Herbalife Shareholders Should Be Frightened by This FTC Release

Last January, the FTC halted Fortune Hi-Tech Marketing, froze its assets, and charged its executives with operating an illegal pyramid scheme. This week, the FTC reached a settlement with Fortune Hi-Tech, shuttering the company permanently, seizing assets, and banning its operators from the multilevel-marketing industry.

A similar fate could soon befall Herbalife (NYSE: HLF  ) . With an FTC investigation ongoing, shareholders could, at virtually any moment, have their investment completely wiped out. Although such an outcome remains highly uncertain, the language used in the FTC's most recent news release should frighten Herbalife shareholders -- since much of what the FTC found disturbing about Fortune Hi-Tech Marketing applies equally to Herbalife.

Getting rich quick:

The FTC and the states charged the Fortune Hi-Tech Marketing (FHTM) defendants with deceiving consumers by claiming they would earn significant income through selling various products and services if they signed up as FHTM representatives.

Although Herbalife freely admits that few of its distributors actually earn any money selling Herbalife's products, its management team has a long history of making grandiose promises. Herbalife's founder, the late Mark Hughes, was perhaps the most aggressive when it came to selling the Herbalife dream:

Let me tell you how much money you're gonna be making... write this down. Put down your total income that you're making per month, right now. Write that down. Minimum, five times what you're making at this moment. Write that figure down. Stare at it. Get a feeling of it. Where could you be living? Some of you are going to be making 10 times ... what you're making right now.

Hughes is long gone, but Herbalife's top management, including board member John Tartol, have continued his legacy. In a video freely available online, Tartol tells distributors just how much money they could be making:

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!

Targeting Spanish-speaking immigrants:

In recent years, [Fortune Hi-Tech Marketing]  targeted Spanish-speaking and immigrant communities.

Ultimately, if Herbalife is found to be a pyramid scheme, the ethnicity of its victims shouldn't matter. Still, it's interesting that the FTC would choose to note this in its Fortune Hi-Tech Marketing release. The majority of Herbalife distributors in the U.S. are Hispanic (Herbalife's management reported in 2010 that almost two-thirds of its net sales in the U.S. were from Hispanics). The Hispanic Federation, a group that provides grants to Latino nonprofit agencies, urged the FTC to investigate Herbalife last year, noting that the promise of Herbalife riches could be of particular appeal to poor, Hispanic immigrants.

Start-up costs and renewal fees:

[Fortune Hi-Tech Marketing p]articipants were required to pay substantial start-up costs and monthly fees to retain their positions with the company. 

Fortune Hi-Tech Marketing required new participants to pay $249 up front. Herbalife's official start-up fee is less -- $59.50 or $92.25 -- but the company operates with the same basic structure. After purchasing am "Herbalife Member Pack," Herbalife distributors must earn a set number of "volume points" to retain their positions in the company.

These volume points are earned when the Herbalife distributor, or people the distributor has recruited to become new distributors (to a limited extent), purchase products from Herbalife. Each product (Herbalife's Formula 1 shake mix, for example) has a certain set volume point value that does not vary by region. In the U.S., one volume point roughly corresponds to $1 in terms of products purchased.

Herbalife requires that its members "requalify" on an annual basis in order to retain their positions within the company. In order to requalify, they must pay an annual fee and earn a set number of volume points every year. In an Herbalife instructional video, Tartol and Herbalife distributor Leslie Stanford explain:

To requalify as a qualified producer, all you have to do is accumulate at least 2,500 volume points within a 1- to 3-month period each year ... [To requalify as a] supervisor, achieve 4,000 volume points in one month ... or achieve 2,500 volume points in each of two consecutive months ... the third way you can requalify as supervisior is with a 12-month requalification method ... you have two options, you can accumulate 4,000 volume points within the 12-month requalification period ... all of those volume points must be unencumbered.

If this sounds confusing, it's because it is (note: the SEC warns would-be multilevel-marketing participants to beware complex commission structures). Suffice it to say, if you're a Herbalife distributor with any sort of downline, you will need to purchase potentially thousands of dollars of Herbalife product on an annual basis to retain your position within the company. 

Most lost money:

The overwhelming majority of people -- more than 98 percent -- [who bought into FHTM] lost more money than they ever made. At least 88 percent of consumers did not even recoup their enrollment fees.

Herbalife freely admits in its statement of average gross compensation that 88% of Herbalife distributors receive no income from the company whatsoever. Herbalife argues that these members receive "economic benefits" from the products they purchased through Herbalife at a discounted rate, but assuming they bought into the company with the intent to make money, then roughly the same percentage of Herbalife members as Fortune Hi-Tech Marketing distributors lost money.

Nearly all quit after one year:

... [a]t least 94 percent of [Fortune Hi-Tech Marketing] consumers did not renew their membership after their initial year.

