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Former San Diegan Herb Greenberg, a senior stocks correspondent for the business news channel CNBC, last year spent ten months investigating multilevel marketing, the controversial strategy by which salespeople are not only paid for the products they peddle but also for goods sold by other people that they recruited into the web.

Multilevel marketing is often called “pyramid marketing” because if the salespeople make more money recruiting other salespeople than they do selling products, then the government may consider the enterprise a pyramid.

Greenberg did several TV reports on the topic, and that proved timely. In December, Bill Ackman, who runs a big hedge fund, bet $1 billion that the stock of Herbalife, a multilevel marketer selling mainly weight-loss products, would go down. In Wall Street parlance, that’s going short. In a highly detailed study, Ackman said Herbalife is a pyramid scheme. But then another hedge fund speculator, Dan Loeb (joined by corporate raider Carl Icahn), tried to thwart Ackman by buying Herbalife stock. That’s going long. On January 25, Icahn and Ackman had a profanity-laced TV shouting match that riveted traders’ attention.

Now, the Herbalife story is essentially a poker game among Wall Street longs (Loeb, Icahn, et al.) and shorts (Ackman). But more is at stake: the Wall Street Journal says that the Securities and Exchange Commission is looking into the Herbalife imbroglio. The Federal Trade Commission is essentially obligated to study Ackman’s evidence. Is Herbalife a pyramid? A Brussels court ruled in 2011 that Herbalife is an illegal pyramid.

If that’s true in the United States, does the government have the guts to close down a company that has 3.2 million salespeople in 87 countries? The company’s sales are largely in foreign countries: South and Central America, 16 percent; Mexico, 12.7 percent; and North America, only 20.2 percent. Herbalife told Greenberg that the Latin market accounts for 63.7 percent of business.

Founder Michael Ellis went to prison following the Metabolife debacle.

In several CNBC shows, Greenberg interviewed economically pinched people who had listened to the Herbalife get-rich-quick pitch, plunked down money, then lost a bundle. Greenberg interviewed an expert in multilevel marketing who says that most participants lose money and the annual turnover rate exceeds 90 percent. Greenberg summed up, “Multi-level marketing, which has been dogged by the same legal questions and controversies for 65 years, needs to be cleaned up.”

Indeed, Greenberg believes that congressional staffers, looking for the next financial scandal, “are likely to see multi-level marketing as red meat in predatory business practices.”

If there is such a probe, San Diego should be a target. That’s because San Diego isn’t just a haven for telemarketing, hard money lending, penny stock, and Ponzi schemes. It’s also a multilevel marketing trap: through the years, San Diegans by the thousands have plunged into multilevel marketing scams — many homegrown — and been wiped out.

The most infamous local one was Metabolife, which peddled an ephedra-based diet supplement. Metabolife was not, however, a pyramid scheme, because people actually bought the stuff — tragically. Some experienced serious side effects, such as strokes, and some died. A founder, Michael Ellis, went to prison for lying to the Food and Drug Administration about those adverse effects. The company went bankrupt in 2005.

Barry Minkow criticized, then took hush money from, multi-level marketers.

Herb Greenberg spent 10 months investigating multi-level marketing.

Ackman is not the first short-seller to attack Herbalife. Back in 2008, a San Diego self-professed man of God (now in a high security prison) attacked Herbalife with the intention of driving its stock down. He is Barry Minkow. His charge was similar to Ackman’s: the company is a pyramid because it makes its money recruiting salespeople; product sales are not so important. Minkow compared Herbalife to Usana, another multilevel marketing organization. Both had something in common: entanglements with offshore tax havens. (Herbalife’s filings with the Securities and Exchange Commission list its main office in the tax and secrecy haven of the Cayman Islands, although it primarily operates out of Los Angeles.)

Minkow’s Fraud Discovery Institute made money on its short position. The business press picked up the story, as did the Reader. Minkow’s research was almost always thorough. That’s why government agencies would take information from him and invite him to speak before employees.

Minkow could spot a scam because he had pulled an amazing one — San Fernando Valley–based ZZZZ Best, whose sales, it turned out, were 90 percent fraudulent. He was sentenced to 25 years in prison but found religion and was sprung in 7 years. He became senior pastor of the Community Bible Church in Mira Mesa, splitting his time between saving souls and chasing crooks.

But he got in trouble when he took on the big builder Lennar. He denounced the company as “a financial crime in progress.” The stock plunged. Once again, Minkow cleaned up on his short position. Lennar sued. A judge found Minkow had repeatedly lied under oath and concealed evidence and witnesses. Criminal authorities investigated. Eventually, Minkow admitted that he had used nonpublic information to drive down Lennar stock. He pleaded guilty to conspiracy to commit securities fraud. Admitting he was unworthy to be a pastor, he resigned from the Community Bible Church and was sentenced to prison. He is now in the Federal Medical Center in Lexington, Kentucky, and is due to be released January 28, 2016. The facility is known for treatment of addicts; Minkow admitted to Fortune magazine that he became addicted to OxyContin.

