Pershing Square’s lawyer, David Klafter, Sends a Letter to Herbalife’s Chief of Compliance, Pamela Jones Harbour

AdviceDavid Klafter, Senior counsel at Pershing Square, wrote an extensive letter to Herbalife’s new chief of compliance, Pamela Jones Harbour. Before diving into the letter, the basics:

Pam Harbour was a former FTC Commissioner. The FTC is led by 5 commissioners, she was one of them for 7 years. She recently took a position as head of compliance at Herbalife. Based on public comments, she’s been given tremendous authority.

David Klafter is a lawyer. He’s obviously well qualified and talented. With that being said, in this arena, I think it’s safe to assume the following:

He’s never represented a network marketing company;
He’s never represented a distributor in a network marketing company;
He’s never represented a network marketing company against Federal regulators;
He’s never worked with a compliance department in a network marketing company;
He’s never given advice on the appropriateness of penalties for compliance violations;
He’s never sued a network marketing company;
He’s published no articles, neither academic nor online, relative to the network marketing industry.

I’m not saying he’s a bad lawyer. He’s actually a good one. But it’s important to step back and look at the full picture.

As for his employer, Bill Ackman: Ackman warns PwC

He’s vowed to “go to the end of the earth” with his assault on Herbalife;
He’s bet $1,000,000,000 on Herbalife’s demise, accusing them of being a sophisticated pyramid scheme;
He’s spent $50,000,000 researching / attacking Herbalife;
He’s being investigated by the SEC for Insider Trading;
He’s counting on the Federal government to bail him out of his bet with Herbalife, hoping for regulatory action;
He’s suing the Federal government over Fannie Mae and Freddie Mac;
He’s been busy bribing / lobbying Congress to stimulate regulatory pressure. There’s nothing illegal about bribing people in Congress…money in politics is a disgusting reality these days;
He secretly promised a disgruntled former Herbalife executive as much as $3.6 million over 10 years if he blew the whistle.

With all of that being said, it was very magnanimous of Pershing Square to offer assistance to Pamala Harbour.

Since you now have a little more context into the history, it’s time to dive into the letter (available here if you’re reading this via email).

I’ve always believed it to be important to understand from the critic’s point of view. When I process all of the information, both good and bad, I feel I’m in a better position to give advice and make decisions. The “we’re completely right and they’re completely wrong” attitude is held by many in the MLM industry, and it’s juvenile and stupid. This eyes-wide-shut mentality has led to the proliferation of countless scams, all operating under the guise of legitimate network marketing. The largest trade association of network marketing companies, the DSA, has failed to appreciate the enormity of this problem. It’s this failure to spot these issues both inside and outside of its walls has led some member companies to question their continued involvement.

To steal a word from Herb Greenberg, the industry is due for a reset. Based on methodologies, this reset will impact some companies more than others. But make no mistake about it, the screws are about to be tightened and companies will no longer be able to turn a blind eye to questionable activities in the field. The days of “faux compliance” are over.

The question that has analysts on Wall Street scratching their heads: How will this reset affect Herbalife’s revenue? Is the more responsible Herbalife capable of producing similar results as the pre-Ackman Herbalife?

The reality is that the industry absolutely needs to improve. It’s true that many of the sins being referenced by Pershing Square are indeed problematic. Do those transgressions warrant an injunction? No. Is Herbalife a pyramid scheme? No. Have they been caught in the middle of some embarrassing mistakes? Yes. Will they continue to grow? Yes.

In my opinion, unless he exits from his position, Ackman is not going to profit from his gamble with Herbalife. Instead, he’s made an investment that will ultimately benefit the entire network marketing industry, revealing the vulnerabilities and leading to eventual reforms.

Back to the letter…

It’s hard to take this letter seriously when it starts off by saying “[W]e believe Herbalife operates the largest and best managed pyramid scheme in the world.” And with that being said, Klafter proceeds to offer Harbour some free advice.

He does have some good ideas. His compliance recommendations, of which he makes 17, can be boiled down to 2 categories:

(1) Transparency
(2) Authority

Transparency

DisclosuresThe majority of the letter is dedicated to Herbalife’s purported lack of adequate income disclosures. According to Klafter, Herbalife’s current income disclosure document needs to be more robust. Klafter appears to think that more substantial disclosures will result in fewer enrollments and less revenue. He writes, “It is the image (true or not) of their financial success that motivates existing distributors to continue investing time and money, and arms these top distributors with an essential deception that they use to lure new recruits into the scheme.”

He accuses Herbalife of condoning a “fake it till you make it” culture. Earlier in the letter, he writes, “Consider what would happen if, in all meetings with potential recruits, the recruiters were required to remind the audience clearly of certain key facts, for example: 88% earn nothing from the Company; Most money goes to the top 1%; Members churn rapidly; Most distributors suffer net losses. . . ”

Cultures of hype and hyperbole are problematic and do exist. Is it inherent in Herbalife’s culture? Does Herbalife sanitize this sort of behavior with its income disclosure measures? It’s not for me to decide.

Will an increase in disclosures slow down enrollments? No.

I have had numerous clients become more aggressive with its disclosures of average earnings. I’ve seen a client go so far as to say, on camera, “there’s a good chance you’re not going to make any money in this business.” As it turns out, the majority of people aren’t stupid. People intuitively know that there are no guarantees in anything, especially with an income opportunity. When they hear clear messages regarding average earnings, their level of Trust for a company increases, which is actually good for business.

