In 2012, hedge fund manager Bill Ackman

who runs the hedge fund Pershing Square Capital Management, made a big short bet. He short the stock of Herbal Life, a multi-level marketing company. He launched his attempt to bring down the company with a three-hour presentation titled, Who Wants to Be a Millionaire?

He fought Herbalife for four years, tried to get the SEC to investigate Herbalife, as SEC did. He also got the attention of some other billionaires, Carl Icahn and Daniel Loeb, George Soros. They took the other side of the trade and bought Herbalife stock. The stock increased. It didn't fall. In July 2016, the Federal Trade Commission settled with Herbalife. Herbalife agreed to pay $200 million in

in consumer relief, hire an outside monitor, and to make substantial changes to its business practices in the U.S.

They didn't shut the company down. In their complaint, the Federal Trade Commission said defendants at Herbalife have operated as a common enterprise while engaging in the deceptive and unlawful acts and practices alleged in the complaint. They said, though, it wasn't a pyramid. Well, they didn't say that specifically, but if it had been a pyramid scheme, they would have shut it down. And we're going to look at what's the difference between a pyramid scheme, a Ponzi scheme, and a legitimate business.

The FTC says pyramid schemes are scams. They can look remarkably like legitimate multi-level marketing businesses.

They can sell actual products. The difference, though, between a pyramid scheme and a legitimate multi-level marketing firm is a pyramid scheme focuses more on not selling the product, but in having you as the distributor find other people. Most of the income isn't driven from product sales, at least product sales to individuals outside of the network. It's product sales from new recruits and

And it's those commissions from bringing in those new recruits from their introductory packages that they buy, that is the bulk of the income. Oftentimes, the pyramid schemes overpromise in terms of how much a distributor can make. Oftentimes, these new distributors will go in debt to purchase the inventory and feel compelled to continue to purchase it to continue to be part of the program. The FDL,

FTC continues to shut down multi-level marketing programs that they consider to be pyramid schemes. But many continue to operate, including Herbalife. The SEC filed another complaint with Herbalife in 2019 over how it described its business practices in China. Herbalife had to pay a $20 million fine then. But the stock still operates.

It's still publicly traded. When Pershing Square, Bill Ackman, started shorting the stock in early 2012, the stock traded between $25 and $35 a share. When the complaint was lodged by the Federal Trade Commission against Herbal Life, the stock was at $29 a share. It reached a high of $60 a share in February 2019. It was in September 2019 that, again, Herbal

Herbalife had to pay another fine. The stock fell to $45 per share, and now it's about $24 per share because it's sold off in the current bear market. But it continues to operate, continues to make profits. It's a multi-level marketing business with, again, challenging to figure out, is it a pyramid scheme or isn't it? Some examples of pyramid schemes that the Federal Trade Commission has shut down this year, Avocare, there's a Texas-based company,

that operated what the FTC says, the Federal Trade Commission, is an illegal pyramid scheme that deceived consumers into believing they could earn significant income as distributors of its health and wellness products. The FTC says, Avacare operated an illegal pyramid scheme that pushed distributors to focus on recruiting new distributors rather than selling products to customers.

and that the compensation structure incentivized distributors to purchase large quantities of AdvoCare products, even when they couldn't sell the products, and to recruit a downline of other participants with the same incentives. Another company that was shut down this year by the FTC is the My Online Business Education platform. This was a business coaching scheme that, according to the FTC, made bogus promises about how much money participants could make

Consumers would pay $49 to enter their 21-step program and then were bombarded with sales pitches for membership packages that cost thousands of dollars and that their proven system of online business required participants to sell memberships to other people. The FTC said most consumers were unable to recoup their cost and many experienced crippling losses or mounting debts.

Another pyramid scheme that was shut down this year is Michigan-based Financial Education Services that also did business as United Wealth Services. They promised to fix consumers' credit reports for $89 per month, but they were very focused not on that product, but getting others to sell these credit repair services, most of which were worthless. Yet again, Herbalife wasn't shut down. They had to adjust their strategies because

Because the FTC took a deep dive into Herbalife, they found that the overwhelming majority of Herbalife distributors who pursued the business opportunity did not make anything approaching full-time or even part-time minimum wage because the promised retail sales to customers simply were not there. Even their own surveys that Herbalife did, they found that only 39% of

of Herbalife's product sales were to people outside of the network. It was actually pretty high for some of these companies. 60% or 61% were to their own distributors. Those that were considered sales leaders with Herbalife averaged less than $5 a month in profit from retail sales to others. Most of the profits came from the recruiting of others.

