Court shuts down energy drink network marketer Vemma over pyramid scheme allegation

By Hank Schultz

- Last updated on GMT

Court shuts down energy drink network marketer Vemma over pyramid scheme allegation

Related tags Network marketing Pyramid scheme Multi-level marketing

Vemma Nutrition, a multilevel marketing company that based its business on a line of mangosteen juice drinks, has been shut down by an Arizona court acting on a Federal Trade Commission request for allegedly operating an illegal pyramid scheme.

FTC said the Tempe, AZ-based company targeted college students and other young adults with the prospect of getting rich without the need of a 9-to-5 job. The commission said that Vemma had annual revenues in 2013 and 2014 that topped $200 million.

Focus on false income promises, not product sales

“Rather than focusing on selling products, Vemma uses false promises of high income potential to convince consumers to pay money to join their organization,”​ said Jessica Rich, director of the FTC’s Bureau of Consumer Protection. “We are also alleging that Vemma is an illegal pyramid scheme.”

The shutdown is temporary pending an appeal. Vemma’s CEO BK Boryenko said in a statement that the company has a hearing scheduled for Sept. 3.

The lynchpin of the complaint, and the lesson for other network marketing companies, is the focus Vemma allegedly put on new member recruitment without an emphasis on acquiring actual consumers, the end users of the company’s drinks.  The company promised monthly incomes as high as $50,000, while requiring new distributors to spend $400 to $500 on a so-called “Affiliate Pack” of products and business tools, and to buy an additional $150 worth of products each month to remain eligible for bonuses.  In a pyramid or Ponzi scheme, the primary determinant of the return a participant can expect is when they sign up.  A tiny proportion of early adopters can receive more than they put in, while everyone else loses money.

“They didn’t seem to have any consumers. If it is just distributors buying from the company then FTC could very well look at that as a pyramid scheme,” ​Ivan Wasserman, the managing partner of the Washington DC office of the law firm Manatt, Phelps & Phillips told NutraIngredients-USA.

This point has been driven home in a big way by the recent experience of Herbalife, the giant in the field of network marketing of nutritional products. Beginning several years ago, Herbalife has struggled with public criticisms on the part of activist investors that its business model amounts to a pyramid scheme. The company is also reportedly being investigated by FTC.

The company has fought back, and has responded with changes to it accounting procedures it says much more clearly break out sales to end users. It has also altered the way in which distributors qualify for higher bonus levels, a change the company said serves to de-emphasize the reward for merely signing up new members and to place the emphasis on building sales organizations to sell products to end users. Another network marketing company, Usana, also in 2013 made similar changes to its compensation structure that it said made it easier for distributors to earn bonuses.

Targeting at-risk populations

Another issue with Vemma’s business practices, and another lesson for other network marketers, was the company’s alleged focus on a particular segment of the population that could be construed as at risk, either from the impulsiveness of youth or the lack of financial sophistication. FTC says that the company has been targeting people in their late teens and early twenties, but at one time the company’s target audience skewed even younger. According to the watchdog group Truth in Advertising, after a series of complaints to FTC the company moved in 2013 to stop allowing 14- through 17-year-olds to sign up as distributors.  The watchdog group said despite the ban some in this age bracket were still signing up with the company.

Herbalife has been forced to deal with these type of allegations as well. Activist investor William Ackman, who has taken a huge short position in Herbalife stock, has alleged in the past that the company’s practice of encouraging its distributors to open “nutrition clubs”—rented retail space to house their businesses—was unfairly targeting Hispanic populations who might be less sophisticated in balancing business costs vs revenue and was leaving many of these distributors on the hook for retail leases on office space that was not generating sufficient cash flow. Herbalife has vociferously denied this charge, too, though to judge from recent earnings communications the company seems to have deemphasized the nutrition club concept.

History of regulatory issues

This is not Vemma’s first regulatory rodeo. In April, 2014, the The Italian Competition and Markets Authority, roughly analogous to the FTC, ruled that Vemma’s business model constituted an illegal pyramid scheme and fined the company €100,000 (approximately $140,000 US at the 2014 exchange rate) and ordered it to cease operating in Italy. At last report, Vemma was still operating in that country while the ruling was appealed.

Nor is it the first run-in for Boryenko.  According to Truth in Advertising, he entered into a settlement with FTC in 1999 over claims a previous company of his was making on a dietary supplement about its ability to treat or cure ADD and ADHD.

Wasserman said he does not see this as any sort of death knell for the network marketing approach for nutritional products.

“You can certainly do it right, if you follow the rules about disclosures and compensation. Ultimately you need to show people are using the products,”​ Wasserman said.

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