As pointed out by Plaintiff’s counsel in the proposed settlement order in the class action case, “Herbalife claims, and has produced some documents and information indicating, that, since it began publishing the information regarding the winners and losers in its 2012 Statement of Average Gross Compensation [which contained more information regarding the average results], the number of people becoming new Herbalife members has not declined at all. In fact, new memberships have increased. In other words, Herbalife argues that after it began disclosing more information about those who received no payment from Herbalife in its SAGCs, there was no ‘impact’ on the number of people who wanted to become Herbalife members.”

While Klafter is looking to give Herbalife a poison pill, one that he thinks will lead to their end, pressuring them to up their game with income disclosures is not it.

Regarding the sale of “recruiting materials,” Klafter might have traction here. In some companies, particularly the older ones like Amway and Herbalife, some sales leaders have historically made additional income selling “tools.” In some cases, this “additional income” dramatically exceeds the money provided by the MLM. With Herbalife, it has come out that some of their leaders have earned significant incomes from the sales of leads (an old practice, recently shut down) and tools. The issue: It can be construed as misleading when leaders are showing images of wealth at an opportunity meeting when the source of that wealth was not from the sale of products. Amway has bled because of this very issue, being the main driver for its $50M+ settlement to a class action case. If leaders are talking about yachts and mansions while they’ve only made $200,000 from an MLM and $2,000,000 from tool sales, it’s a problem.

Companies in the industry need to be better when it comes to MLM income disclosures. The rules are simple. Whenever money is discussed, the prospect needs to see the average earnings. Instead of simply checking a box where the new person asserts that he or she has seen the disclosure document, I recommend that companies be more clear and have the prospects assert “I understand that the average participant earns a net income of $20 in this business.”

Authority

BOSTON_BOMB3_2541703bThis other category of his compliance suggestions is far more interesting. And candidly, I had never considered these sorts of concepts. Basically, Klafter expresses his hope that Pamela Harbour will have enough authority to protect consumers, regardless of the impact it may have on her employer. This is made clear in the letter when he writes:

“You may find yourself at the fulcrum of choosing between protecting consumers or protecting the Company. Based upon our research, we do not believe you can do both.”

He wants Harbour to have the authority to act independent, free from company pressure, to protect consumers. I’ve seen this sort of conflict inside companies between compliance administrators and company executives. Field leaders will align themselves with company executives, insulating themselves from the big, bad compliance department. When it comes time for the compliance department to root out bad behaviors, the distributors run to mom and dad and ask for protection. And more often than not, they get protection.

He also pushes for the compliance department to have the authority to retain separate legal counsel and/or report wrongdoings to the proper authorities without fear of termination.

His compliance suggestions are summarized below:

Modifications to rules to allow online selling

This is a poison pill. Herbalife, along with every other network marketing company, has every incentive to protect its channel of distribution. Online selling (via eBay and other third-party sites) should never be allowed because it completely undermines the field’s ability to sell. And candidly, online selling amounts to less than 1% of all sales activity.

Public announcements of the imposition of sanctions.

I call this the “head on a stake” policy. I’ve seen companies do it and it’s effective.

Protections for compliance admin to allow them to work without fear of termination.

This is interesting. It’s important; however, I’m drawing a blank as to how to execute this at the employment level. People can be fired for anything (in most states); thus, it would be hard for a compliance officer to argue that he or she was terminated because of their actions against distributors.

Independence of compliance from senior executives and senior distributors, such that top distributors are prohibited from inserting themselves into investigations.

This is very important. I’ve never seen a compliance admin be given the ultimate freedom to sanction distributors without an executive’s authority. And executives are under tremendous pressure to protect the relationship with top-leaders; thus, there’s usually a bit of a conflict between protecting consumers and protecting the leaders.

An anonymous procedure for receiving and investigating wrong-doing.

I call this a “911 Mechanism” where people can report bad activity. Most companies already have this in place.

An extensive monitoring system to capture distributor promotional material.

These tools exist. It’s my understanding Herbalife has some cutting edge tools to search content on YouTube and other areas of the web.

Making top distributors responsible for conduct in their downline.

I like it. If the distributors are going to profit from the bad behavior, they need to also share in the consequences.

Imposition of material financial sanctions to those who profit from wrongdoing.

I like it. I would surmise that regulators want to see more than slaps on the wrist when fraud in the field is detected.

Authority for the compliance department to engage separate legal counsel.

This is interesting. I’m not sure how it would work logistically, though.

Authority for the compliance department to refer matters to Federal, State and local regulators.

This is also interesting. I actually agree with it, provided that this authority is used sparingly. I’ve seen clients of mine snitch on field leaders AFTER the leaders were terminated, to give the authorities a heads up. It’s a pro-active way of saying “If you see this knukcle-head, he’s not with us!”

Conclusion

Regarding Herbalife, these changes, if adopted, would not sink the organization as many critics hope. I have found that investments in tighter compliance processes leads to MORE growth, not less. Compliance kills pyramid schemes, not legitimate companies that offer real products. While Herbalife’s domestic revenue has slowed as the field is absorbing these changes, it’s not going to collapse.

Regarding the network marketing community in general, some of these suggestions are worth considering. If done properly, a robust compliance department can actually be really good for business.

It’s true that some companies operate with a “veneer” of compliance, without taking it seriously with the hopes of fooling regulators. Those days are long-gone. The sooner companies come to terms with this reality, the safer they’ll be. Build the ark before it rains.

What do you think? Do you think some of these ideas could fly?

