UPDATED 2008: USANA Health Sciences, Inc. (NASDAQ: USNA) announced today that a California State court has dismissed the distributor class action suit, Johnson v. USANA, filed in 2007 against the company and certain of its officers, distributors and directors. The Plaintiffs agreed to request that the court dismiss the case with prejudice after plaintiffs reviewed recent evidence and determined there was no longer any merit to maintaining a class action lawsuit.
One evening last May, about 450 people squeezed into a ballroom at Auckland’s Crowne Plaza hotel where a young woman was explaining how to achieve “true health and true wealth” by selling products from Usana Health Sciences, a US-based vitamin company with thousands of distributors in New Zealand.
“Close your eyes and think about your childhood dreams,” she said.
“Sing out your dreams.”
There was an awkward moment, but then people started calling out visions of racecars, airplanes, fancy homes.
The woman, a Usana distributor, started flipping through a series of PowerPoint diagrams and talking about how Usana’s unique compensation plan can help people achieve their dreams.
All you have to do to qualify for your own Usana business, she said, is buy an initial minimum amount of Usana business tools and health products, and then buy a certain quota of Usana products every month after that.
And that’s the catch.
According to Usana corporate documents, most of the company’s distributors don’t make enough commissions to recover the cost of their qualifying purchases from Usana. In fact, most of the company’s distributors don’t make any commissions at all.
This information was obviously crucial to the hundreds of people in the Crowne Plaza ballroom who were deciding whether or not to become Usana distributors.
But the woman addressing them didn’t mention it. Maybe she was not aware of it.
Nor did she mention any of the following facts:
--In the US, Usana is being investigated by both the FBI and the US Securities and Exchange Commission (SEC), which regulates companies listed on the US stock market.
--Usana shareholders have recently filed three class action lawsuits, claiming that the company “failed to disclose…material adverse facts” including that it “operated as a pyramid scheme.”
In the US, Usana blamed its financial setbacks on what it calls “a series of false and defamatory statements” against it.
If you’re thinking of joining Usana, they said, “your timing couldn’t be better.”
Until last autumn, Usana’s performance had been dazzling, with a market value of about $US1 billion, stock prices that had increased more than 1600 per cent in 18 quarters and sales in 14 countries including New Zealand.
With 50 per cent of the shares, Dr Myron Wentz, the company’s founder and CEO, was worth hundreds of millions of dollars.
Forbes picked Usana as one of America’s 200 Best Small Companies in 2004, 2005 and 2006.
Usana is a multilevel marketing company, or MLM, a rapidly expanding industry whose distributors work from home and make commissions based not only on their own sales but on sales by other distributors they recruit into the company.
Usana distributors follow a “binary compensation plan,” in which one person recruits two others, those two recruit four others, those four recruit eight others, and so on.
According to several recruiting presentations NBR attended in New Zealand, each new Usana distributor must buy a minimum of about $445 worth of the company’s business tools and health products, then continue to buy $290 worth of its health products every month thereafter in order to qualify for commissions.
Usana’s critics say these monthly qualifying purchases are the reason so many of its distributors fail to make a return on their investments.
But Usana Executive Vice President of Operations Fred Cooper said most of the company’s distributors don’t think of themselves as failing — they’re happy to get $290 a month worth of Usana products for their own use, whether or not they sell anything.
In fact, Mr Cooper said Usana’s research indicated that most of its distributors are “not interested in commissions.”
In New Zealand, however, Usana distributors seem to be very interested in making commissions.
“WORKING HARD WON’T MAKE YOU RICH,” say advertisements for recent Usana recruitment meetings in Tauranga and Wellington.
“Learn how you can fire your boss in the next 3-5 years…so you can live the lifestyle of your dreams.”
And though the ads promise to explain how to improve your health with Usana products, they also say you “really can use this knowledge to become wealthy.”
But according to government statistician Murray H Smith, very few Usana distributors are likely to become wealthy. In fact, he said, “you can make a very strong argument that this could be a pyramid scheme.”
Dr Smith’s opinion counts in these matters. He’s been an expert witness in every one of the Commerce Commission’s cases against pyramid schemes during the last 10 years.
