The Opinion Pages | OP-ED COLUMNIST
Riddle of the Pyramids: What Is Herbalife?
JAN. 9, 2015
“We’re doing God’s work,” said William Ackman, the hedge fund manager, on CNBC this week. He was referring to his $1 billion bet against Herbalife, the company that he accuses of being an illegal pyramid scheme.
For the two years that Ackman has been “short” Herbalife, it has been the most entertaining of business stories. Carl Icahn and Daniel Loeb — both, like Ackman, activist investors — made a grand show of buying Herbalife stock. The stock went up, meaning Icahn and Loeb were making money while Ackman was losing it. Icahn called Ackman a “crybaby in the schoolyard.” Then the two men kissed and made up at a CNBC conference.
Ackman made lengthy presentations laying out his evidence that Herbalife was a pyramid scheme. He set up a website dedicated to exposing it. He raised enough of a stink that both the Federal Trade Commission and the Department of Justice opened investigations. Herbalife fought back with its own battery of P.R. people and lobbyists. The company adamantly denies being a pyramid scheme. Since the middle of last year, however, it has failed to meet Wall Street’s expectations. Now Herbalife’s stock is way down. Although Ackman is now making money on his Herbalife bet, he is not satisfied. He expects the stock to go to zero.
In a way, the ongoing Ackman-Herbalife story is a little like the coverage of a hotly contested political campaign. The horse-race aspect is so entertaining that sometimes more serious issues get short shrift. In this case, the issue is not whether Ackman is up or down or feuding with Icahn, but whether Herbalife — like dozens of other “multilevel marketing” companies — is, in fact, a pyramid scheme.
Pyramid schemes are terrible things — in some ways worse than Ponzi schemes. For one thing, they often involve more money — the direct-selling industry, which includes multilevel marketing, claims that it generates $154 billion in annual revenue and has some 90 million members worldwide. For another, most pyramid schemes take advantage of lower-income people, who are lured in by the prospect of making money while working from home, only to discover that, as pyramid scheme experts will tell you, 99 percent of the people who participate wind up losing money, and sometimes a lot of money.
“There are millions of victims,” says a pyramid scheme expert named Bruce Craig. “I don’t know why people aren’t interested in this.”
Craig is a former Wisconsin assistant attorney general, now retired, who brought a number of pyramid scheme lawsuits in his day. He is passionate about the issue. What frustrates him even more than the lack of attention is the way the government has, in his view, largely rolled over for the industry.
A pyramid scheme, fundamentally, is a scheme in which the only way to make money is to recruit other people, who recruit other people, and so on. It is a kind of chain letter with a product attached to give it the sheen of legitimacy. Until 1979, the Federal Trade Commission was pretty tough on pyramid schemes, according to Craig. But that year, an administrative judge for the F.T.C. ruled that Amway was not a pyramid scheme because it had certain protections for its members, such as not requiring a large entry fee and buying back excessive inventory. Since then, with a little finesse, pyramid schemes could turn themselves into multilevel marketing companies.
Craig has written letters to F.T.C. commissioners asking them to review the Amway decision “on the question of enforcement and enforceability of its rules,” an issue he believes allows companies like Amway — and Herbalife — to pretend to be real when in fact they are pyramid schemes. In one of those letters, he quoted from a 2010 F.T.C. staff report that said that identifying pyramid schemes “entails a complex economic analysis.” The report added that “there is no bright line disclosure that would help consumers identify a fraudulent pyramid from a legitimate [multilevel marketing company].” Really?
When I spoke to John DeSimone, the chief financial officer of Herbalife, he insisted that the company was legit. He said it was built on sales of its weight and nutrition products rather than recruitment. He said it offered numerous protections, such as a money-back guarantee for the first year. He said 80 percent of its members never recruit another person. Ackman, for his part, says that none of this is true, and that the F.T.C. will ultimately see that Herbalife is the very definition of a pyramid scheme.
Assuming, of course, that the F.T.C. has a definition. On Friday afternoon, I called the agency and asked what distinguished an illegal pyramid scheme from a legal direct-selling company. Even having talked to Craig, I found it hard to believe that it wouldn’t have some kind of definition.
A few hours later, I received an email from an F.T.C. public relations staffer. “I’m sorry,” it began, “but we won’t be able to offer you any on (or off) record assistance.”
BILL ACKMAN: We’re Doing ‘God’s Work’ On Herbalife
Bill Ackman channeled his inner Lloyd Blankfein on CNBC Wednesday morning, saying that he’s doing “God’s work” on Herbalife.
For over two years, Ackman has been publicly crusading against Herbalife — a multilevel marketer that sell weight loss products — saying that the company’s stock is worthless.
The phrase “God’s work” was made famous by Goldman Sachs CEO Lloyd Blankfein in a 2009 interview. The comment, which was meant as a joke, was not taken as such and has since become infamous in finance.
In December 2012, Ackman gave a 342-slide presentation declaring that he was short $1 billion worth of Herbalife shares. Ackman believes that the company operates as a “pyramid scheme” that targets poor people, especially those from the Hispanic population.
His investment thesis is predicated on regulators, specifically the Federal Trade Commission, shutting the company down. (The FTC opened an investigation into the company back in March of 2014.)
In the months that followed his initial presentation, Herbalife shares skyrocketed as a number of fund managers piled on by going long against Ackman’s position. Herbalife’s stock traded as high as $83.51 last year but has recently declined and shares closed at $30.42 on Tuesday.
Ackman told CNBC on Wednesday that he thinks the stock will continue to fall.
“A few more days and we are done,” Ackman said after pointing to the stock’s decline so far this week.
Ackman told CNBC that he thinks Herbalife is “going to miss earnings massively,” and added that the company is going to have to re-do their guidance for next year. Ackman also believes there’s a big seller right now.
In 2014, Pershing Square impressive 40%, while most other funds struggled to beat the S&P 500. One of Ackman’s big winners last year was Allergan.
For a large part of 2014, Ackman’s Pershing Square and Canadian pharmaceutical company Valeant had been pushing to buy Allergan, the maker of Botox. Allergan had repeatedly rejected Valeant’s offers.
Then, Irish pharmaceutical company Actavis came in as a white knight and agreed to buy Allergan, the maker of Botox, for a much higher price than Valeant was going to pay.
Ackman, who owned about 10% of Allergan shares, made over $2.2 billion on the Actavis/Allergan deal.
“I’m not disappointed,” he said on “Squawk Box,” adding that he thought the transaction was “great for shareholders.”
Ackman was widely criticized for the trade.
Ackman also told CNBC that he had talked for years about partnering with someone to buy a business. “I think we’ll do it again,” he said, clarifying that it’s a “hypothetical” and he doesn’t have a target right now.