Pershing Square Letter to Pamela Jones Harbour by kevin_thompson

Herbalife Settles Bostick Class Action Case

Herbalife announced its settlement to a class action lawsuit. The case was filed within months of Bill Ackman’s initial presentation where he announced his short position, so it could be an example of a law firm seizing on “blood in the water.” But I digress…

The settlement basically amounts to two things: (1) $15,000,000 in cash for product refunds and remuneration for excessive business expenses (with $5M of that fund going to the lawyers); and (2) Several reforms to Herbalife’s marketing practices. Candidly, Herbalife is already doing most (if not all) of the reforms required as part of this settlement. The cash portion of the settlement was quite smaller than I anticipated, given the size of Amway’s settlement to a similar lawsuit a few years ago ($60,000,000).

Already, there’s a group that’s announced they’re going to oppose the settlement. Brent Wilkes, the director of the League of the United Latin American Citizens (“LULAC”) said via a NY Post Article, “We plan to object to the settlement because it won’t begin to pay for the true damages that Herbalife has caused this class.” On a related topic, I have for a few months suspected that Bill Ackman promised to contribute some of his gains (if the bet goes his way) to various civic organizations. I suspect that LULAC is on that list. I sent both Brent Wilkes and LULAC a message via Twitter on Monday morning asking if any funds were promised. I have yet to receive a response. The question is relevant, in my opinion, because it’s important for all material facts to be fully disclosed. If there’s financial motivation in the background, the public deserves to know so the attacks can be judged accordingly. Again, it’s an unconfirmed suspicion. When I get a response, I’ll update the article.

UPDATE: See below. Brent Wilkes denies having any financial motivation in his attacks against Herbalife.

The required corporate reforms are included below. h/t to Seeking Alpha contributor, Ben_Nimaj for typing it up.

1) Simplified Pricing Structure: combine “Package & Handling” and “Order Shipping Charge” into a single “Shipping & Handling” charge

2) Differentiate “Members” and “Distributors”

3) Discourage members from incurring debt to buy product

4) Pay return shipping charges for legitimately returned product

5) Prohibit members from selling “leads” to or purchasing “leads” from other members

6) Prohibit the purchase of product as a condition of being a member

7) maintain procedures for enforcement of these and other rules, ie. implement a member compliance department

8) Include the Statement of Average Gross Compensation (SAGC) of member with any membership application

9) Require any applicant to actually acknowledge having reviewed the SAGC

10) The SAGC must contain the total number and percentage of all members who do not receive any compensation payment directly from Herbalife, [not just numbers from members that actually made money].

Bostick v Herbalife_Preliminary Settlement by kevin_thompson

Time to Revisit DSA’s Code of Ethics: Suggestions

It’s old news now. Avon left the DSA. In their announcement, they stated the DSA’s Code of Ethics needed revision. Specifically, Cheryl Heinonen at Avon said, “We believe the association’s agenda in the U.S. is overly focused on the issues of a few specific brands rather than industry-wide challenges. . . We believe that the U.S. DSA Code of Ethics requires updating to better reflect the current state of the industry in the U.S.”

In a separate article in the Washington Post, Heinonen gave a quote that shed a little light on what she meant. She said,

I think it’s problematic when you sell inventory — bulk product — that the person who is acquiring it can’t use themselves and sometimes may not know how to sell,” Heinonen said. She added that the language in the trade association’s code of ethics on this point and other aspects of consumer protection need to be firmer.

The problem: inventory loading. And I’ll drill down a little deeper because inventory loading, when it exists, is a symptom of a larger problem: lack of product value. In other words, when there’s a lack of legitimate demand for product, companies incentivize participants to “load up” on items they might not want or need in an effort to qualify for bonuses.

The cure for this problem has historically been the 12-month refund policy. If you boil down the DSA’s Code of Ethics, the most valuable requirement is the 12-month refund policy. According to Avon, this is not enough. And I agree.

The DSA has invited people to propose changes to the Code. Here’s a start. Call it “The KT Optimus-Prime Plan” (everything is better when you use Transformer names).

(1) Proper Customer Coding

I suggest that companies be required to offer an option for Customers to receive product discounts without joining. The technology exists. The most basic of startup companies in the industry can pull this off. The Preferred Customer concept has been around for at least 5 years, possibly longer. Today, it’s a great source of confusion when we, as an industry, say “We’re not able to deduce the amount of customer activity because many people join to save money on product.” While it’s a true statement, we’re in a position to clear this ambiguity and offer clean data. The alternative is nebulous and unprovable (short of paying for surveys, which has been done by Herbalife). Understand, it’s not illegal to operate without a preferred customer option. The absence of a customer option is not conclusive proof of fraud; thus, it’s not legally required. But, in my opinion, the DSA should not want to swim with average, they should strive to be above-average. Currently, the 12-month refund requirement is good, but by itself, it’s not good enough. There’s a cancer that has developed where companies, using the DSA’s Code, are “looking good” without actually being good.

Requiring that companies clearly track their buyer motivations / offering a clear path for customers will help eliminate all doubt regarding the motivations driving volume consumption. There’s no need to mandate the AMOUNT that needs to come via customers, just to have the ability to clearly track the data.

Also, along these same lines, when it comes to direct sales i.e. belly to belly sales, there needs to be a requirement that companies accumulate receipts from their sales leaders. The excuse that “we’re not able to track the retail activity in the field” needs to end. In the past, the excuse was reasonable. Going forward, it makes little sense.

The downside (or upside, depending on how you view it): regulators, via a subpoena, will be able to clearly see the amount of customer activity.

An argument against this concept: “When people join to save money on product, they might turn out to be productive distributors later.” In my opinion, the likelihood of these participants producing significant volume is slim; thus, the upside is not worth the alternative.

