Multi-Level Marketing Stocks: Forgotten in the ESG Conversation

It has become commonplace to see the letters “ESG” in investor letters, annual reports, and analyst coverage. Perhaps no other trend has been more pervasive in business and finance in recent times than the heightened awareness around social responsibility. Often measured through the lenses of environmental, social and governance (ESG) factors, the aim is to assess how well companies or investors consider ethical responsibilities in their pursuits of success. Investor sentiment has increasingly shifted from purely profit-driven to seeking out investments that will also contribute positively to society – or at minimum, do no harm. This change has prompted companies to rethink their investments and business practices as well as given rise to a new sector of ESG investing, which has already accumulated tens of trillions of dollars in assets under management.

ESG-focused investors and funds can take two approaches to achieve their goals: actively invest in socially responsible companies and industries or avoid stocks and sectors that have been labeled harmful or unethical. The latter strategy has mainly targeted so-called “sin stocks,” which do business in industries with questionable benefits to society, such as tobacco, firearms or gambling. One industry that has been very heavily targeted by ESG-conscious-investing is energy, particularly oil and gas. As climate change becomes a more prominent and mainstream issue, investors are understandably shying away from fossil fuels. While investment is shifting away from these controversial sectors, one has managed to keep itself out of the crosshairs of socially responsible investing: multi-level marketing (MLM) companies.

Although largely past their prime, numerous MLM companies remain publicly traded. Their business models, often referred to as “direct-selling,” involve selling a product to individual distributors who hope to sell it to others to make a profit. However, these distributors are not technically employees of the company. The MLM company cashes out as soon as the distributor buys the product. These distributors are also incentivized to recruit others to sell the product as they often get a portion of these revenues as well. In many cases, the more lucrative opportunity lies in recruiting more distributors rather than actually selling the product to customers, which has led to the comparison of MLMs with pyramid schemes. This business model allows MLM companies to operate in a very lean manner with few listed corporate employees, while their independent distributors compound their revenues by bringing in more sellers who will also purchase the product. Often marketed as a way for people to make extra money on the side or “be their own boss,” many see MLMs as an attractive financial opportunity.

This business model is also one of the key factors that have made MLM companies attractive to investors. Looking for ways to hedge their bets against downside risk, MLM companies have been cited as being recession resistant, since they see an uptick in activity when people are looking for work. In fact, many publicly listed MLM companies have seen significant increases in their stock prices since the COVID-19 induced dip in the markets, as those who have lost work seek ways to earn extra cash. Unfortunately, people who turn to these companies as a way to make ends meet usually end up achieving the opposite. An FTC report found that up to 99% of people who engaged in MLMs actually ended up losing money. The very reason that MLMs are attractive to investors is almost cynical in nature, they are able to capitalize on sales from people who are already struggling. Obviously not all MLMs are the same, and there are those who have profited as distributors. However, as a whole, the overarching business model of MLMs is dubious. Their profits are sourced from distributors who are incentivized to continually recruit more people into the business, rather than selling a quality product to happily paying customers.

The laws around MLM companies are vague and difficult to enforce. While outright pyramid schemes, which these companies are sometimes compared to, are banned, regulators seem to have difficulty labelling MLM businesses as pyramid schemes. One of the largest of these companies, Herbalife, has managed to stay alive despite an FTC settlement and significant public scrutiny following a critical segment on Last Week Tonight with John Oliver and a 2016 documentary, Betting on Zero, dedicated to exposing its exploitative practices. The latter depicted famed investor Bill Ackman’s billion dollar short position against Herbalife, stating he believed “[The company’s] intrinsic value is zero.” While Herbalife prevailed and Ackman dropped his bet, succumbing to despair, the tables could have turned the other way if there had been more ESG awareness and investor scrutiny. Evidently, regulation has been ineffective, especially as MLM companies prey on the vulnerable, including minority communities and women, who seek a path to entrepreneurship.

While ESG investor sentiment and MLM companies have yet to collide, it seems to be a grand opportunity for responsible investors to put their money where their mouth is and drop investments in these companies that actively harm communities. One thing is for sure: MLM stocks should be placed under ESG scrutiny. From a socially responsible perspective, these companies fail the test, and the fact that they shine bright in recessions only further proves the predatory nature of their practices. If regulators cannot find a way to crack down on MLMs, investors can.