The FTC Could Be About to Wipe Out Herbalife Shareholders

Last January, the FTC halted Fortune Hi-Tech Marketing, seized its assets, and charged its executives with operating an illegal pyramid scheme. While the ultimate outcome rests on a trial, if it had been a public company, its shares would've plummeted.

This an outcome Herbalife (NYSE: HLF  ) investors have to live with every day. It could take years (Pershing Square's Bill Ackman insists that won't be the case), but with a formal investigation now under way, the FTC could conceivably shut down Herbalife at any moment.

FTC on Fortune Hi-Tech Marketing
"These defendants were promising people that if they worked hard they could make lots of money. But it was a rigged game, and the vast majority of people lost money," said C. Steven Baker, director of the FTC's Midwest region. He was referring to Fortune Hi-Tech Marketing, but Baker could've just as easily been talking about Herbalife.

In a series of videos freely available online, Herbalife Director John Tartol boasts about the opportunity offered to Herbalife distributors, explaining how to rack up monthly bonuses totaling several thousand dollars:

You could become a Millionaire Team member ... Wow! Can you imagine getting to tell people that you're part of the Millionaire Team! Such an honor! ... It's possible to earn a total of $5,500 or more [per month] ... Those who have reached the President's Team level ... could potentially be earning a total of $13,000 and up, every month!

Herbalife CEO Michael Johnson has often made similar remarks. In a presentation to Herbalife distributors in 2012, Johnson offered up the rags-to-riches story of a now-successful Herbalife distributor:

Then you look at Herbalife, you meet a distributor ... This is me before Herbalife, this is me after ... this is the apartment above the garage [where I used to live] ... I met Herbalife on a bus bench, and I cleaned homes, and 10 years later I went back and I purchased one of the homes that I cleaned -- that's an Herbalife story!

Later, Johnson presented Herbalife's top 10 distributors with bonus checks totaling more than $50 million. "Give me one of those checks!" Johnson shouted, as the crowd went wild.

But the million-dollar bonus checks are reserved for the very few -- indeed, 88% of Herbalife's distributors receive no commissions at all. In fact, 87% of all commission checks go to the top 1% of Herbalife distributors.

The bull case has evaporated
The best-case scenario for Herbalife is that the FTC finds no evidence of wrongdoing -- which, while possible, seems unlikely. Obviously, the multitude of issues Pershing Square has raised regarding Herbalife's business has been enough to attract regulators, a possibility that has been downplayed by Herbalife shareholders.

Herbalife's largest shareholder, Carl Icahn, has argued that an FTC investigation was unlikely -- "The FTC investigates fraud; it does not put people out of work ... especially [not] to satisfy guys like Ackman who ... sort of insults them, tells them they're not doing their job," Icahn told CNBC.

And yet, here we are with an investigation looming. Some have claimed that Icahn's investment was motivated by his personal dislike of Ackman -- which seems plausible, given that Icahn has said things about Herbalife's business model that seem downright ludicrous. "Multi-level marketing is here to stay," Icahn told CNBC last year. "It's a great way to move product to consumers." I suppose Amazon and Wal-Mart should be concerned.

Not the same FTC
In truth, the multilevel-marketing industry is sketchy at best, one that has, throughout its history, received a level of scrutiny far more intense than any other type of retailer -- the Chinese government outlawed multilevel-marketing firms entirely for almost a decade, before allowing them (under strict regulation) to reopen in 2005. Even those who have argued in favor of Herbalife, like John Hempton, say that the company is run by "scumbags."

Of course, the regulators haven't always won in their battle against multilevel marketing firms -- Amway survived its 1979 run-in with the FTC, while the SEC did little to clamp down on Usana in 2008. But there's reason to believe this time will be different.

It's no secret that the multilevel-marketing industry has enormous ties to the Republican Party. The DeVos family, owners of Amway, have donated millions to the Republican Party in recent years -- Dick DeVos even ran for governor of Michigan (as a Republican) eight years ago. Pyramid Scheme Alert's Robert FitzPatrick notes that, under the George W. Bush administration, MLMs faced almost no prosecution; the FTC head at the time, Timothy Muris, was a former industry lawyer.