(2) Zero Personal Volume Requirements

This should be easier than the #1 idea above. It’s common for companies to require personal volume each month for participants to earn commissions i.e. move $100 worth of product to remain qualified for bonuses. While companies are smart enough to construct this in a way where it’s technically not required for people to buy the product (because they can qualify by SELLING too), in most cases, participants get on autoship and self-qualify. This is not illegal; however, the concept has been abused. It leads people to buy things they might not otherwise want or need in order to remain qualified for bonuses.

This sort of rule would be consistent with the current state of the law. In BurnLounge, the court cited the fact that participants were required to purchase products in order to qualify for commissions. This fact was used to prove that the participants were buying products primarily to qualify for money instead of the value. While companies today can argue that participants are technically not required to buy, BurnLounge also teaches us that courts and regulators will look at how companies “operate in practice.” If the vast majority of participants qualify via an autoship, it matters not what’s on paper. It’ll be used as proof to show that the opportunity is driving consumption, not the products. Yes, it might be more difficult for companies to get participants to buy products. But if participants do not WANT to buy product, why force them? The DSA, in my opinion, should create space here.

(3) Income Disclosure Statements

The DSA should require its member companies to publish average earnings. We know that EVERYONE makes income claims in the industry. When recruiting, the question always comes up: “What’s in for me?” The pay plan has to be explained, which means that income will be referenced. It’s not illegal to make income claims. It is, however, misleading to make income claims WITHOUT ADEQUATE DISCLOSURE. With this in mind, why allow companies admittance without a solid income disclosure document?

(4) Undisclosed Financial Arrangements

It’s common in the industry for a company to offer additional compensation to leaders in exchange for them leaving another company. While the agreements never explicitly say “We’re paying you to leave Organization X and raid your old downline,” they might as well. This sort of behavior has spun out of control, causing companies to rip into each other and there needs to be a clear signal at the highest levels that this will not be tolerated.

First, the FTC’s Testimonial and Endorsement Guidelines strongly suggests that these sorts of undisclosed deals are fraudulent. I wrote an article on the subject in June of 2010 here.

Second, these sorts of deals are not illegal. It’s only a problem when there’s no disclosure. If the DSA were to require that these deals be disclosed, it might actually curb the activity.

Third, these sorts of deals are bad for the industry because, candidly, they rarely make economic sense. The leader leaves, boasts about the greatness of the new company, takes very few people with him or her and subsequently crashes. This leaves hyperbolic activity in the industry where companies are trying to out-hype each other.

Fourth, the DSA’s Code Administrator, when put onto the case, can easily deduce if a deal has been struck and whether the deal was publicly disclosed.

(5) Compliance Training

Rule 11 in the Code of Ethics states: “Member companies shall provide adequate training to enable independent salespeople to operate ethically.” But what does this mean? If companies are going to be allowed to sell starter packs ranging in price between $500 and $2,000, there needs to be solid training to ensure that the inventory moves properly. Compliance training can be delivered a number of ways: videos, email blasts, etc. If a new distributor was promised easy money, the time to cure this false expectation is at the beginning of their tenure. This is where the company can explain its refund policy, explain that success takes work and also reference its income disclosure statement. And, if the company were confident, it would be a great opportunity to suggest that if the distributor wants easy money, they should quit now and get a refund.

(6) Sales Aides

The Code needs to improve in this category by clearly prohibiting the practice of paying commissions on sales aides. First, it’s clearly pyramiding. Sales aides are not commissionable because there’s no market for the products beyond the network itself i.e. there’s no opportunity for customer sales, i.e x 2 the resulting rewards are “unrelated to product sales to ‘ultimate users,’ i.e. x 3 it’s pyramiding. The Code tries to create space from this practice by saying, “This Code provision is not intended to endorse marketing plans that provide financial benefits to independent salespeople for the sale of company-produced promotional materials, sales aids or kits (“tools”).” The Code needs to revisit this issue and address it head-on.

If the company, or its leaders in the field, sell tools and pay commissions on those tools, they need to adjust or get out. Tool sales are highly profitable, leading sellers to focus primarily on recruiting new participants to expand the market for those tools (because there’s no market outside the network itself; thus, recruiting is the only way to maximize profitability). It leads to a twisted culture in the field, one that depends on hype and hyperbole. The DSA needs to create space here.

Conclusion

It’s time to have an honest discussion about the future of the industry. Candidly, it’s BEEN time for several years. But, it sometimes takes a good crisis to mobilize support for change. Avon’s departure is a good catalyst for this sort of discussion. I’m not a fan of closed door meetings. Transparency is key. And transparency, at times, makes people uncomfortable. If you know me by now, you know that I’m not one to “kiss the hand” and play political games. In other words, I’m not trying to be liked by everyone.

Leadership at the DSA needs to understand that building a consensus on any of these issues is going to be impossible. In order to “tighten the screws,” it’s going to frustrate some member companies. It needs to prepare itself for a little internal-controversy. Candidly, the DSA avoiding some of these issues has also frustrated members, leading to Avon’s departure. Avon was not a fluke. While this subject matter is unpopular, it’s very important for the health of the industry. I think the best ideas come by way of open discussion. And I’m not afraid to lead it.

Do you agree with any of the “KT Optimus-Prime Plan” items referenced above? Disagree?

Don’t be bashful. Share your thoughts and share this article.


Memo by Hedge Fund Manager Robert Chapman: Bill Ackman’s Attempt to Goad Regulators Into a Baseless, Unnecessary Legal Battle

The attacks on Herbalife have been staged on many fronts.  Almost two years into Ackman’s bear raid against Herbalife, the clock is ticking and Ackman undoubtedly needs a government bailout / regulatory action against Herbalife.  Ackman’s thoughts about those on the long-side of $HLF: they’re all idiots.  Kenny Moelis, Bill Stiritz, Carl Icahn, Joele Frank, Boies Schiller, PWC, “uneducated” Herbalife distributors….all operating with inferior minds to his own.  Do Ackman and his gang have an explanation for the 0.25% rate of return on Herbalife products (which offers a 100% buyback)?  Sure they do. It’s magic.  I’m not kidding.  Brent Wilkes, director of a Latin American advocacy group, attributed the low rate of return of inventory to a “magical hold” Herbalife has over its distributors.  In other words, consumers, if they were thinking clearly, would demand more refunds.  

