Federal regulators on Friday closed an investigation of multinational nutritional supplements company Herbalife Ltd, which has for years been dogged by accusations that it was run as an elaborate pyramid scheme.
Though Herbalife was ordered to restructure its US operations and pay a US$200 million settlement, it avoided being classified by the US as a pyramid scheme.
According to the settlement, Herbalife must rework the way in which it pays its salespeople. They must be compensated for selling Herbalife products and the company must scrap incentives that reward them for recruiting other salespeople.
A business model that rewards participants for bringing in others to take part in an enterprise is essentially the base model of a pyramid scheme.
“The settlements are an acknowledgment that our business model is sound and underscore our confidence in our ability to move forward successfully, otherwise we would not have agreed to the terms,” Herbalife chairman and CEO Michael Johnson said.
News that the US Federal Trade Commission (FTC) was closing its two-year investigation without labeling Herbalife as a pyramid scheme sent shares soaring by 16 percent at the open of trade.
The company’s shares were hammered almost four years ago when a prominent hedge fund manager unleashed a blistering attack on the company. Since that time, Herbalife has become a proxy battlefield for major Wall Street players who took opposing sides, some shorting the company’s stock believing it would collapse, while others bought huge caches of Herbalife shares.
One of the most vocal supporters has been activist investor and billionaire Carl Icahn, who built up an 18 percent stake in the company after it came under assault from hedge fund manager Bill Ackman in 2012.
On Friday, Herbalife announced that it was boosting Icahn’s stock ownership limit from 25 percent to 34.99 percent.
“The FTC settlement announced today [Friday], coming after a two-year investigation also concluded that Herbalife is not a pyramid scheme — a conclusion that obviously vindicates our research and conviction,” Icahn said in a printed release.
“While Bill Ackman and I are on friendly terms, we have agreed to disagree (vehemently) on this subject,” the statement said.
The two had once sparred when they both called into the business channel CNBC, with Ackman calling Icahn a bully, and Icahn saying that Ackman reminded him of a little boy crying on a playground.
On Friday, Ackman’s Pershing Square Capital Management LP issued a statement to say it was standing behind its characterization of Herbalife.
“While it appears that Herbalife negotiated away the words ‘pyramid scheme’ from the settlement agreement, the FTC’s findings are clear,” it said.
Pershing Square said that it foresees Herbalife’s top distributors and others leaving the company once its restructuring is fully implemented.
A number of Wall Street heavyweights, from George Soros to Michael Gordon, at some point took sizeable positions in Herbalife against Ackman.
However, under requirements of the deal it struck with the FTC, Herbalife is facing some significant hurdles going forward.
At least 80 percent of Herbalife’s product sales must come from “legitimate end-users,” the FTC said.
That is exactly the contention that Ackerman first made four years ago, that Herbalife was able to generate huge sales because so much of its products were sold to its own salespeople, who in turn would have to sell the products to turn a profit themselves.
Shares of Herbalife gained more than 9 percent in Friday afternoon trading.
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