NBR asked him to review Usana’s business structure and compensation plan, and— although he was careful to state that he was qualified to make only statistical judgments and not legal judgments—he said Usana showed some of the characteristics that commonly occur in pyramid schemes:
--At any given instant, most members will not have made enough money to recoup what they've paid to participate in the company;
--The people at the top of the company structure are more likely to make money than the people at the bottom of the structure; and
--As more people join the company over time it will become harder for the majority at the bottom of the company structure to recruit others. Those people tend to become discouraged and drop out.
What Dr Smith found is supported by Usana’s company documents, which show:
--87 per cent of commission-earning distributors did not make enough to recoup the cost of their monthly qualifying purchases;
--The company has a “significant turnover” in its distributors every year according to its 2006 SEC filings, and so it “must continually recruit” new distributors.
The bottom line, Dr Smith said, is that the vast majority of Usana distributors end up paying more to qualify for commissions than they actually make in commissions.
“Most people,” he said, “won’t get their money back.”
Usana’s Vice President Mr Cooper said that many of the distributors who fail or drop out simply haven’t worked hard enough. He also pointed out that all distributors get something for their money— a monthly shipment of Usana health products.
If they don’t like the products, he said, Usana has a generous return policy.
That may not help a lot of distributors whose businesses have failed, however. Since Usana urges distributors to take the vitamins they have to buy each month, they’re not likely to have any products to return.
As to whether Usana is a pyramid scheme, the company has forcefully denied any such suggestions in press releases in the US.
Although some of its shareholders— and in a recent court filing, some of its distributors— have accused Usana of being a pyramid scheme, no court or regulatory agency has yet taken a position or made a finding on the issue.
NBR cannot say whether the allegations that Usana is a pyramid scheme are true or not. What we can say is that, in the Usana recruitment meetings we observed, audience members were never told that these court cases and investigations existed, or that they might pose a threat to the company’s future.
Usana spokesman Joe Poulos brushed off the arguments about pyramid schemes, saying the concept doesn’t even apply to Usana.
“The company sells vitamins,” he said.
“In a pyramid scheme there’s no product.”
But that’s not true in New Zealand, according to Stuart Wallace of the Commerce Commission’s Fair Trading Branch. Mr Wallace has investigated numerous pyramid schemes—including companies that sold products, he said.
And he said New Zealand courts have shut those companies down and convicted their promoters.
Mr Wallace said New Zealand courts consider a number of factors in pyramid scheme cases.
But a “critical point” he said, “is whether [a company] is primarily a scheme to recruit other members or to sell products.”
He added, “To what degree are their products sold to real customers, retail customers?”
Usana does not keep records of retail sales. But according to its 2006 SEC filings, the company makes 86 per cent of its net sales to its own distributors and 14 per cent to what it calls “preferred customers,” who buy products at wholesale prices.
In New Zealand and Australia — which Usana reports as one market— Usana has three times as many distributors as preferred customers.
Mr Wallace said that he could not discuss Usana specifically. But he also said that in his experience, New Zealand courts had judged pyramid schemes not only by how they paid their participants, but also by whether they had misled participants about how much money they could make.
He also said that such schemes often attract recruits with claims about passive, or residual, income— income you don’t have to work for.
“The two things tend to go hand in glove,” he said.
“If you’re claiming you can make thousands while you’re out playing golf, then that is probably an unfair scheme.”
Many of Usana’s promotional materials seem to fit this description.
“I don’t even have to be there to earn it!” says the speaker on a Usana promotional CD that was handed out at a recent recruitment meeting in Wellington.
At some point in their presentations, most Usana speakers are careful to say they can’t promise anything, and that it takes time and work to build a successful Usana business.
But they also say that any distributor who follows Usana’s plan can benefit from “the magic of residual income.”
“If you understand this concept, you’ll make a fortune,” says the speaker on the Usana promotional CD.
“In one to five years you could retire with residual income of $50,000, $100,000, even $250,000 a year.”
You don’t even have to be alive to make money with Usana, according to one New Zealand-based website:
“Imagine receiving an income of $100,000 plus for the rest of your life…And when you die? Will it on to your children—what a legacy to leave them!”
Usana’s troubles began when the company came to the attention of Barry Minkow, a former conman who spent seven and a half years in prison for perpetrating a multi-million dollar fraud in the 1980s.
Since his release from prison in 1995, Minkow has worked with the FBI and SEC on numerous investigations, including the case of New Zealand’s biggest-ever fraudster, Derek Turner. (see article NBR July 7, “It takes a thief to catch a thief,”)
In late February, Minkow sent the FBI and the SEC a lengthy report claiming Usana was a pyramid scheme that cheated most of its distributors out of their money.