This is not even the tip of the iceberg on the elitist logic used by MLM critics.  Lately, the “influence-by-insult” strategy has been directed towards federal regulators.  With titles like “Does Herbalife Think The FTC Is Dumber Than A Bag Of Hammers?,” the critics are directing their ammo at regulators.  In other words, if the FTC fails to intervene, they’re “asleep at the wheel” and stupid like the rest of us.

Robert Chapman calls out this strategy in a very well-researched memo.  With his permission, I’ve included the full content below.  The actual PDF can be downloaded here.

Begin memo

DATE:            August 8, 2014

TO:                  Herbalife Regulators and Related Parties

RE:                  Bill Ackman’s Attempt to Goad Regulators Into a Baseless, Unnecessary Legal Battle

Introduction.  As has been covered widely by the media, Pershing Square Capital Management’s Bill Ackman has been engaged in a nearly two-year campaign to profit by putting Herbalife out of business.  Ackman’s goal appears quite obvious:  to add $2 billion to Pershing Square’s and his own wealth while feeding his apparently insatiable appetite for ego and reputational aggrandizement.  The first goal – earning profits for himself and his investors, is the cornerstone of legal and socially acceptable capitalism.  As such, it deserves no rebuke.  However, Ackman’s unconventional method of accomplishing that profit goal – making what I and an indisputably respectable list of Herbalife institutional and individual investors view as a seemingly endless string of false, exaggerated, and/or misleading statements via an unprecedented $50 million “research” (propaganda) campaign–  is worthy of the high volume of criticism it has received.

My Motive.  Unlike Ackman and his gang, I shall not attempt to obfuscate the motive underlying this communication, nor will I make false claims about what conclusions I believe the short sellers have drawn.  Unlike the short sellers preposterously stating that the shareholders of Herbalife believe it to be an illegal operation, I shall not baselessly state that the short sellers of Herbalife believe it to be a legal operation, although there are various signs that Ackman belatedly has come to realize that is the case and thus shall pivot next to goading lawmakers into changing the law itself.  I shall state my motive honestly and clearly: to portray accurately my view of this last ditch tactic being used by Ackman and his gang – to goad and attempt to shame regulators into a baseless, unnecessary legal battle against Herbalife.

Desperate Situations Require Desperate Measures.  Having incurred an estimated $200 million – $400 million in realized and unrealized losses on this one investment, Pershing Square finds itself in a fragile reputational position.  Particularly following Ackman’s unapologetic yet highly influential role in the dismantling and near bankrupting of 100-year old retailer JCPenney, his status as an investment superstar is in further jeopardy with Pershing Square’s Herbalife debacle, which unlike massive money losers JCPenney or Target, is far from over. Having proclaimed ubiquitously that Pershing Square’s research on Herbalife had led to this “best investment idea ever,”  — this despite Ackman’s reported decision not to have even one meeting with Herbalife management before launching his bear raid in December 2012 — his reputation, and potentially his franchise should there be legal repercussions, is on the line.  Indeed, the investment and regulatory worlds appear to be converging on an agreement that Ackman’s claims vs. Herbalife are mostly wrong.  Moreover, there exists no shortage of those who believe that Ackman now appears to know that his emotionally fraught analysis was and remains “wrong.” Even so, he persists in a quixotic and  most un-valiant holy war against an enemy of his own fabrication.

Ackman’s Final, Desperate Strategy:       Goad/Shame the FTC into a Self Serving, Baseless Legal Battle

