On Dec. 19, 2012, activist investor William Ackman publicly confirmed that he was “betting” against the stock of Herbalife because “the company operates like a pyramid scheme.” Ackman claimed in a 334-slide, three-hour presentation, “Herbalife is a pyramid scheme because, among other reasons, distributors earn more than 10 times as much from recruitment as they do by selling the company’s overpriced products to bona fide retail customers.” During his presentation, Ackman disclosed that he had an “enormous” short position in Herbalife’s stock, betting that shares in the company would fall.
“Here is an investor that’s not just taking a financial stake,” said Jim Conversano, CFE, CFA, Principal at Berkeley Research Group, LCC. “He’s announcing it to the world.”
Were Ackman’s claims correct? Conversano discussed the investor’s qualms about Herbalife, one of the world’s largest multi-level marketing companies, in his breakout session, “The War Against Herbalife: Pyramid Scheme or Multi-level Marketing Master?”
Conversano started the session by giving attendees a brief overview of the difference between Ponzi and pyramid schemes. In short, investors in Ponzi schemes expect to earn a return from profitable investments. Participants in illegal pyramid schemes expect to earn profits from recruiting new members.
Multi-level marketing companies, on the other hand, are legal companies that sell legitimate products and services, use pyramid-like sales and distribution structures, and participants earn commission for products or services they and the distributors in their “downline” sell to others. Your downline consists of the participants you recruit and their recruits.
So where does Herbalife fit into this equation? Herbalife is a global nutrition company founded in 1980 that develops and sells weight management, healthy meals and snacks, sports and fitness, energy and targeted nutritional products as well as personal care products. Members can earn profits by purchasing Herbalife products at (discounted) wholesale prices and reselling those products, and earning commissions and bonuses by establishing and maintaining their own sales organizations (i.e. sponsoring other members).
“Herbalife does require its participants to invest in a start-up fee,” said Conversano. “This is very widely out there, it’s not a secret fee. That’s what this investor [Ackman] had a problem with.”
According to Conversano, cases against Herbalife’s business structure, including Ackman’s, have brought into question the legal nature of their operations. In March 1985, Herbalife was sued by the California Attorney General and two other California regulators, alleging that the company made false claims about its diet products and employed an “illegal endless chain” to market them.
In October 1986, Herbalife announced that it agreed to pay $850,000 to settle the suit brought by the California regulators, but they admitted no wrongdoing in the settlement.
Most recently, on March 11, 2014, Pershing Square Capital Management, L.P. argued that Herbalife is violating China's direct-selling law by paying multi-level royalties based upon unlimited downline levels, and paying royalties and commissions totaling more than 30 percent of sales volume, among other accusations.
Despite all accusations, Herbalife vehemently defends its business practices and hasn’t yet been convicted of any wrongdoing. Opinions in the session were varied and active debate ensued. Conversano explained that while Herbalife doesn’t technically present itself as a pyramid scheme, it can’t be denied that there are red flags that should be considered.
So he left it up to us. Could Herbalife really be a decades-long fraud, similar to Madoff? What do you think?