In its 2005 annual filing, Herbalife admitted that roughly 60% of its supervisors exited the company in the prior year, and 90% of non-supervisors (lower-level distributors). This means approximately 80% of distributors left in a year. This information was not disclosed in subsequent filings, but, assuming Herbalife's retention has not dramatically increased, the company is seeing a turnover rate on par with Fortune Hi-Tech Marketing's.
 
Is the FTC foreshadowing an Herbalife shutdown?
Obviously, Herbalife is not identical to Fortune Hi-Tech Marketing, but the similarities are uncanny. Like Fortune Hi-Tech, Herbalife is operating a supposed multilevel-marketing business that promises riches, targets Hispanics, levies aggressive annual fees, enriches the few at the expense of the many, and sees a high annual turnover rate.
 
Will Herbalife, like Fortune Hi-Tech, also be shuttered by the FTC? Investors in Herbalife should be aware of the possibility.
 

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Read/Post Comments (16) | Recommend This Article (7)

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 May 16, 2014, at 1:52 PM, powershake wrote:

    FHTM didn't even have a product, let along manufacture one!

    Two major difference between HLF & FHTM are ---

    1) HLF distributors make ZERO money in recruiting others. Anyone signing

    up as member has 90 days to return the starter kit for a full refund (around

    $100). The kit includes around $100 of products and samples plus dvd's,

    complete business information and a coach to orientate and assist new

    person. Note: products and the kit do NOT need to be sent back to HLF to receive a

    full refund.

    2) All members that purchase products have a full year to return

    products to HLF, free of shipping charges, to receive full refund of their

    investment. This generous product return policy - Gold Standard - is the best in the

    industry and since introduced last year...HLF reported Q1 to have the lowest

    product return in their history - 0.2%

    The Gold Standard Rules are unprecedented in the whole of Direct

    Selling Industry. The highest of standard in the direct selling industry.

  • Report this Comment On May 16, 2014, at 1:55 PM, Ackmascam wrote:

    Your article refers to Fortune Hi Tech and not Herbalife. HLF shareholders have no reason to be concerned over this.

    Herbalife does offer disclaimers on their videos and in their presentations regarding potential income.

    As a HLF long, I have examined Herbalife's marketing. Notice they do use words like "could", "may", "possible" Never make any guarantees.

    The fact is that there are many people doing extremely well in Herbalife. It is not a pyramid scheme and as a HLF long, I am very happy with the returns I am getting with the stock.

    We all know it is options expiration day today. Are you trying to scare investors??

  • Report this Comment On May 16, 2014, at 2:29 PM, Textextextextex wrote:

    Herbalife operates very similar to not only FHTM, but also Amway, the world's largest MLM scam: http://www.stoptheamwaytoolscam.wordpress.com

  • Report this Comment On May 16, 2014, at 2:47 PM, Zarthegreat wrote:

    Wow, really Ackmascam? HLF longs should not be worried when the company's business is very similar to FHTM, a company that just got shut down by the FTC?

    Furthermore, that same agency that shut down FHTM is now investigating Herbalife along with the FBI, DOJ, 2 attorney generals and etc.

    Are you seriously buying the crap you are shoveling?

    In all honesty longs should be very concerned instead of being so complacent, because the evidence indicates that there could be severe loss of principle for long investors in HLF, plain and simple!!

  • Report this Comment On May 16, 2014, at 4:07 PM, LTInvstr wrote:

    Hey Acmascam, very good points - Fortune was a completely different business than Herbalife. Also love that you pointed out options expiration!

    As a side note, I just saw that *another* hedge fund (Hayman Capital) just took a long position in HLF. The same report also mentioned two other LONG moves by funds during Q1 '14:

    *Soros Fund Management added 1.7 million shares

    *Perry Capital added 1.8 million shares

    It's a pretty good read if you're in the long camp (as I am): http://www.bloomberg.com/news/2014-05-15/soros-perry-build-h...

    Thinking Sam should join the "scare and cover" folks over at SA's site. (-:

    Good luck to you shorts - hope you get out without too much $ damage.

  • Report this Comment On May 16, 2014, at 4:59 PM, mike2cu2 wrote:

    The first thing I research in an article is: What is the Author's motive?, because you are writing an article to influence investors of a particular stock. After reading the article, I was not surprised to see this author as a short seller of Herbalife: WOW, what a shock!!!!

  • Report this Comment On May 16, 2014, at 5:12 PM, powershake wrote:

    George Soros, Richard Perry and Kyle Bass threw more money behind Herbalife Ltd. in the first quarter even as Bill Ackman pushed regulators to probe the marketer of vitamins and weight-loss shakes and the stock slumped. http://bloom.bg/1g9IMeG

    Could be the biggest SHORT SQUEEZE in history!

    If you're short please stay short - you're brilliant!

    You clearly see what no on else does! Increase your position! You'll be rich! :)

  • Report this Comment On May 16, 2014, at 5:19 PM, gskinner75006 wrote:

    I doubt that anyone investing in an MLM is afraid of much of anything.