  • Goading/Prodding Just the Latest Tactic at Manipulating Regulators:  It is no coincidence that Bill Ackman kick started his July 22nd Herbalife-bashing presentation with John Hempton’s thoughtless categorization of the global nutrition products company Herbalife as “scumbags” in a 2012 CNBC interview.  Ackman’s nutrition club presentation followed Bruce Craig’s letter from the day earlier to FTC Chairwoman Edith Ramirez, in which the anti-MLM campaigner went over the heads of both FTC Bureau of Consumer Protection (CPB) Director Jessica Rich and FTC CPB Marketing Practices Director Lois Greisman in an overtly hostile attack.  Essentially, Craig publicly accused Ramirez subordinate Jessica Rich of having the wrong priorities (based on a March 2014 speech whereof in a MLM clampdown was not highlighted) and preposterously seemed to categorize her subordinate Lois Greisman as a feckless shill for the MLM industry, based apparently on the absurd theory that since her prior boss at the FTC was Amway’s lawyer, she must be aligned with the MLM industry herself.  I can only imagine how Ms. Rich and Ms. Greisman felt when they read how they were being depicted by Ackman ally Mr. Craig to their own common boss.
  • The Order Apparently Has Been Sent Down from Pershing Square:  Very recently and non-coincidentally, one can hardly read any of the myriad Seeking Alpha “articles” or other short seller propaganda without recognizing an obvious pattern of the short sellers trying to shame the FTC into shutting down or otherwise impairing Herbalife.  In the most recent post by Bill Ackman’s close personal friend and Herbalife short seller Whitney Tilson, Tilson claimed that many of Herbalife’s investors “concede the company is deceptive, but invest because they think regulators are spineless.”  Tilson is surprisingly shameless in displaying his coopting of Ackman’s “goad the FTC” tactic.  As one of his correspondents (per Tilson’s own concession) wrote to him on July 26 and then published proudly by Tilson, “I believe you are correct that the regulators will ultimately be goaded into action.” Tilson’s correspondent then took a shot at goading the regulators himself:  “Many of our regulators are not fond of complex cases and hard work.”  One can expect more disrespectful propaganda like this coming from those who stand to strike it rich by maiming or dealing a “death blow” to Herbalife.  They indeed seem willing to try virtually any tactic to manipulate the markets, media or regulators to that dire end.
  • Short Sellers Must Know Their Claims Are False:  The short sellers are spreading these transparently manipulative and, in my view, knowingly false depictions of the true investment thesis of Herbalife’s investors.  The true long/bullish thesis I actually do hear is that the Company is a legitimate, legally operating global MLM selling products desired and purchased by ultimate consumers, both internally and externally.  Again, whether it be D.A. Davidson’s (Tim Ramey) or Barclays (Meredith Adler) with their in-depth sell-side research, or 19% Herbalife owner Carl Icahn’s repeated public statements that he believes Herbalife is a legitimate, legally run company selling products that help people worldwide, there is not a single Herbalife investor amongst the many with whom I have spoken who ever has indicated in any way that Herbalife is ‘deceptive’ or ‘fraudulent’.  Even John Hempton’s careless choice of words in 2012 was intended to convey his view that the MLM industry has participants, including some distributers of Herbalife products, who are overly aggressive and opportunistic.  Moreover, that singular statement, no matter how taken out of context by Bill Ackman, did not represent anyone but John Hempton’s apparent view at that particular time.
  • Short Sellers Insult the Regulators’ Collective Intelligence:  The irony and hypocrisy of the Herbalife Short sellers vis-à-vis the MLM’s regulators is nothing short of astounding.  Ackman and his cabal of profiteers are not dissimilar to a small but high pitched gang of school yard bullies who repeatedly egg on an honors student to start a fight by shouting, “Come on!  He called you a wimp!  You really gonna take that?”  As I shake my head in disbelief, I wonder how Ackman & Co. actually believe that these truly sedulous regulators, who have a history of taking on the likes of the Mafia, international drug dealers and money launderers, possibly could be goaded into doing the short sellers’ bidding with this patently obvious shaming tactic.
  • Charming, Cajoling, Overwhelming, Bullying and Now Goading and Shaming Regulators:  In mid-late 2012, nearly two years ago, it appeared that Bill Ackman began his version of a charm offensive with the FTC, SEC and other state regulators.  Exhibiting a typical lack self-awareness, Ackman essentially told the FTC, the SEC, and state regulators that Pershing Square was doing these regulators a huge favor by blessing them with his propriety analysis that supposedly proved Herbalife to be a “criminal enterprise.”  Again, allow me to emphasize, Ackman essentially accused these regulators of having been asleep at the switch for nothing short of decades, and, as such delinquents, they all require Pershing Square’s collective perspicacity to finally do their regulatory jobs.  When his unique form of enchantment predictably failed, Ackman moved on to overwhelming the regulators with a deluge of documentation estimated into the thousands of pages.  As that tactic did not attain the immediate prosecution Ackman sought, Ackman moved onto his well-practiced approach of bullying, enlisting a relatively small segment of LULAC and a U.S. Senator to replace his own public face of his war.  In March this year, some 15 months after his first public presentation, Ackman’s final bullying thrust seemed to pay dividends when the FTC launched the formal investigation for which Ackman had agitated.  However, there is a great distance between the investigation and shutting down of Herbalife, as the now 1.5 year SEC investigation exhibits.  One may want to ask the following hypothetical:  “What might Ackman do if the SEC has turned its focus on Pershing Square and/or one of its current or former employees involved in Herbalife? What theoretically might Ackman do if he begins to sense that the results of the FTC investigation were heading toward actually vindicating rather than crucifying Herbalife? Might Ackman and his gang then begin to goad, prod and attempt to shame the FTC into a fight that was baseless and solely served the interests of those who have sold short Herbalife’s stock?”  This is precisely what I believe is happening.
  • Regulators of Herbalife are Diligent, Not Spineless:  At the risk of stating the obvious, every bull on Herbalife shares I know thinks the FTC/SEC/AGs/DOJ are anything but spineless.  Instead, they are extremely diligent in prosecuting truly illegal, endless chain pyramid schemes that primarily compensate distributers for ENROLLING their downline (vs. selling product/inventory to that down line).  The FTC, and the Illinois, Kentucky and North Carolina attorneys general hardly were “spineless when they worked for years together ahead of halting truly illegal pyramid scheme Fortune High Tech Marketing.  For over half a decade, the FTC investigated and then prosecuted truly illegal pyramid scheme BurnLounge, successfully pursuing justice through 2014 all the way to the Ninth Circuit Court of Appeals. The diligently laboring Securities and Exchange Commission (SEC) hardly was “spineless” when it slapped TelexFree with a lawsuit on charges it sold fraudulent and unregistered securities to mostly Brazilian and Dominican immigrants, who served as its promoters.  New York Attorney General Eric Schneiderman, amongst a plethora of other effective and legitimate law enforcement, ferociously has pursued enforcement against the High Frequency Trading players, whose business model involves front running the investments made indirectly and directly by America’s hard working citizens.  California Attorney General Kamala Harris has risen to superhero status on a national scale for her hard charging battle against the nation’s top banks to win a $20 billion settlement for mortgage fraud.  This is but a tiny sample of many examples of strict, appropriate enforcement.  The list of “fully spined” regulators and their persistent pursuit of justice via the prosecution of legitimate, non-falsified or fabricated cases is truly endless.  Therefore, I apologize for the many I failed to include in my list above.

