The FTC has opened an investigation into Herbalife [Update]

The FTC has opened an investigation into Herbalife [Update]

Dan McCrum

| Mar 12 17:31 | Comment | Share

Part of the LIVING THE HERBALIFE SERIES

After we got in touch with the company to tell them we were writing this story, they halted trading and put out a statement confirming the investigation.

The Federal Trade Commission has opened a formal investigation into Herbalife, the multi-level marketing company that hedge fund manager Bill Ackman has called a pyramid scheme, according to people familiar with the situation.

The probe comes after a year of intense scrutiny of the Los Angeles based group, which sells nutritional shakes and supplements through and to a network of millions of independent distributors in more than 80 countries worldwide.

Herbalife said:

Herbalife welcomes the inquiry given the tremendous amount of misinformation in the marketplace, and will cooperate fully with the FTC. We are confident that Herbalife is in compliance with all applicable laws and regulations. Herbalife is a financially strong and successful company, having created meaningful value for shareholders, significant opportunities for distributors and positively impacted the live and health of its consumers for over 34 years.

Since Mr Ackman first aired his allegations in December 2012 and called on the FTC to investigate, that call has been echoed by consumer groups, a congressperson, a senator, and even an analyst supportive of the company who wished to clear the air.

The FTC declined to comment. It does not disclose whether or not it is investigating a company until that process is complete, although it might be able to do so if a majority of its five commissioners agreed to a public statement.

In a recent letter responding to questions about Herbalife from Senator Edward J Markey of Massachusetts, FTC Chairwoman Edith Ramirez said:

With respect to the allegations against Herbalife, Ltd, a number of statutory provisions and the Commission Rules of Practice prevent me from discussing what action, if any, the Commission may take in a particular situation. I can assure you however that the information you provided and the concerns you expressed are being carefully considered.

The Securities and Exchange Commission has also looked at Herbalife, exchangingletters with company about the quality of its disclosure in 2012. Since Mr Ackman accused Herbalife of being a pyramid scheme, shares in the company have traded as low as $27, but recovered to a high of more than $80 in January, as investors have debated the likelihood of any regulatory action.

North America represented less than a fifth of Herbalife sales in 2013, however its management and most senior distributors are based in the US.

A pyramid scheme is a business where the majority of profits within the system accrue from recruitment, rather than genuine sales of a product to consumers. Like a ponzi scheme, a pyramid requires a steady stream of new recruits, almost of all of whom will lose money.

According to people familiar with the FTC, the process of investigating potential pyramid scheme behaviour typically takes 12 to 18 months.

The process begins with a review of the company’s commission and compensation structure, to see if it has an inherent bias towards recruitment. For instance, commissions paid based on sales by people many layers below you in the network. A requirement to make minimum monthly purchases to receive those commission payments may also be problematic.

The FTC will then look at what safeguards are in place to protect recruits. If the company makes use of common industry safeguards known as an “Amway type plan”, the FTC will then look for evidence that these safeguards are enforced and that the company makes substantial sales to customers outside its network of distributors. The Commission has extensive powers to demand a company under investigation hand over data about its sales and the structure of its network.

Investigators may also look at the behaviour of individuals throughout the network of independent salespeople, known in the jargon as “distributors”, for instance if there is evidence of false claims for the income to be made from any business opportunity.

The FTC is a civil agency, and may bring civil claims only. It may also work in conjunction with prosecutors at the federal and state levels if it deems criminal fraud charges appropriate. The investigation into Herbalife is at an early stage and may not lead to any action.

[Update: the FTC has since confirmed the investigation, now that it is public, but declined to comment further.]

A quick guide to the Living the Herbalife series

A good place to start is the key post on the case law, Herbalife and the FTC.

For more on the issue of internal consumption, That’s my answer and if you don’t like it… and These are not the customers you are looking for considers the way Herbalife has responded to allegations it is a pyramid scheme and asserted its legitimacy.

Widening the focus, the second half of the post A few reasons to sell Herbalife looked at the evolution of direct selling into the modern multi-level marketing industry.

Then in terms of how the government thinks about the law, The FTC is standing in a shrinking circle of grey lays out why the Federal Trade Commission must take a view on internal consumption, and The multi-level endgame, part one explains what we think it will do this year.

For the arguments around Herbalife’s share price, we have looked at the buy case, while the lessons aren’t in the laundry addresses some of the debate around the business model.

Or if you just want to reflect on the deep underlying oddness of the battle between a billionaire and a nutritional shake marketing company, then you want Ten weird things about the Herbalife saga.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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