With a theatrical air, he also told the FBI, the SEC and several reporters that he’d bought “put” options on the company’s shares, so that he would make money if their price fell.
Usana shot back with a defamation lawsuit against Minkow, accusing him of driving down the company’s stock to enrich himself and others.
“What’s mindboggling to me is that Barry Minkow has admitted he’s short-selling the stock,” Mr Poulos said.
“You have this felon who’s credited as one of the biggest fraudsters of the last century… shorting the stock and going around saying negative and misleading things about the company.”
Minkow said Usana’s accusations are “a joke” because he hasn’t made a penny on his put options—he bought them too early. He said he doesn’t even have a paying client for the case because his client backed out.
Nevertheless, he has continued his efforts against Usana.
Soon after Usana filed suit against him, he made a series of videos on YouTube in which he interviewed several failed Usana distributors, including Steve Estes, a blind man who claimed to have lost his life savings to Usana.
“If I had known then what I know now,” Mr Estes said, “I would have run like the wind after the first Usana convention.”
Minkow also turned up some embarrassing facts about Usana’s executives, including Usana board member Denis Waitley who was falsely claiming to have a master’s degree, and Usana medical advisory board member Ladd McNamara who was falsely claiming to have a medical license after it had been revoked in two states.
Both subsequently stepped down from their positions at Usana.
Mr Poulos said both men made harmless mistakes that had not affected Usana’s operations.
“The most important point is that the company continues to grow sales year after year,” he said.
He suggested that Usana’s quarterly report, which is due on July 17 in the US, will confirm that.
He added, “New Zealand is a great market for Usana.”
Indeed, Usana’s operations in New Zealand keep humming along as if nothing was happening across the Pacific.
Usana’s recruitment speakers and promotional materials here still talk about Denis Waitley and Ladd McNamara as though they’d never left their positions at the company.
Hundreds of Kiwis show up every month to Usana recruitment meetings. And according to its latest SEC filing, the ranks of “active” Usana distributors in New Zealand and Australia are 18,000 and growing.
The company did not report numbers of “inactive” distributors— those who had quit making their qualifying purchases of Usana products.
As for the Commerce Commission, Mr Wallace said that it was not currently investigating Usana.
“But obviously,” he added, “if there was a ruling in the US one way or the other we would follow it with interest.”
Troubled Usana faces new stock woes, 20 July 2007
Forbes is Usana's latest critic, 2 August 2007
Usana defends practices, 10 August 2007
Auditor at troubled Usana quits, 16 August 2007
Usana appoints new auditor, 7 September 2007
How we reported our figures: --We started with Usana’s SEC filings including its most recent 10-K, 10-Q and its 2006 North American Average Earnings Chart.
--We spoke to Usana’s executive vice president of operations Fred Cooper, who confirmed that the North American Average Earnings Chart is accurate and that it applies in roughly the same way to Usana’s operations worldwide.
--Mr. Cooper also confirmed that 67 per cent of all distributors did not make any commissions—that’s why the Chart shows only 33 per cent participating.
--Mr. Cooper said that a fair portrayal of Usana’s business should deal only with the figures for commission-making distributors. So we followed his guidance and calculated the following figures using only the number of commission-making distributors.
--87 per cent of commission-earning Usana distributors don’t make enough money to recover the cost of their monthly qualifying purchases from the company
--72.2 per cent of all Usana’s commissions are earned by 7.7 per cent of commission-earning distributors.
--Mr. Cooper did not argue with these numbers, but he said that Usana believed most of the company’s distributors were “not interested in commissions” and were happy to get their monthly qualifying purchases of vitamins for their own use. We reported that in the story.
Usana's Initial Response to this article:
Joseph Poulos, spokesman for Usana Health Sciences, has sent the following response:
To clarify statements made in the story regarding the company’s earnings on July 17:
I informed you that the company would report earnings on July 17th, stating clearly that regardless of whether earnings would be positive or negative, it was a material company event that you should be aware of and might want to include in the article.
I never suggested that the quarterly earnings report would confirm that the company continues to grow sales year after year.
This statement is false. As a footnote to this whole conversation, USANA’s publicly announced guidance does in fact indicate continued financial growth in sales and earnings. Joseph Poulos Vice President Financial Communications & IR Edelman
To read a further response to the NBR article, go to:
Usana defends practices
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