And there was very high turnover. 50% of Herbalife distributors quit within a year. 80% didn't recruit anyone successfully. And of those that actually had recruited someone in their downline, 43% of them didn't make any money at it. They weren't recruiting enough people. Sales leaders with Herbalife with a downline, about 60% of

of distributors in that elite group. So they've actually recruited people. They're in the top 13% of all distributors. They grossed on average about $300 per year. It's something, but it's not enough to live on. But the top 0.03% of distributors averaged gross reward payments of over $600,000 per year.

0.03% were meaningfully successful as an Herbalife distributor. Multi-level marketing is incredibly difficult. The turnover rate is very, very high. But all business is difficult. Think about the podcasting business, a business I've been in for over eight years. Apple Podcasts lists out 2.4 million podcasts in the directory. The podcast index is over 4 million, but only 8%.

About 400,000 podcasts have actually released 10 episodes in the past year. Only 500,000 have released one in the last 90 days. So the vast majority of podcasts no longer are publishing episodes. It's called podfate. And of those 400,000, only about 1% get enough downloads to make money, enough that it makes sense to accept sponsors. Certainly enough money to live on.

The median downloads for a given podcast is 130 downloads or basically 130 listens. So half a podcast get less than 130 listens per episode. Only 5% of podcasts gets more than about 8,000 downloads per episode. And to really get in to the top 1%, like our show, you need more than 35,000 downloads. But even then, it's an incredibly difficult business.

So just because multi-level marketing is difficult doesn't mean it's not legitimate. All business can be challenging. The problem with multi-level marketing is many are not truthful. Before we continue, let me pause and share some words from this week's sponsors.

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The Truth in Advertising website did a comprehensive study in 2017 of multi-level marketing companies, those that were part of the Direct Sales Association, which is the self-regulatory group for direct sales companies. And they looked at the materials that these multi-level marketing companies produced and what they were promising. And they found that 97%

Of those DSA member companies made atypical or unsubstantiated income claims. The Truth in Advertising documented more than 3,000 instances of deceptive income claims among 137 companies.

They also found for DSA member companies that were selling nutritional supplements, they found 60 out of 62 or 97% made claims that the company's products could treat, cure, prevent, alleviate the symptoms of or reduce the risk of developing diseases or disorders. These are non-regulated products. And it's a violation of law to make those type of claims with those type of products.

So there's some challenges within the multi-level marketing business. Very challenging business. Most people quit. Many of the companies just are providing inaccurate information, but many are legitimate and been around for decades. But successful distributors are a tiny, tiny percentage. How then does a pyramid scheme differ from a Ponzi scheme?

The FTC says a Ponzi scheme is an investment scam that involves the payment of purported returns to existing investors from the funds contributed by new investors. The most famous is Bernie Madoff's Ponzi scheme. Essentially, those returns were so good, 12% annualized reported returns, but they were being funded when an investor wanted a distribution that was funded from new investors coming on board.

That brings us to a news item that I saw yesterday that got a great deal of press. I saw an article in Financial Times, there was one in the Wall Street Journal, and I'm sure many other publications. The Securities and Exchange Commission, not the FTC this time, but the SEC charged 11 individuals...

with creating and promoting a fraudulent platform that operates as a global crypto pyramid and Ponzi scheme, combining Ponzi aspects with a pyramid scheme. The company is Versage. It's a platform that was launched in January 2020. Versage has raised more than $300 million from millions of individual investors.

The SEC says Versage is a textbook pyramid and Ponzi scheme. It did not sell or purport to sell any actual consumable product to bona fide retail customers. A pyramid scheme needs to have more focus on recruiting others versus the product. Versage had no product.

If you go to Versage's website, they say they are the number one smart contract for starting and developing a blockchain-powered online business. You could have your own online business on the blockchain. Versage's website says Versage operates as a decentralized platform that connects people from all over the world and provides unlimited opportunities for a brand new economics.

Here's what the SEC said was how investors made money at Forsage. The primary way for investors to make money from Forsage was to recruit others into the scheme. To participate, an investor created a crypto asset wallet and then purchased slots in Forsage's smart contracts.

which gave the investor the right to earn compensation from others whom the investor recruited into the scheme, the downlines, and compensation from the larger Versace community of investors, in the form of profit-sharing of payments known as spillovers.