ConclusionThat regulators refuse to be cajoled, bullied, prodded, goaded and “shamed” into pursuing Bill Ackman’s profiteering and self- aggrandizing agenda does not come anywhere close to making them “spineless.”  This is so obvious that any reasonable observer, Herbalife investor or otherwise, would have to agree. Bill Ackman and his compliant operatives should feel ashamed for their transparent attempts to manipulate not only the markets[1], but those who assiduously and honorably have been regulating them for decades.

[1] Herbalife’s illiquid convertible bonds (2’s of 2019) in the past few weeks have been sold down aggressively and disproportionately to the common stock, with some speculating that Pershing Square directly or indirectly (via CDS bidding) having influenced their lower pricing to create the appearance and related media “reporting” of a symptom of financial distress, despite the company’s healthy debt service coverage.

End

MLM Attorney, Kevin Thompson, on Bloomberg TV

I had the privilege of being on Bloomberg for a small segment talking about Bill Ackman’s latest presentation. The 7-minute segment can be viewed above. Ackman’s presentation today, if you can spare 3+ hours, can be found here.

Before summarizing his argument, it needs to be said that he heavily promoted this presentation yesterday. He was like Muhammad Ali talking about the Thrilla in Manila, saying it was “the most important presentation of his life.” He further said that this would be the “death blow” to Herbalife. He successfully spooked the market, causing it to sink 11%. Instead of “conclusively proving fraud,” which was his intent, he ignited confidence in the market due to the lack of substance. After the presentation, the stock UP 25% (same day). I’m not making this up. Up 25% the day of the death blow. Only on Wall Street.

I’ll summarize his thesis:

    • Herbalife’s usage of “Nutrition Clubs” operates like a bait and switch for consumers.
    • The prospects are lured into the clubs on the auspices of hanging out with friends and sampling products.
    • These prospects are then pressured to “get on the treadmill” and join as distributors and recruit more people to visit the clubs.
    • The Club concept is designed to recruit, not to sell.
    • Herbalife’s stance that the clubs foster community efforts for weight loss is smoke and mirrors.
    • He goes further and argues that the positioning of some of the clubs as “success universities” is misleading because they’re not accredited as real universities.
    • He further argues that the Clubs violate various labor laws since the members are expected to help out in keeping the club operational i.e. free labor.
    • He argues that Michael Johnson learned of these strategies of penetrating the hispanic market while at Disney. In my opinion, he gave Michael Johnson way more credit than he deserved in this regard. The Nutrition Club concept was likely an invention in the field.

We discuss the presentation during the interview. Herbalife has issued its own response, including the findings from an economist about its model. Based on his data, he concluded that the vast majority of revenue is attributable to legitimate product consumption i.e. people buying for legitimate value. The data is significant, as it essentially puts the pyramid scheme argument to bed. If true, the majority of commissions are driven via legitimate economic activity by “ultimate users.” This is why, in my opinion, Ackman paid very little attention to the law today. I think he knows the law is not in his favor on a macro level with Herbalife. Instead, he was arguing the facts on a micro level, painting a picture that there’s a massive bait-and-switch occurring with the Nutrition Clubs. In his mind, if he can kill the Nutrition Clubs, he can kill Herbalife.

Commentary from me

Herbalife needs to avoid gloating. They sort of spiked the football today with their remarks. Yes, Ackman’s presentation went off like a snap bomp instead of the full scale firework show we were promised. But, with that being said, he’s certainly not someone to poke. He’s obviously emotionally charged on the issue. He cried on a few occasions during the presentation. In his mind, he sees himself as a “Superman” that needs to rescue these poor, hispanic citizens. While 93% of Herbalife Nutrition Club operators are happy with their experience (based on a recent survey), Ackman would argue that they’re under a trance that only he can break. Referencing the history of his great-grandfather that came to America from Russia, Ackman sees Herbalife as preying on people like his great-granddad, causing significant damage for future generations.

Bottom line: he’s amped up. And his puts expire in January of 2015, which means he needs to land a punch soon to get the stock to soften before he eats the loss. I think he’s done his worst to Herbalife. It’s now in the hands of regulators. Speaking of regulators, he did not provide them with any new ammunition today that they did not already possess yesterday. I stand firm with my initial opinion, made in January of 2013. Admittedly, I could be wrong. But I do not think the FTC will file an action against Herbalife. Instead, I think there’s going to be some sort of negotiated settlement that will involve some sort of penalty for past transgressions. They’re the Federal government…they’re going to find something. Give me Ackman’s investigatory budget of $50,000,000 and I’ll find dirt on whatever you want. The return on his $50M investment was anti-climatic and the market made him pay.

What do you think? What’s next for Herbalife? What’s next in Bill Ackman’s playbook?

