Nearly 22 months after the Federal Trade Commission commenced a formal inquiry into the business practices of Herbalife, a meal replacement and nutritional supplements company, the firm disclosed on Thursday that it and the agency are “in discussions . . . regarding a potential resolution of these matters.”
The revelation, which was made in an SEC filing, plays it very close to the vest, however, leaving all possible outcomes—positive and negative—very much on the table: “The possible range of outcomes include the filing by the FTC of a contested civil complaint, further discussions leading to a settlement which could include a monetary payment and other relief or the closure of these matters without action,” the company wrote.
The probe was prompted by billionaire activist investor Bill Ackman, whose Pershing Square Capital Management hedge fund unveiled a $1 billion short position in the company’s stock in December 2012, at which time he also presented a 3.5 hour, 340-slide PowerPoint lecture declaring that the company was a pyramid scheme. Herbalife has strenuously denied the accusation. I wrote a feature story about Ackman’s siege last September.
Thursday’s disclosure, which accompanied the release of the company’s favorable fourth quarter and annual financial results, was met by the market with an ecstatic response in after hours trading, with Herbalife stock soaring as much as 16%. (As of this writing, the stock is up about 12.5%, at about $52, after having closed at $45.76.)
Still, Herbalife’s disclosure itself is scrupulously opaque. “The Company is cooperating with the investigation,” it says, “and at this time it is difficult to predict the timing, and the likely outcome, of these matters. Moreover, no assurances can be given that the outcome of these matters will not have a material adverse impact on the Company’s business operations, its financial condition or its results of operations. At the present time, the Company is unable to estimate a range of potential loss, if any, relating to these matters.”
The FTC investigates “unfair or deceptive acts or practices.” A pyramid scheme is one particularly severe such practice, and when the FTC believes that one exists, it ordinarily must try to shut it down.
However, if the commission finds that the target of an inquiry is not a pyramid scheme, it might still accuse it of lesser unfair practices—like making false representations or having done so in the past. In such instances, an inquiry could be resolved with a fine and, say, a consent decree. In a consent decree, the defendant—often without admitting wrongdoing—agrees to submit to a court order ensuring that it will play fair in the future, on pain of contempt sanctions. (Ackman has accused Herbalife, for instance, of misleading its independent distributors into believing they have a better chance of making money than they do.)
Herbalife is a multi-level marketing company, or MLM. Such companies distribute their products through a network of independent contractors who are rewarded not just for selling the product, but also for recruiting other distributors to sell the product, who are incentivized, in turn, to recruit still more distributors to sell the product, in a pyramidal pattern.
Some consumer advocates argue that all MLMs should be illegal because they can become pyramid schemes. But courts have said that such businesses can be lawful so long as they observe certain safeguards to ensure sustainability.
At the time I wrote in my feature last September, Ackman said that Herbalife’s stock would have to dip to the low-30s for him to make a profit, and that the cost of maintaining his position came to about $100 million a year. He has repeatedly asserted that Herbalife’s stock will eventually go to zero, either due to being shut down by the authorities or from collapsing of its own unsustainability.
Last month, the Wall Street Journal suggested that Manhattan federal prosecutors were dropping an inquiry into criminal allegations that Ackman had leveled against Herbalife, as well as into criminal counter-allegations—mainly stock manipulation—that Herbalife had leveled against Ackman.
However, the standards for proving an unfair and deceptive act or practice are different from those for proving federal crimes. In any case, Herbalife’s disclosure on Thursday did not suggest that any probes were definitively over, or that they were continuing.
Spokesmen for Herbalife and Pershing Square both declined comment.