  • Report this Comment On May 17, 2014, at 12:21 AM, Zarthegreat wrote:

    Yea, I see what no one else does, that's why almost 40% of Herbalife's float is short.

    History is full of "big money" investors taking big stakes in companies that eventually fail, that's just the way greed seems to work.

    It's beginning not to surprise me the way the longs are completely ambivalent of the dangers that await them.

    It reminds me of the brainwashed cult members who are involved in the HLF scam trying to get rich.... When only about 1 in 5000 does. Thats about the same chances you have making money on the long side of this trade over time.

  • Report this Comment On May 17, 2014, at 2:08 AM, knjimd wrote:

    are you really serious with this misleading article???? OMG you must be one of the seeking alpha tards!

  • Report this Comment On May 17, 2014, at 6:46 AM, Zarthegreat wrote:

    Why do you block people's comments and responses that may differ with your point of view? I don't think that is a very objective way to hold a discussion.

  • Report this Comment On May 17, 2014, at 11:35 AM, earlcarroll wrote:

    meanwhile back at the ranch THE STOCK IS UP THIS MONTH.....bill stiritz, carl Icahn, George soros and several other billionaires who are long the stock and selling puts have done their own investigation...this group of billionaires have a lot better investigators, lawyers, and analysts than the government could ever hire.. do you think Icahn would have put so many on the hlf board if he had not done a thorough investigation...DUE DILIGENCE..it is what these billionaires do and they do it very well, ackman on the other hand NOT SO MUCH I use j c penny , target. and now hlf as my examples...these billionaires just keep selling puts and the puts just keep expiring worthless.. and once these investigations end and hlf gets a fine and a slap on the wrist the stock goes to 100 bucks a share and all the shorts will be SQUEEEEEZED like volkswagon was..this is going to make a great movie once it is over....one more thing...only 18 percent of hlf sales are in the united states so WHAT IS THE WORST POSSIBLE OUTCOME?? they lose 18 percent of there sales...IT IS NOT POSSIBLE FOR IT TO GO TO ZERO...

  • Report this Comment On May 17, 2014, at 12:36 PM, Zarthegreat wrote:

    Are you stupid? Don't you know that the whole world takes cue from America, especially if the company is American.

    You think that if HLF gets shut down in the U.S., It's operations around the world won't be impacted, really?

  • Report this Comment On May 18, 2014, at 2:35 PM, Ackmascam wrote:

    Hey Zar,

    Yes I am serious and it appears as though others agree with me. As you know, these incredulous investigations and charges against Herbalife were all brought about by people connected with Ackman and all of them starting with Sen Markey are now being investigated.

    Doesn't it seem strange even to you that only people owing Ackman IOUs and are powerful politically are bringing charges against Herbalife? It's not rocket science.

    The charges are bogus.

    As for Fortune, there is no comparison. They were charging fees which went as commissions to distributors for recruiting. Herbalife doesn't do this. No reputable MLM does either like Amway. Comparing the two Fortune and Herbalife is like comparing apples and oranges. In the case of Fortune, it is like a rotten apple.

    And I have seen your posts on SA as well. It seems you are a Johnny-One-Note and it is pretty obvious who you are and what your intent is here.

    I tried to post on Friday but was blocked.

  • Report this Comment On May 18, 2014, at 2:41 PM, Ackmascam wrote:

    Ltinvest,

    Thanks for your nice comments and kudos to you as well for a nice retort. And congrats to the others who posted. I was blocked on Friday so couldn't respond to Zar's ridiculous comment. Can you guess who Zar really is? I think it is obvious.

    Shorts, if they stay short will get crushed. One of the first rules I learned as a investor is not to get emotionally involved with a stock regardless of whether you are long or short. Play it by the numbers and when/if it goes against you, or when in doubt, get out.

    These shorts like Zar and the author are holding on to a dream.

  • Report this Comment On May 20, 2014, at 3:35 PM, Ackmascam wrote:

    Zar wrote,

    Yea, I see what no one else does, that's why almost 40% of Herbalife's float is short.

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

    Haven't we heard this line many times before on the SA board with the SA bozo twins writing their fairytale stories that appear as though they belong in a tabloid?

    How many times have we hear, "You longs just don't get it." Like he is the only one who does. And now Zar states, "Yea, I see what no one else does, that's why almost 40% of Herbalife's float is short. " He must wear special glasses or have incredible insight. LOL.

    What excites me about Zar's statement (and by the way, all investors who study their craft and do due diligence already know about the 40% short) is what happened when these 40% cover and they will have to in due course. We should see HLF pop to over $85 - $100 easy.

    Now of course most of that short position is owned by Ackman which Zar fails to mention. And we all know that Ackman is melting and will be covering on this very reckless gamble that no intelligent investor would have ever done irregardless of the billions of $$$$ he /she may be backed with.

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