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Twitter Roundup: Herbalife Battle Between Ackman and Icahn

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As a financial journalist, Twitter is indispensable to me. It's a personal wire service that I customize to suit my appetite for information; an instant way of getting breaking news from multiple perspectives. Plus I follow some pretty clever people who can cram a lot of insight into 140 characters.

So, once a week I curate my favorite tweets and add a little context to help explain an emerging story. Last week's big news was that Herbalife (NYSE: HLF  ) , a multi-level marketing firm (MLM) that sells nutritional products, is now being investigated by the Federal Trade Commission (FTC) over allegations of fraud. 

A little background: Herbalife is currently in the midst of a tussle between billionaire money managers Bill Ackman and Carl Icahn. Icahn owns 17% of the company that Ackman accuses of being a pyramid scheme, so it's no wonder that he took offense when Ackman did this:

Over the next 15 months, Mr. Ackman campaigned heavily to "expose" Herbalife. Now they're under investigation. You do the math. 

For those who don't watch Netflix's House of Cards, it's about a calculating politician who ruthlessly schemes and plots to get his way. And a "put" is a financial position that profits when a stock price declines. (Tangential: Everyone should watch House of Cards. It's amazing.)

Part of the problem is that regulators haven't made it clear at what point a multi-level marketing firm degenerates into a pyramid scheme.

For the past 35 years, MLMs have run amok. Back in 1979, the FTC laid down some basic rules, most importantly that:

  1. Distributors must sell at least 70% of their product at retail value. Pyramid schemes rely on growing their distributor network, often by selling discount product to new recruits (or using the products themselves) and still counting it as regular sales. When enough distributors behave in that fashion, usually because the firm rewards aggressive recruitment, the business model is no longer built on real sales.
  2. Distributors should have at least 10 unique customers. The logic behind that is simple -- it's easier to get someone to buy your products than it is to convince them that their lives are better served selling random stuff to their friends. 
Seems simple enough, right? The problem is that it was all bark and no bite. No one agency was given jurisdiction and no transparency measures were enforced. Which brings us back to the present day.

Ackman clearly stands to profit by slandering Herbalife, but it doesn't mean he's wrong. The company has yet to address some very serious questions.

And on a more human level...

It's become clear that Mr. Ackman won't be pulling any punches, but Mr. Icahn -- who gained his fame and fortune as an activist investor -- isn't the type to back down from a fight.

An unfinished story...

One can only hope that the FTC will act on the merits of the case. In any case, they should review and update MLM regulations to ensure the protection of bottom-tier distributors. But there's a larger problem at stake.

It took more than a quarter of a million dollars and a very public tête-à-tête between two members of the uber-wealthy just to get the FTC to pay attention. It's almost cliche to say that money -- in the form of lobbying and campaign contributions -- dominates political decision making, but we've rarely had a clearer example than this. 

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 26, 2014, at 4:24 PM, amyrobinson wrote:

    This article makes a careless error with regard to the description of the so-called “70 percent rule” and the “10 customer rule.” These are not FTC rules at all, but instead were merely existing policies Amway had in place in 1979, which the FTC cited in its ruling as evidence of legitimate operations.

    Since that decision in 1979, many other companies have proactively adopted policies similar to those Amway had in place, but there is no FTC rule to this effect. There have been cases when law enforcement has taken action against an alleged pyramid scheme, ultimately requiring the company in question to adopt a version of one or both of these policies in order to continue to operate as legitimate, reformed operations. However, the existence or absence of such a rule does not alone determine whether a company is a pyramid scheme – it is merely one piece of evidence that can be used in evaluating a company’s operations.

    Furthermore, the FTC has very clear authority to prosecute pyramid schemes under Section 5 of the FTC Act. The FTC has exercised this authority many times, even citing this authority as one of the reasons direct sellers were in not included in the FTC’s recent revision of the Business Opportunity Rule.

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Gaurav Seetharam

Gaurav has been writing for The Motley Fool since December 2012. His core interests include banking, financial regulation, and macroeconomics. Oh, and Game of Thrones.

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