Earlier this week, The New York Times, in an article that was largely critical of Ackman, noted that he's been able to mobilize members of Congress to support him in his battle with Herbalife -- not so coincidentally, they're Democrats. The current FTC head, Chairwoman Edith Ramirez, was sworn into office in 2010 -- an Obama appointee.

It may be best to avoid political issues when discussing investments, but given that the case in favor of (or against) Herbalife rests almost solely on government action, the political ties of regulators cannot be discounted.

A terrible risk/reward profile
Ultimately, Herbalife is a stock investors should stay away from. While continued earnings growth could send shares to the upside, the looming possibility of an FTC shutdown means that the worst-case scenario is an ever-present danger.

Should the FTC find nothing in its investigation, Herbalife shares will more than likely surge to the upside. But given that the agency has found Ackman's argument to be compelling enough to take a look, the risk/reward profile for the stock is, at best, terrible.

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Read/Post Comments (14) | Recommend This Article (6)

Comments from our Foolish Readers

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  • Report this Comment On March 15, 2014, at 9:36 AM, tradepro2009 wrote:

    About 18 months ago I responded to an ad on the radio, "workathome.com". The next day I got a call from a gentleman that was retired like me. I paid $9.95 to see one video, the I paid $199.95 to see the rest of the story. If I spent $2,000 I could become a distributor with a 25% profit and would have to buy like $1,000 per month in product, $3,000 and I would have a 37.5% profit and only have to buy $500 per month in product or I could pay $4,000 and have a 50% profit with no monthly obligation to buy anything. The monthly investment was a motivator for you to sell monthly supposedly. I told the guy h#ll no and he said ok but I couldn't get a refund. I called American Express and they refunded my $209.90. Yes folks, it is truly a pyramid and herbalife is doomed to go out of business. I just feel sorry for all the "distributors" and investors that fell for this crap.

  • Report this Comment On March 15, 2014, at 10:08 AM, success14 wrote:

    Your article presupposes that just because there is an investigation, Herbalife will be found guilty.USANA was investigated by the FTC and was found guilty of no wrong doing. Herbalife was also investigated before going back to 1985 with no action being taken. This event included a senate sub committee hearing in Washington, DC and Herbalife officers were grilled. Again, Herbalife was found gulty of no wrong doing.

    An investigation is just a request for more information. It is a shame that a shameless self serving egotistical individual is wasting the governments time and money on something like this. In the end, Herbalife will be cleared again. For now I see this as a buying opportunity.Dead Cat bounce time. Stock is way oversold.

    As for traderpro 2009's comments, what you mention here is when Shawn Dahl and his team were working the business as you said over 18 months ago. Amidst many complaints, Herbalife terminated this group and no one in Herbalife is conducting business this way.

    Isn't it funny how people bring up stuff from the past that is no longer relevant?

  • Report this Comment On March 15, 2014, at 2:08 PM, ibarz wrote:

    You don't have to be a genius to see that this is a scheme. The basic goal of HLF is to get customers in guise of being a distributor. In essence, they offer a make lots of money scheme, but truly the chance of making any profit is slim to none.

    I just find it funny how anyone could not see this as it truly is - unless a) you are a shareholder or b) you are a distributor with a lot of downstream income coming from people you have recruited.

    My experience with those successful distributors - they've lost all their friends.

  • Report this Comment On March 15, 2014, at 2:37 PM, bigjohn327 wrote:

    success i did notice you did not give any examples of how the article is not accurate. funny how you mention that 18 months ago is not relevant but an investigation in 1985,,,,29 years ago is. just because hlf is not breaking any law or tip toeing along the loophole line does not mean it is not a pyramid scheme,,,,,if the ftc finds hundreds of "distributors" that were led to believe they would get rich and then lost money only for the top tier to reap millions,,,,,guess what,,,,its a pyramid scheme and maybe the rules need to be changed going forward which would also crush hlf...