Herbalife Announces FTC Investigation

Herbalife announced that the FTC has initiated an investigation. While it’s not pleasant to deal with a government subpoena, this gives Herbalife an opportunity to put this issue to rest. Watch the video below to get my thoughts. In summary, I believe the FTC will use the data it collects from Herbalife to sharpen its saw in an effort to create better guidelines for network marketing companies. They’re not going to sue Herbalife (though I’m sure they’re thinking about it). If you’re reading this via email, click here to watch the video. The paper referenced in my video can be found embedded below (or here).
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Senator Markey’s Letter to the FTC: Prediction

Recently, Senator Markey from Massachusetts called upon the FTC to investigate Herbalife.  His full letter is included below. Click here to read if you’re reading via email. It’s worth mentioning that that the letter was likely originated by someone at Pershing Square, as observed by John Hempton. Markey has useful letterhead, being a U.S. Senator and all. I digress…

These are my predictions:

  • The FTC will respond. While Markey’s letter called for a response by February 28, I’m guessing they’ll respond after the deadline but by late April.
  • The FTC is not going to respond specifically about Herbalife. Three points worth mentioning here: (1) The FTC lacks the data to provide any meaningful commentary about Herbalife; (2) If the FTC had a problem with Herbalife, they’re not going to announce same at the behest of a Senator; and most importantly (3) Herbalife is not a pyramid scheme.  Ackman is playing another confidence game, and the market has grown immune to his tricks.
  • The FTC is going to take this as an opportunity to start a broader discussion about the network marketing space.  There’s an ocean of gray that separates legitimate network marketing companies from illegal pyramid schemes.  As a result of this ambiguity, fraudulent programs are flying under the guise of network marketing, claiming legitimacy because they’re “just like Amway.”  In my opinion, this is the underbelly of the space that the FTC needs to address, not companies like Herbalife.  What will these guidelines look like in the future?  That’s a different set of predictions for another time.

The video is a short one. I hope you find it informative. If you’re reading this via email, please click here to view the video.

Update: Herbalife’s CEO, Michael Johnson, personally wrote a response to Senator Markey. It’s also included below.

Article on Seeking Alpha: Ackman’s Folly With Herbalife: 7 Assumptions That Led Him Astray

I published an article on Seeking Alpha yesterday. SA is a site dedicated to stock analysis. As a wannabe-tech nerd, I think their site is brilliant. People interested in a stock can subscribe to receive updates when articles are published about the specific stock. If you have the mobile app, you’re notified when new articles are live. Herbalife has been a widely discussed stock over the past year. It’s been almost a year since Bill Ackman gave his first presentation about Herbalife. In this article, I outline the seven assumptions that caused Ackman to miss big. The article got 90+ comments on day 1. Some favorable, some not-so-favorable.

Check it. Chime in. Share.

Bill Ackman’s Folly With Herbalife: 7 Assumptions That Led Him Astray

Bill Ackman Throws a Hail Mary: warns auditing firm about liability if they validate Herbalife


If you’re reading this via email, please click this link to watch a full video update.

Ackman Warns PwC

In an attempt to thwart the inevitable short squeeze on Herbalife’s stock, Bill Ackman has recently turned to “warning” PricewaterhouseCoopers of potential exposure if they validate Herbalife’s accounting. The letter is included in full below. Irrespective of the fact that PwC has been in business for over 150 years and have maintained a stellar reputation among auditing firms, Ackman felt the need to educate them on accounting. In the letter, he sites a number of issues with Herbalife’s numbers, none of which will be addressed here because, candidly, I have no idea what it all means. However, I do trust analyst Tim Ramey. He wrote a solid rebuttal to Ackman’s letter, which was included on ValueWalk. The key bullets:

The opening point in the PWC letter is that Herbalife is a pyramid scheme, and PWC will have risk if it audits the Herbalife books and does not disclose that fact. The remainder of the 52 pages does absolutely nothing to prove or allege the pyramid scheme hypothesis. Remarkable.

The letter is an eleven-point discussion of various accounting treatments that Herbalife and its previous auditors have taken. We did not see a single “smoking gun” or anything that would cause us meaningful concern. There are audit-type questions, something that two accountants might have a spirited discussion about at a cocktail party, but nothing that seems material. If this is all Ackman has after millions spent on forensic accounting, Ackman has been cheated. On some of the points Pershing Square is just wrong, in our opinion; a risk you take when your securities analysis does not ever engage in a dialog with the company.

What Does This All Mean?

It’s the fourth quarter with 2 minutes left on the clock. The ball is on Ackman’s 5 yard line. He’s down by 16. He needs to traverse the field, score a touchdown, get a two-point conversion, recover the onside kick, score another touchdown and get another two point conversion. Ackman claims to be armed with the “truth;” however, it’s his version of the truth. In order to pull out of his self-induced tailspin, he needs two things to happen: He needs Herbalife to report a decrease in earnings next quarter (not likely to happen). And he needs, more than anything, the FTC to take action. The FTC is NOT going to take action. Care to know why? (1) HERBALIFE IS NOT A PYRAMID SCHEME; and (2), the existing regulations leave plenty of room for debate on both sides. If there were a lawsuit, the FTC would lose. Plain and simple. The FTC, in my opinion, is not equipped to target companies in the gray. They’ve got to go after the easy targets. And Herbalife, without question, does not fit that definition.

If you’re reading this via email, click here to download the letter.

Herbalife Distributors Continue to Win Despite War on Wall Street

This post is for the unsung heroes carrying the Herbalife organization through this difficult period. Candidly, their distributors are dominating! 2nd Quarter Earnings are in for Herbalife. All of the major metrics are up. Despite the war on Wall Street over the fate of Herbalife between several notable players, the Herbalife distributors continue to produce results. In this video, I explain the importance of their achievement. I also give a few predictions about what this conflict means for the future of the industry.

If you’re interested in the financial elements surrounding Herbalife stock, check out the video below. Robert Chapman does a great job explaining the current and potential value of $HLF. He understands the network marketing model AND the markets, which makes his insight valuable. If you’ll recall, Robert Chapman was literally the first professional on Wall Street to question Bill Ackman’s analysis. His article titled “Herbalife: Why I Made It a 35% Position after the Bill Ackman Bear Raid,” let a lot of air out of Ackman’s proverbial tires. It moved the market. I’m proud to know him.

http://video.cnbc.com/gallery/?play=1&video=3000187031