Who do you trust? That’s an issue that often arises for the former CFO of Crazy Eddie, Sam Antar. He’s been writing extensively about the financial statement fraud at Overstock.com, and has been dismissed by some as a con artist with ulterior motives.  But Sam has been vindicated, as Overstock.com has announced another restatement of earnings, meaning the company has a full decade of inaccurate financial statements now on file with the SEC. (Thankfully, the officers and directors of Overstock.com don’t have to take any responsibility for repeated misstatements of the financials, and are still getting health bonuses!!!!)

I’ve learned that sometimes, it takes one to know one. When we analyze public companies, a guy like Sam sees something different than I do. I come from side of walking the straight and narrow and abiding by the laws. He comes from the side of the criminals, and he asks himself “how would I commit fraud at this company.”

One of my favorite topics on this blog is multi-level marketing companies (MLMs). Let me be clear: The laws in the United States protect these companies. They have a long history of projecting public images that make them look like legitimate business opportunities, in spite of the fact that almost everyone who gets involved loses money. In my opinion, they’re nothing more than glorified pyramid schemes, disguised by a “product” which everyone pretends is the focus of the opportunity. The truth is that recruiting people into an endless chain recruitment scheme is the real deal, and that my friends, is the pyramid.

So it is with great interest that I read the writings of Greg Caton, a multi-level marketing scammer. Admittedly, he’s still involved in some sketchy science with a product called Cansema, which purports to cure skin cancer.  He was sentenced to 33 months in prison and 3 years of supervised release for selling this product without FDA approval and for fraud in the marketing of it.  The guy still sells the product, however, as he ran off to Ecuador in 2008 to avoid regulation by U.S. authorities.

But lets set aside the facts about his products for a minute, and focus on the issue of selling products through a multi-level marketing system. Caton founded Consumer Express in 1984, and the company later became Nutrition For Life. It utilized MLM methods to “sell” the products and was apparently successful in doing so.

Caton published a book called MLM Fraud in 1990, and continues to speak out occasionally on the issue of fraud in multi-level marketing companies. Here he has written about why companies selling nutritional products via the MLM method are full of it. I submit to you that the fraud via multi-level marketing is not just limited to health products, but that is simply what Caton writes about because it’s what he is familiar with. But his arguments against MLM can be applied to virtually all MLMs, no matter what they’re selling.

Here’s a summary of why he believes that multi-level marketing (often called “network marketing” or “direct selling” in an effort to avoid association with the concept of pyramid schemes) sucks:

Myth 1: MLM Products Are A Competitive Alternative To Conventional Retail Marketing

MLM promoters go out of their way to tell you how expensive it is for companies to market through “traditional” outlets. They point out the “middlemen”, the advertising costs, and the chain of distribution. They claim that multi-level marketing companies eliminate all this by selling their product directly to distributors, who sell directly to end-users.

Sounds great, right? Except the MLM method is neither better nor cheaper. The MLM companies do have one distinct advantage in this regard: the people marketing their products can get away with a lot of improprieties that the companies themselves cannot. If the companies advertise their products, they have to be careful about claims they make. They have to be truthful! Independent distributors, on the other hand, run around largely unregulated. They can say whatever they want with little chance of them ever being taken to task for false claims, and the companies themselves can disavow knowledge of false claims and remind everyone that the distributors are “independent” and whatever they say is not sanctioned by the company.

But as for being a cheaper method of distribution? Not true. Caton explains:

The commission structures of the more successful MLM companies put them at a huge disadvantage to other forms of retailing. Example: at Alpha Omega Labs it is not uncommon for us to purchase a product from another manufacturer in quantity, paying the very same price that a large MLM company would pay, private-labelling it, and then marking it up just 50%. In other words, the product cost us $10 and we are retailing that product for just $15. That very same product will retail in the MLM pipeline for $70 to $100. It simply has to — MLM companies cannot survive on small markups.

When we have been approached by MLM companies in the past to purchase something that WE manufacture (about 50% of everything we sell is manufactured in-house), we are invaluably told upfront, “Now realize that your price has to be competitive enough for us to add our customary 5 to 10 times markup!”

Multi-level marketing companies simply do not make their money because they have an amazing product at a competitive price. They make money because they are recruiting people into the “business opportunity.” They wish for consumers to focus on the existence of the product, but all of the company’s activities are really focused on recruiting. Caton says:

What drives MLM is not the product or its price.

What drives MLM is the “business opportunity” — thus making the product a means to an end and not the end in itself.

MLM products are not a competitive alternative to conventional retail marketing for one very simple reason:

They don’t have to be.

Let’s look at another example — in terms of hour-for-hour entertainment value, are gaming devices at any of the thousands of casinos and other gambling establishments in North America competitive with even the most expensive Nintendo or Game Boy products that entertain youngsters? Of course not.

Some might not think this is a fair comparison, but the fact is, both MLM marketing programs and gambling establishments share an appeal for those who believe in “Something for nothing.”