  • Report this Comment On March 15, 2014, at 2:40 PM, bigjohn327 wrote:

    ibarz,,,if it walks like a duck and quacks like a duck,,,,,,,its a duck.....atacking ackman is what you do to divert attention away from the facts,,,,,

  • Report this Comment On March 15, 2014, at 3:07 PM, Grampoptemp wrote:

    Aside from my investment in HLF at the beginning of this short squeeze, it seems to me that the much larger issue here is the unlimited ability of special interests to "invest" in a political campaign.

    Usage of our elected officials to serve this narrow interest is a perfect example of the abuse the Supreme Court rained down, not only on our election system, but on our financial system now.

    Even if this instance results in a "no action" decision by the FTC, our system has been seriously harmed by this misuse of government agencies to resolve politically motivated issues affecting our corporate population.

    Unless the Supreme Court can be convinced otherwise, this trend will only worsen in impacting the entire election process, but now our financial system.

  • Report this Comment On March 15, 2014, at 3:42 PM, thejungle wrote:

    Hi Sam, other than writing that Herbalife is being investigated, you don't show much to support a case against Herbalife. The investigation at this point is just a request for information to finally put an end to this soap opera. The Globe has an article about how Sen Markey's office grossly exaggerated any potential victim losses and both supposed victims never asked for a refund from Herbalife. Ackman is trying to search for victims like a quest for gold. In the meantime, the bull case for Herbalife is earnings growth, tons of case, stock buyback, major supporters such as Icahn and Stiritz, and a worldwide successful business plan.

  • Report this Comment On March 16, 2014, at 9:41 AM, MKArch wrote:

    The case for and against HLF comes down to a single argument:

    Is the "ghetto" really the largest market in the world for weight loss products?

    I don't use the term "ghetto" as a derogatory term; I use it just to emphasize the absurdity of the HLF defenders case. They can come up with all the calculus equations based on unverifiable assumptions they want, common sense tells you the "ghetto" isn't the largest market in the world for weight loss products and HLF is the only company in the world to figure it out. Ackman is forcing the FTC to finally use common sense. HLF is toast and easy point for me in CAPS.

  • Report this Comment On March 16, 2014, at 9:44 AM, AllenElliott wrote:

    See how easy it is to do legal theft?

  • Report this Comment On March 16, 2014, at 12:10 PM, mustang6 wrote:

    Anyone that believes Bill Ackman didn't do his homework on HLF is truly clueless...You should read "The Confidence Game" by Christine Richard...he was a frontrunner on the mortgage backed securities company MBIA going back to approximately 2003 trying to convince Congress about the fraud until the bubble burst in 2008...By the way, he made billions on that, also, check his record on Canadian Pacific...unseating the board there about 1 1/2 years ago when the stock was I n the low 60's ...now trading in the 150's... True JCP was a big loss, but Ackman is the current day Warren Buffet...there is zero doubt he is going to be proven correct on his short position in HLF.

  • Report this Comment On March 16, 2014, at 12:20 PM, amy1982 wrote:

    The FTC could be about to wipe out Herbalife Shareholders? Really? Now how did you come to that conclusion? Actually this article could also read, The FTC could be the final nail in Ackman's coffin. What will Ackman have left when the FTC finds Herbalife clean as a whistle? Hmmmm?

    As others have mentioned, the FTC investigation is just a request for more information. Sort of like an IRS audit. If you get audited, doesn't mean you are guilty only means the IRS has questions. And if you have done nothing wrong, nothing happens.

    Ackman is betting on the average persons delusion that network marketing is a pyramid scheme. And he thinks he can buy off anyone he wants.

    The FTC investigated Herbalife previously and found no wrong doing. This time will be no different. And when that happens, then what is Ackman going to do?

    Some people have way too much confidence in Ackman. His losses on JCP and other investments show that he is very reckless and made costly mistakes. No doubt HLF will be his biggest loss to date.

    The time to be short was prior to last Tuesday. The short play is over. HLF is going up from here.

