Herbalife's 'pyramid scheme' problem
The Federal Trade Commission stopped just short of labeling Herbalife a flat-out pyramid scheme
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"Judgment Day has come for Herbalife," said Michelle Celarier at New York. The Los Angeles–based seller of diet shakes, nutritional supplements, and other weight loss products last week agreed to pay $200 million in order to settle charges with the Federal Trade Commission, which stopped just short of labeling the business a flat-out pyramid scheme. The FTC, which has been investigating the multi-level marketing firm for the past two years, concluded that Herbalife "deceives" its more than 680,000 independent contractors in the U.S. by promising them they can quit their jobs and get rich quick by buying Herbalife products and reselling them to friends and acquaintances for a profit. "The truth is," said the FTC, "that the overwhelming majority of distributors...earn little or no money." More than half the distributors known as "sales leaders" make less than $5 a month, and many lose money. Those who do earn large sums make the bulk of their earnings from recruiting large numbers of new distributors, who are then required to purchase Herbalife products to sell.
Beyond its effect on Herbalife, this settlement ends a "Wall Street dogfight between two billionaire investors," said Matthew Goldstein and Alexandra Stevenson at The New York Times. Activist hedge funder Bill Ackman has for years lobbied regulators to crack down on Herbalife, famously shorting its stock by $1 billion in a bet that the company would be shut down for its "predatory" behavior. In response, famed investor Carl Icahn bought gobs of the company's stock, betting that it "would weather the regulatory scrutiny." At first glance, "it looks like Icahn came out on top," said Brooke Sutherland and Gillian Tan at Bloomberg. Herbalife shares jumped more than 20 percent after news broke that the FTC wouldn't be shutting down the firm completely. But Ackman "has reason to feel at least somewhat vindicated." Herbalife has agreed to completely revamp its business model — rewarding salespeople based on what they sell rather on how many people they recruit, with distributors having to prove with detailed records that 80 percent of their earnings come from retail sales.
"The FTC couldn't have been clearer that it thinks that Herbalife is a pyramid scheme, without actually using the words 'pyramid scheme,'" said Matt Levine, also at Bloomberg. So why did the regulator allow Herbalife to survive? The company's most believable defense may have been that many of its distributors aren't actually in it to make money, but to get discounts on Herbalife products for their own use. That could be true, but we'll see whether the company can continue to recruit new salespeople now that it's specifically barred from featuring "images of opulent mansions, private jets, and yachts" in its marketing materials. The rest of the multilevel marketing industry, including companies like USANA, Nu Skin, Amway, and Avon, has been watching warily, said Roger Parloff at Fortune. Already, the FTC is poised to issue new "guidance" for such companies based on this decision, perhaps including requirements to hand over records of sales. Herbalife may survive the new restrictions that have been imposed on it, but those same terms "would likely cripple, if not kill off, many of its competitors."