企業法務

Too Big To Fail, Too Big To Be A Pyramid Scheme?

In 2012, Bill Ackman, founder and CEO of U.S. hedge fund, Pershing Square, made a US$1 billion trade “against” Herbalife, a global multi-level marketing (“MLM”) company, listed on the New York Stock Exchange, by “shorting” its shares. 

He also alleged that Herbalife’s market practices effectively made it a global pyramid scheme, where distributors were misled by illusions of great returns, but where the reality was a product that would not sell on the open market and distributors who regularly lost money.

Herbalife’s response was to restate the fact that they offered healthy products and an opportunity to “change one’s life” by becoming a distributor.

Herbalife’s “distribution” structure had already attracted investigation by many entities, most recently by the U.S. Federal Trade Commission (“FTC”). That resulted in a 2016 settlement, with Herbalife being fined US$200 million and agreeing to change its business model.

After the “short” on Herbalife, several other investors, notably Carl Icahn went “long” on Herbalife stock, attacking Ackman’s short position, showing that Herbalife had much support, not only from its investors, but also self-servingly from its own distributors.

MLMs tend to do well where there are minority communities, with people within a community selling to each other and trying to recruit each other.

It seems that in an MLM structure, it is only the top-level that gets huge profits, and such a structure disturbs “normal” economic order and affects social stability. This is the rationale from the Chinese government as to why MLMs were banned in China, in 2005.

The visible enforcement of this prohibition in China is shown by the fact that only recently have there been large-scale coordinated raids by Chinese police and local government officials, where over 1200 people have been arrested on suspicion of having links to a pyramid scheme in southern China, involving over US$50 million.

In Hong Kong, MLMs do legally exist and conduct business, but consumer protection comes from the Pyramid Schemes Prohibition Ordinance (Cap. 617) (the “Ordinance”). The Ordinance provides a legal definition of a “pyramid scheme”, such a scheme requiring the following characteristics:

i) New participants must make a payment to existing participants or promoters of the scheme;
ii) New participants are being represented regarding the prospects of receiving payment once they join the scheme (the “recruitment payment”); and
iii) The “recruitment payment”, as its name suggests, is entirely or substantially derived from the new participants finding further new participants to join the scheme.

Typically, the practical difficulty will be in deciding whether a “legitimate” MLM actually has “pyramid” scheme elements.

Section 5(2)(a) of the Ordinance provides the offence of “participating” in a pyramid scheme, so the risk is to identify whether each MLM business model is actually legitimate.

In various common law jurisdictions, there have been investigations and prosecutions for involvement in pyramid schemes, but as yet no one has targeted any listed MLM claiming that it is a pyramid scheme, although self-servingly people who lose money in those MLMs often make such claims.

Caution needs to be exercised when making any investment, and when deciding to participate in any marketing scheme.