  • Report this Comment On March 16, 2014, at 12:50 PM, success14 wrote:

    Big John,

    This is the post I responded to:

    About 18 months ago I responded to an ad on the radio, "workathome.com". The next day I got a call from a gentleman that was retired like me. I paid $9.95 to see one video, the I paid $199.95 to see the rest of the story. If I spent $2,000 I could become a distributor with a 25% profit and would have to buy like $1,000 per month in product, $3,000 and I would have a 37.5% profit and only have to buy $500 per month in product or I could pay $4,000 and have a 50% profit with no monthly obligation to buy anything. The monthly investment was a motivator for you to sell monthly supposedly. I told the guy h#ll no and he said ok but I couldn't get a refund. I called American Express and they refunded my $209.90. Yes folks, it is truly a pyramid and herbalife is doomed to go out of business. I just feel sorry for all the "distributors" and investors that fell for this crap.

    --------------------------------------------

    As I stated Shawn Dahl and his team are no longer with Herbalife but doesn't it appear, even though he states this happened 18 months ago that Herbaife distributors are still doing this today? One of the issues with network marketing is that when the opportunity gets away from the company to the distributors a lot can go wrong. Unless complaints are registered. With Shawn Dahl and his team there were a lot of complaints and Dahl was removed even though he was one of the top ranking distirbutors in the company. I believe this shows fair play by Herbalife. Top producer or not, you break the rules, it's bye, bye.

    Also, if he bought products from Herbalife, they fall under the guarantee so he should have recieved a refund on any unopened products.

    More to the point this was not Herbalife but Shawn Dahl and his organization. I will end by saying that I strongly discourage anyone from "buying in" at certain levels to get big discounts on a business opportunity that you are contemplating and know little about. The successful Herbalife distirbutors I know built their businesses the old fashioned way, distributor at a time, retail customer at a time. Never buy in. Who ever started that should be shot.

    I didn't comment on the article itself because I think the statements are without merit and basically opinionated.

    As for bringing up what happened in 1985, I think people should know that Herbalife was investigated thoroughly back then and it is pertinent.

    The comments by the author that things are different now and that this is a different FTC is absurd. I disagree.

  • Report this Comment On March 16, 2014, at 2:35 PM, MKArch wrote:

    <<<I didn't comment on the article itself because I think the statements are without merit and basically opinionated.>>>

    *************************************

    It's funny you would want to write the author off because I decided to check your TMF history as you seemed like someone with more than just a casual interest in HLF. Seeing you also only joined TMF yesterday I'm inclined to take your opinions with a grain of salt. I'm not so sure sharing investment knowledge is your primary motive.

  • Report this Comment On March 16, 2014, at 3:42 PM, Ackmanscam wrote:

    <<<<<<More to the point this was not Herbalife but Shawn Dahl and his organization. I will end by saying that I strongly discourage anyone from "buying in" at certain levels to get big discounts on a business opportunity that you are contemplating and know little about. The successful Herbalife distirbutors I know built their businesses the old fashioned way, distributor at a time, retail customer at a time. Never buy in. Who ever started that should be shot.

    I didn't comment on the article itself because I think the statements are without merit and basically opinionated.

    As for bringing up what happened in 1985, I think people should know that Herbalife was investigated thoroughly back then and it is pertinent.

    The comments by the author that things are different now and that this is a different FTC is absurd. I disagree.>>>>>>>

    Well stated succcess14. I think we need more people like you to clear the air and tell the truth about Herbalife. But I am curious, you didn't indicate if you are investor. I assume you are. Perhaps you can come back and explain.

    I am long HLF and I think this whole Ackman thing stinks to high hell. I also feel this author is very opinionated and obviously doesn't understand the mlm industry at all.

    As an investor, I made it point to meet Herbalife distributors, attend some of their meetings and visit the nutrition clubs. Not surprisingly what I saw was the complete opposite of what Ackman described.

    Also, there is no difference with the FTC today than just 5 years ago when they investigated USANA or in 1985 when they thoroughly investigated Herbalife. Just another boogey man that Ackman and his cohorts are using to try to manipulate HLF stock price.

    Finally, regarding network marketing or mlm, did you know that in the 1950s there was a move to close down franchising because the powers that be at that time thought it was a pyramid scheme, illegal and should be outlawed?? We could and probably will see the same thing happening with network marketing. It is coming of age.

    I know a lot of stock traders and other business professionals who are diversifing into mlm. Not all financial people are in the dark ages. I too as of only a few years ago was positively against mlm. Some of us learn.

    HLF long and a believer in network marketing.

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