The gambler who sits before a “one-armed bandit,” believing he has a reasonable chance of being the next big winner, is running off the very same motivation that drives an MLM distributor to work a downline in the hopes of soon retiring off the labor of those beneath him. Both are motivated by the dream of huge returns for comparatively small efforts expended. And both are working in the hope that these rare exceptions, and not the normal play of Universal or Natural Laws — will apply to them. And this is what defines MLM — it is a corporate-sponsored form of a lottery . . . (Okay, maybe that’s the best comparison . . . Lotteries have a higher “percentage payout” then most MLM companies — “percentage payout” defined as the total given out in winnings (commissions) divided by gross sales.)

Since when do lotteries have to be competitively priced?

Answer: They don’t.

Myth 2: My MLM Company has proprietary products not available elsewhere
It seems every multi-level marketing company is selling something special…. magical juice, face potions, weight-loss miracles, super-duper energy drinks, and cosmetics like no other. The guise of something unique or special is used as a tool to justify the high price of the products. As you’ve already seen, the overpriced nature of MLM products is a result of the need to pay out commissions to many levels (not that any of those levels other than the top one or two makes enough to actually make a living, but that’s a different article on a different day.)

I write quite a bit about Mary Kay Cosmetics. Their products are average, at best. Yes, some women happen to have extraordinary results with the products when no other products worked for them. That’s to be expected with any facial product… it’s going to work for some and not for others. But by and large, the products are of the quality you can find at Walgreens, Target, or Walmart. Yet the prices are closer to what you see in department stores with high-end brands. Why? Because of the commissions paid to multiple levels. The products are not priced based on quality, they’re priced based on what the company needs to bring in to pay the commissions.

So are MLM products “cutting edge” and special and magical and all-around different from what you find in retail stores? No. Caton says:

If you discovered an ingredient or other proprietary health product and you wanted to recoup your investment by maximizing the distribution possibilities would you: (1) Sell exclusively through an MLM company, or (2) Sell to both direct sales and conventional retailing channels — thus maximizing sales potential? Everyone knows the answer to that question. The “closed architecture” model for the distribution of proprietary products doesn’t work — or at the least can cause substantial loss of market share. (Can you spell “Apple Computer”?)

Whether it’s “Sea Silver,” or transfer factor, or specialized colloidal minerals, or “egg immune factors” — you name it — there are multiple sources of supply.

Excepting the fair use of trademarks, which provide distinction between the product of one maker versus those of his competitors, beware vendors who will tell you, “You can only get this from us.”

A company may well own a trademark, but rarely do they own the technology that produces a given product’s underlying functionality — and if they did, they certainly wouldn’t restrict themselves to the MLM market.

Myth 3:  The MLM Industry is highly regulated so they are usually truthful on product claims

This is a total joke. MLM is barely regulated at all. In fact, multi-level marketing companies have a little organization they call the Direct Selling Association.  They’ve mis-named it purposely, again trying to get the focus away from the recruiting aspect on which the companies rely. Direct selling? They really mean direct recruiting!

Then they promote their fake agenda: “Ethics. Trust. Confidence.” You can be assured that none of those three are really a concern of the MLM companies that are members of the DSA. This slogan is merely an attempt to fool readers into thinking the DSA is some sort of “industry watchdog” or consumer protection organization. It is neither.

The DSA exists solely to lobby lawmakers in Washington D.C. to ensure that laws are never enacted that restrict the activities of MLM companies. Remember the proposed Business Opportunity Rule from a few years back, which would have forced multi-level marketing companies to back up their income claims, provide data on distributors, and generally NOT engage in fraudulent practices? The DSA lobbied so hard against this rule that it is now permanently shelved. It’s in limbo, and unlikely to ever emerge from there. Mission accomplished by the DSA! Provide more information to the people you’re trying to recruit into your scheme? Never!!!!

The laws that do exist regarding pyramid schemes and business opportunity schemes are rarely enforced. And there are a bunch of attorneys out there just waiting for you to hire them so they can tell you how to get around any pesky laws that might affect your multi-level marketing scheme.

Regulation of MLMs is almost non-existent. Caton writes:

Even those on the inside at the various state Consumer Protection divisions will tell you that most MLM companies are hard to regulate or bring into compliance because they do not advertise their outrageous or false claims — but instead, let them propagate informally, via word of mouth, throughout their network. In addition, there are too many companies to regulate versus those assigned to enforcement.

As for self-policing, this is almost non-existent in the MLM industry, since industry “watch groups,” such as MLM Watchdog or MLM Watch exist as media for the publications’ principals to shill their own latest plans. (Another example of misdirection is MLM Fraud, an organization that has nothing to do with reforming the industry.)

Given its propensity for legal entanglements, few are surprised that the industry has, just within the last twenty years, given rise to attorneys specializing in defending MLM companies.

(Similar points on this issue are made in Vandruff’s piece: What’s Wrong With Multi-Level Marketing?)

So there you have it… the words of a scammer himself. A guy who was on the inside of multi-level marketing and knows the truth about their false claims.