Pyramid scheme alleged
Federal regulators close down a Raleigh company with 150,000 sales representatives, charging that most of its revenue comes from recruiting new salespeople.
By DAVID RANII and HUE Q. HA, Staff Writers
RALEIGH -- The Securities and Exchange Commission has shut down International Heritage Inc., which it says has defrauded investors nationwide through "a massive, ongoing pyramid scheme" that generated more than $150 million in revenue.
SEC enforcement director William McLucas called the case one of the largest pyramid schemes -- in terms of the money involved -- ever encountered by the agency.
A court-appointed receiver took control of the business after arriving at the company's Raleigh headquarters late Monday with a U.S. marshal, armed with a temporary restraining order issued by U.S. District Judge Richard Story in Atlanta.
"Right now, the receiver controls International Heritage," SEC spokesman Jay Perlman said.
The commission's complaint accuses IHI and its founders -- company president Stanley Van Etten of Raleigh, Claude W. Savage of Charlotte and Larry G. Smith of Greenville, S.C. -- of three civil counts of fraud, filing false reports and illegal sale of unregistered securities. The agency is seeking unspecified fines and the return of "all ill-gotten gains."
International Heritage spokesman Marks Carlton Lane said the company isn't breaking the law and expects to prevail in court.
"I guess we're caught in the cross hairs of regulatory authorities again," Lane said. "It is a fight we fight well and will continue as long as it takes." He called the SEC action a blow to the company's 200 employees, all in Raleigh.
The SEC action was foreshadowed Friday when, after the company's stock soared and more than 1 million shares changed hands in a day and a half, the agency suspended trading for 10 business days. The suspension order cited concerns about returns promised to investors and "the regulatory background of the company and the background of its president."
International Heritage, established two years ago, portrays itself as a company that sells jewelry the way Amway sells detergent. But an SEC complaint filed Monday characterizes the sales operation as a front for a pyramid scheme.
The complaint alleges that the company's 150,000 independent sales representatives are really investors because they generally pay $250 up front for the right to operate a "business center" and to recruit other sales reps. Each representative can operate up to seven business centers at $250 apiece.
"Although investors can nominally earn income by selling products, the sales pitch clearly implies that the significant income will come from enrolling new members, who will in turn enroll new members, in a typical pyramid arrangement," the complaint says. "The vast majority of revenues to IHI, and the significant compensation to investors, comes from signing up new members.
"As in all pyramid schemes, the defendants do not disclose that at some point, the market becomes saturated, the supply of new members runs out, and the newest investors are unable to generate returns."
The company posted $107 million in revenue last year, more than double its 1996 revenue of $47.7 million, although it lost money both years.
In June, International Heritage agreed to alter its sales practices in North Carolina after the Attorney General's Office claimed it was violating the state's anti-pyramid law. A consent agreement, signed after the state threatened to shut down the company, generated refunds totaling $1 million to sales representatives who filed complaints against the company.
Also last year, a Wake County Superior Court jury found Van Etten, 35, the IHI president, not liable in a securities fraud case. He had been sued by investors over his activities at F.N. Wolf & Co., a national brokerage firm that was shut down in 1994 amid stock fraud allegations by the SEC and others. Van Etten, who was regional vice president in Wolf's Raleigh office from 1988 to 1993, said he was a whistle-blower who helped regulators build a case against Wolf.
The consent agreement negotiated by the Attorney General's Office applied only to International Heritage's business in North Carolina. It required IHI to make sure that at least 70 percent of product sales -- jewelry, golf equipment, collectibles, long-distance phone service and much more -- were to customers outside its sales network. The company didn't change its practices in other states.
IHI's operations in North Carolina have been "clean" since the consent decree was negotiated, Attorney General Mike Easley said at a news briefing Tuesday. "Since June 3, people have been protected in North Carolina," Easley said. "The bottom line is that [the SEC is] doing now what this office did nine months ago. It came to our attention first because this is where they are. This is their home office."
International Heritage operates out of two locations in Raleigh: its headquarters on the fifth floor of a Glenwood Avenue office building and an office on Spring Forest Road. Both offices were closed Tuesday, and the locks had been changed.
Lloyd Whitaker, an Atlanta lawyer who was appointed receiver of the company, worked at the Glenwood Avenue headquarters Tuesday. He declined to comment, but International Heritage said in a news release that employees were advised by "SEC representatives" to report to work today.
Lane, the IHI spokesman, said that 20 to 30 company employees were working under Whitaker's direction at the headquarters Tuesday, about half the usual complement at that office.
Late Tuesday, Judge Story said he would rule today on IHI's request that he modify his restraining order, according to SEC lawyer William P. Hicks.
IHI sales representatives who were contacted Tuesday were undaunted by the SEC's action.
International Heritage is "absolutely not" a pyramid scheme, said David Williams, a part-time sales rep and full-time postmaster in Climax, a small town in Guilford County south of Greensboro. "Nobody makes any money unless products are sold."
The court order "doesn't concern me too much," said David Shaw, a sales representative in Winston-Salem.
Shaw added that he has become used to IHI being criticized by the media and regulators. "This company got hammered in the press last year," he said.
International Heritage didn't take the traditional route in transforming itself from a private to a publicly traded company. The usual way is through an IPO -- an initial public offering of common stock. The stock is then bought by investors and traded.
Instead, IHI recently negotiated a merger with Kara International, a Nevada company with publicly traded stock but with no significant assets or operations. The merger put IHI on the radar screen of the SEC, whose mandate is to protect investors in publicly traded companies.
While the company held a convention of 12,500 sales representatives in New Orleans, IHI shares were selling at $26.50 apiece Friday -- giving the company a market value of nearly $1 billion -- when the SEC suspended trading. At the beginning of last week, IHI had been trading at $13 a share.
The SEC complaint said that IHI's sales kit, written by Van Etten and his father, "explicitly discourages recruiting persons with experience in retail sales, because such persons might actually try to sell the products, and neglect their more important function, to bring in new members."
The SEC also alleges that the sales materials failed to disclose sufficient information about the backgrounds of IHI's founders or that the company had limited its activities in Florida and Georgia after regulatory inquiries.
"The IHI materials describe Van Etten's career, including 13-plus years as an 'investment banker,' " the complaint states. "The materials fail to disclose a past IRS lien on Van Etten's residence and his personal bankruptcy in 1990. The IHI materials also fail to disclose that Savage and Smith were involved in a prior failed multilevel marketing scheme."
Multilevel marketing firms, or network marketing firms, are companies -- legitimate or illegitimate -- whose sales representatives reap benefits from recruiting others.