When an investor purchased a slot, a portion of that investment was directed to the persons who recruited the investor, the uplines, and the investor in turn became an upline to whomever the investor recruited. It was all about recruitment. And if you recruited somebody and they got a crypto wallet and they plugged into the Versage smart contract, they put money in that wallet and that money went to the upline. Versage was very upfront about this.

this. On their website, they say Forsage's smart contracts never store participants' funds. Their balance is always zero. The money always goes away because it goes to the upline. The purpose of the smart contract, says Forsage, is to automatically redirect funds from incoming transactions to the wallets of other participants, according to the marketing program rules.

The SEC has filed a complaint against 11 individuals, some of which they haven't been able to find. They believe some are in Russia. There were several in the U.S. they were able to identify. The SEC suggests that some of these smart wallets as part of the Versailles network were controlled by the founders and they were taking some of the profits.

Here's the thing, though. They can't shut Versage down because it is a smart contract on the Ethereum blockchain and on several other blockchains. This can continue, and it'll be interesting to see if it will continue. They could force them to shut down the website, but because this Ponzi scheme, this pyramid scheme is fast,

set up on the blockchain as a smart contract, as far as I can see, it can't be shut down. Maybe it can. We'll see. This is different. Some people say, well, cryptocurrency in general is a Ponzi scheme. Bitcoin's not a Ponzi scheme because the returns are not focused on recruiting other people.

Your returns on Bitcoin is not dependent on other people losing their money, just giving you money. Bitcoin's a speculation. There's disagreement over what it's worth, but it's like any other currency. There's just disagreement, like gold. That's different from...

A Ponzi scheme, where all the returns come from taking money from other people. And it's not a pyramid scheme, where the focus is on recruitment. And most of the rewards come from recruiting other people that are buying product to get started so they can start recruiting other people.

It's not real clear-cut, the difference between direct selling or multi-level marketing and a pyramid scheme. To be a true multi-level marketer, you need a product, ideally a physical product, but it doesn't have to be. But there should be focus on selling the product.

Unlike Versage, where the focus is because it wasn't a product, just finding other people to give you money so you can get some of that money. Often with a legitimate multi-level marketing company, as well as a pyramid, you have to pay to sign up to be a distributor to get a starter package. But there should be some emphasis on selling the product and how good the product is to those outside of the network. In the case of Herbalife, 40% went to outside individuals.

Some of those sales will be internal. That's just the nature of multi-level marketing, but there should be some focus on outside. There will clearly be some emphasis on recruiting other people to sell the products, but that shouldn't be the main thing. Nor should the company overpromise in terms of the income, how much you have to buy, and how much time's recruiting other. And it's a fuzzy line. There are, I'm sure, pyramid schemes out there still operating.

that the FTC hasn't shut down or other regulatory bodies around the world. So be very, very careful with these companies because most participants are unsuccessful. And the part that bugs me the most about it, the people that I see get involved most often in these companies are people that are down and out. They're just looking for a way to get some income.

And then they go to their friends and you just feel bad. You feel bad for them. Try to be supportive in any way you can. We certainly have bought our share of product from multi-level marketing companies. But they oftentimes, they prey on the vulnerability, people that are just having financial struggles. And then these promises to be able to have your own business and quit your job, potentially become financially independent, it's captivating.

And be especially careful of Ponzi schemes. When there is an investment-related product, goes back to the principles that I teach on Money for the Rest of Us, teach in the book, is understand how you make money at the investment. How are returns generated?

What is it invested in? And if it seems too good to be true, it might be. I have certainly looked at a number of products over the years that just, no, this is not sustainable. They may not have been Ponzi schemes, but they were certainly understating the risk. And oftentimes they ended up closing or losing a massive amount of money. So whenever you invest, make sure you understand what the upside is, how the investment works,

What's the potential downside? And if there's any question about how that works or the integrity of whoever is selling it to you, because there are multi-level marketing companies involved in the investment arena that maybe they're not Ponzi companies, but they're being sold by people that don't really understand what it is.

It's one thing to peddle fruit juice as a cure, but investment-related Ponzi schemes, that has cost victims millions of dollars in some cases. That's our discussion on multi-level marketing, pyramid schemes, and Ponzi schemes and how to tell the difference. Thanks for listening.

I have enjoyed teaching about investing on this podcast for over eight years now, but I also love to write. There's a benefit to writing over podcasting, and that's why I write a weekly email newsletter called The Insider's Guide.

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