Herbalife, the nutritional supplement company, has agreed to completely restructure its business operations, hire a third-party compliance auditor and pay a $200 million fine in a settlement with federal regulators over questions about its marketing practices.
The Federal Trade Commission alleged in a complaint that the company had engaged in unfair and deceptive practices, in part by misrepresenting how much money people were likely to make if they signed on as Herbalife distributors. According to the complaint, Herbalife is a multi-level marketing scheme that attracted people by using videos and presentations featuring images of mansions and luxury cars -- and testimonials about others who earned substantial income and even quit their jobs.
The settlement, which calls for broad changes to Herbalife's direct marketing program, contains no admission of wrongdoing and the company said in a press release that it believed many of the allegations by regulators were "factually incorrect."
"The settlements are an acknowledgment that our business model is sound and underscore our confidence in our ability to move forward successfully, otherwise we would not have agreed to the terms," Michael O. Johnson, chairman and chief executive of Herbalife, said in a press release.
The FTC alleged that, contrary to the company's promotion and marketing, the only way to make significant money was by recruiting others -- not by selling products. It also alleged that the majority of distributors did not recruit a single new distributor.
"Participants in a business opportunity should have some reasonable prospect of earning profits from reselling products to customers. However, most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products," the complaint states.
For example, events held by the company, which required an admission fee or a minimum purchase of Herbalife products, featured speakers who had succeeded, according to the complaint.
"[H]ow many of you would like to make at least a million dollars a year in income? I gotta tell ya, every extra million dollars, I find, comes in handy," Herbalife Chairman's Club member John Tartol said in a 2012 summit in Los Angeles, according to the complaint.
The settlement requires Herbalife to change the way it compensates its agents, so that financial rewards are based on retail sales of its nutritional products to people who plan to use them. At minimum, 80 percent of its product sales must be to people legitimately buying the products to use them. The settlement "specifically prohibits Herbalife from claiming that members can 'quit their job' or otherwise enjoy a lavish lifestyle," according to the FTC statement.
"I think what we achieved in this case is unprecedented," FTC chairwoman Edith Ramirez said at a press conference. "I think the protections we have in place here; they're aimed to insure that, going forward, Herbalife operates legitimately."
At 1 p.m., the company's stock was up 12 percent after the announcement. Bill Keep, dean of the business school at the College of New Jersey and an expert on multilevel marketing schemes such as Herbalife, warned that traders might be overly optimistic about the consequences of the settlement for Herbalife.
“The strong language of this settlement will require Herbalife to fundamentally restructure its business,” Keep said. “Investors underestimate the long-term impact of the changes.”
The company has been a battleground between two Wall Street titans: hedge fund manager Bill Ackman who bet big against the company and activist investor Carl Icahn, who is major investor in Herbalife, currently owning 18.3 percent of its shares.
Several years ago, Ackman began accusing the nutritional supplement company of running a pyramid scheme. Ackman, who runs Pershing Capital, bet $1 billion that the company’s stock would fall and lobbied regulators and shareholders to scrutinize the company’s business model.
But Ackman soon found himself squaring off against Icahn, an activist investor who defended the company. Icahn snapped up shares of the firm. Herbalife even agreed to include five people designated by Icahn on its board.
The two billionaires got into a notorious verbal brawl during a 2013 CNBC appearance. Icahn called Ackman "a major loser" and Ackman said Icahn was a bully "not used to someone standing up to him."
The two currently enjoy a more amiable relationship.
“While Bill Ackman and I are on friendly terms, we have agreed to disagree (vehemently) on this subject. Simply stated the shorts have been completely wrong on Herbalife,” Icahn said in a statement. In its statement about the settlement, the company announced Icahn is now permitted to increase his ownership stake in the company up to 35 percent.
Ackman’s firm, Pershing Square Capital Management, continued to defend its position. “While it appears that Herbalife negotiated away the words ‘pyramid scheme’ from the settlement agreement, the FTC’s findings are clear,” the investment firm said. “We expect that once Herbalife’s business restructuring is fully implemented, these fundamental structural changes will cause the pyramid to collapse as top distributors and others take their downlines elsewhere or otherwise quit the business.”
It also appears, the fight isn’t over. Regulators in other countries can now enforce similar requirements against Herbalife, Pershing said in its statement. The hedge fund intends to “work with these regulators to ensure that no future victims are harmed whether in the U.S. or otherwise.”
Staff writer Max Ehrenfreund contributed.