Digging through documents, Greenberg found that, after Minkow leveled his charges, “Herbalife paid Minkow $300,000 to shut up.” Good sources also believe that Minkow got paid off by Usana and Nu Skin, another multilevel marketer.

Did Community Bible Church get a piece of those alleged payoffs? The church isn’t talking. Minkow admitted to Fortune that he commingled the church’s funds with his own. However, he claims he was the church’s biggest donor, so members came out ahead. Some parishioners lost bundles helping to finance an autobiographical film he was making, and a former church member took Minkow to court. A judge has ordered him to pay Lennar $584 million. Amen. ■

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Comments

Visduh Feb. 7, 2013 @ 4:37 p.m.

Many, but not all, of the multilevel marketing schemes don't last long. After filling the channel of distribution with a product that is wildly overpriced or actually worthless, the small time players cannot sell the amount of product they have, don't reorder, and stop making any attempt to move the stuff, and the pyramid collapses. It is these operations like Herbalife that apparently do continue to sell their product(s) that amaze. Are those things actually effective, do they deliver what they promise, and do users actually recommend them to others? If a product is actually that good, the developers don't need to go to all that trouble to sell the stuff, and don't need that pyramid of middlemen. They could sell the stuff through conventional channels that are far more efficient.

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Don Bauder Feb. 7, 2013 @ 5:14 p.m.

Visduh: Many multi-level marketing companies last a long time -- Amway, Herbalife, Usana, etc. Amway has admitted in the past that payments by its salespeople are important in the company's financial stability. Let me ask you a question: have you ever washed your hands with a bar of Amway soap? I haven't. Have you ever used an Amway product? To my knowledge, I haven't. But I have talked with several people who had their garages full of Amway products. Best, Don Bauder

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nokomisjeff Feb. 8, 2013 @ 8:05 a.m.

Amway's expensive, but there are a few of their products I repeatedly buy because of the high quality. My Amway rep has repeatedly tried to recruit me, but there's no way I'd volunteer to take a pay cut compared to what I do.

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Don Bauder Feb. 8, 2013 @ 9:10 a.m.

Jeff: I can't see someone with your knowledge of markets and macroeconomics selling Amway products. You are wise to refuse to be recruited. Best, Don Bauder

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Visduh Feb. 8, 2013 @ 8:34 p.m.

You have made a testimonial for Amway that was not solicited. That's amazing! Would you care to share the names of those products with those of us who bother to read these blogs and comments? If there are really some superior Amway products, we're the kind of folks who would buy them.

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Don Bauder Feb. 9, 2013 @ 7:36 a.m.

Visduh: Even if I thought a product were better than a competing one, I would resist buying from a multi-level-marketing operation. Similarly, I refuse to buy anything at Walmart because I don't want to perpetuate anti-social business activity. Best, Don Bauder

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nokomisjeff Feb. 11, 2013 @ 2 p.m.

Visduh, here is one Amyway product that is best of breed. http://www.amway.com/Shop/Product/Product.aspx?itemno=107858 And Don, here's a good example of Wal-Mart's anti-social business activity(which I really don't understand, as if low prices, profits, and competition are anti-social).http://nhregister.com/articles/2013/02/09/news/doc5116b955dbcb4370260573.txt

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Don Bauder Feb. 23, 2013 @ 3:03 p.m.

Jeff: Yes, Wal-Mart has low prices. What do you expect? Wal-Mart is China's goods distributor in the U.S. Wal-Mart pays extremely low wages to its employees. The company tells these disgracefully low-paid employees how to take advantage of government-supported entitlements, such as food stamps and Medicaid. So, when you think you have gotten goods at a low price at Wal-Mart, think again: you as a taxpayer are also paying for the government subsidies that employees need to survive. So those prices aren't so low after all. Best, Don Bauder

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Twister March 5, 2013 @ 9:50 a.m.

Didn't Amway get started selling alfalfa capsules? I won't visit the links, because I don't want ANY kind of connection with those flim-flammin' crooks.

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Don Bauder March 6, 2013 @ 7:13 a.m.

Twister: I don't know about that history. My guess is you can find it on Wikipedia. Best, Don Bauder

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dwbat Feb. 8, 2013 @ 8:52 a.m.

Minkow and his ZZZZ Best company were involved with organized crime, too.

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Don Bauder Feb. 8, 2013 @ 9:17 a.m.

dwbat: Yes, Minkow borrowed money from an LA entrepreneur with ties to organized crime. The LA fellow sued when he didn't get his money back. Much later, Minkow claimed he was forced to run ZZZZ Best as a Ponzi scheme because of pressure from gangsters. He later recanted that. Best, Don Bauder

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dwbat Feb. 11, 2013 @ 4:17 p.m.

Well, by recanting he probably saved his life (or least avoided a broken leg or two).

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Don Bauder Feb. 23, 2013 @ 3:05 p.m.

dwbat: Another possibility is that he may not have been telling the truth when he recanted. Best, Don Bauder

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