March 17, 2014

FORTUNE — Herbalife (HLF) can’t seem to get a break. Last week, the Federal Trade Commission announced it had opened an official inquiry into the $6 billion nutritional supplement company — a move that surely gave Bill Ackman’s Pershing Square fund a much-needed shot in the arm. The New York City-based hedge fund has placed a virtual bounty on Herbalife’s head by shorting $1 billion worth of its stock and pushing relentlessly to prove that the company’s business model is really a pyramid scheme. But actually proving that is easier said than done, and Ackman could wind up losing big.

Herbalife’s multilevel marketing practices could be viewed as dubious: The company asks distributors to buy its products up front and then sell them on to friends, family, colleagues, etc. and offers a commission to recruit even more distributors to do the same. Its pitch has the makings of a get-rich-quick pyramid scheme that relies on an ever-widening pool of susceptible buyers to keep its promise.

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The problem, however, is proving that it’s indeed a scheme. Convicted fraudster Bernie Madoff’s pyramid scheme was comparatively easy to prove (at least once the Securities and Exchange Commission finally caught on) because there was no genuine underlying “product” except for the investment itself. Returns were generated almost exclusively by securing more investors and using that money to create the illusion of market activity. So the connection between the business model and fraud was more direct. By contrast, Herbalife produces real goods that are technically meant for end users. It’s also secretive about how much is sold to those users as opposed to middlemen, so showing that its true purpose is to fleece distributors could be extremely tough.

There is a reasonable amount of anecdotal evidence that Herbalife forces its distributors to buy even more product in bulk to stay in the game, even when those distributors are unable to sell their original batch, which may be exploitative but not necessarily a crime. Making the situation even more complex is the fact that companies like Avon (AVP) have a similar business model, which are not questioned. In fact, Herbalife seems confident of its position and welcomes the FTC investigation as an opportunity to clear its name.

For Ackman and Pershing Square, this difficulty in proving wrongdoing could become a big problem. If the FTC is unable to prove that Herbalife’s business is a pyramid scheme, not only will the company be in the clear but will be decisively vindicated in the eyes of the markets — which will likely push the stock even higher than before and render the $1 billion short sale a very bad decision.

It’s also worth noting that Ackman reduced his short position by 40% at the end of last year and replaced it with derivatives, which have limited downside, suggesting he is unsure of his own thesis.

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That also explains why Ackman is continuing his crusade against Herbalife despite the odds of a successful FTC investigation being low: He has no choice. Pershing Square’s Herbalife short is not just another market position but is now inextricably tied to the hedge fund’s reputation as a savvy investor, and to back down now could be very damaging.

Of course, the FTC is not the only party pursuing Herbalife. Various political action and community groups, particularly from the Hispanic community, are agitating loudly against the company’s marketing practices, thanks to Ackman. Even if the government ultimately clears Herbalife, its credibility in minority communities (from where it gets many of its distributors) might be impaired.

Perhaps that is what Ackman is really betting on, but either way, it’s a long shot.

Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius. Sanghoee sits on the Board of Davidson Media Group, a mid-market radio station operator. He has an MBA from Columbia Business School and is also the author of two thriller novels. Follow him @sanghoee.

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