From High Energy Clubs to Dashed Dreams: Herbalife Tales
By: Joe Mariano, president of the Direct Selling Association, an industry trade group, said the difference between a pyramid scheme and legitimate multi-level marketing is fairly straightforward.
"The real key is compensation," he said. "If most of it comes from recruitment, you have a problem."
(Read More: How Multi-Level Marketers Dodged a Bullet.)
Nashville multi-level marketing attorney Kevin Thompson, however, says the regulations are "ambiguous" — and he blames the Federal Trade Commission.
Where's the Line?
The tricky part is how much recruiting-based compensation is too much.
"Distributors have to sell product to retail customers, and they can also recruit other participants, and earn commissions on that productivity," Thompson said. "Where the controversy comes into play is the balance. How much are you focused on retailing, how much are you focused on recruiting, and honestly ... we don't have an answer."
Regulators intentionally avoided creating a definition of pyramid scheme when they were drafting the recently revised Business Opportunity Rule, geared to work-at-home and other sales so-called "business opportunities."
In a report, the staff of the FTC wrote:
"The Commission reasoned that any definition of 'pyramid scheme' would provide bad actors with a road map for restructuring their businesses to skirt the definition, at least facially, and thereby provide them with a safe harbor that could undercut law enforcement efforts.
"Similarly, we believe that any definition of 'multi-level marketing opportunity' would allow fraudulent business opportunity sellers to manipulate their corporate structure to evade coverage by the Rule." (Click here to read the full report)
Historically, regulation of multi-level marketing has been the domain of FTC. But TJ Strategies says the Securities and Exchange Commission and the recently created Consumer Financial Protection Bureau could also show interest.
Notably, it says, the CFPB "has recently prioritized several investigations" in industries that have targeted "at-risk consumers."
It's the FTC that has the most authority. But, according to critics, it has shown the least amount of teeth for going after large multi-level marketers, especially over the past decade.
One reason, according to David Vladeck, who until recently was director of the agency's Bureau of Consumer Protection, is that there are few complaints.
"When we get consumers who are willing to tell that story, and the sufficient number of them who are willing to stand up and be counted, then we can do something about it," he said.
Trouble is, many tell us they were simply embarrassed to step forward, instead blaming themselves — people like Nicole Lopez and Sharon Shea, former Herbalife distributors.
Lopez started selling Herbalife in 2005 after inquiring about it on the Internet.
Shea, who had used Herbalife products decades ago to lose weight, thought she would try again after her husband died. She said she was swiftly recruited with high pressure sales tactics in 2010.
Shea said she spent $3,000 she didn't have to become a "supervisor." She didn't have a credit card, so she put the amount on her debit card. Lopez, who was also convinced to sign up early on as a supervisor, also paid with her debit card.
Lopez said she told recruiters that she didn't know much about business and was told not to worry — Herbalife uses a "proven" plan that anybody can use to become successful. And she believed it. Shea said she was told that she could use the Internet to sell and recruit.
But both realized this involved buying sales leads. Lopez said she spent $1,000 for 10 leads until she quit seven months later, leaving her $10,000 in the hole.
Shea lost $15,000 after just a few months.
"My whole goal and my whole purpose wasn't to become amazingly wealthy, to become rich, to never have to worry about working again," she said. "It was just to be able to bring in and help my family survive."
After CNBC contacted Herbalife detailing what happened to Shea and Lopez, Herbalife reimbursed them for some of their losses, blaming their failures on "bad mentoring."
"We don't feel good about what happened to them," Johnson said during the interview with CNBC. "Nobody would. Their opportunity was not realized."
While that may take away some of the sting, the wounds were still evident when CNBC visited with Lopez last summer.
"What they're doing is preying off poor and middle class families," she said. "I gave $10,000 of my money, and I see them on their videos portraying to be, you know, this wonderful company who's saving and helping lives. And that's not the case. All the people down-line for them are paying for their lifestyle. And to me, that's fraudulent."
—By CNBC's Herb Greenberg; Follow him on Twitter @herbgreenberg and Google
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