On Wednesday, nutrition and weight-management company Herbalife announced that they were issued a civil investigation demand (CID) by the Federal Trading Commission over accusations that they are a pyramid scheme. Following the announcement the company’s stock took a hit, falling by as much as 15 percent. By the end of the day, Herbalife’s shares were down by over 7 percent.
For over a year, the company has been defending itself against this accusation of being a pyramid scheme. The accusation against Herbalife has been spearheaded by hedge fund manager William A. Ackman. According to the New York Times, Ackman began his campaign against the company in December of 2012 when he gave a three-hour presentation during which he laid out his information and his case as to why he believes Herbalife is a pyramid scheme and called for the company to be investigated the FTC.
The presentation was followed up by coordinated efforts over the following year, which included meeting with various state representatives to ask them to ask the FTC to begin an investigation, further news conferences and interviews, and letter-writing campaigns.
The year of campaigning has finally paid off. This week the FTC announced that it is opening an investigation into Herbalife by issuing the CID. The FDC issues a small number of these every year, and it is a standard beginning to any investigation. Very few of civil investigation demands turn into something more serious like a financial or legal action against the company.
Ackman has said publicly that he is motivated by patriotism and that by exposing unethical business practices in this and other companies, he is doing something good for the country. But Ackman has also taken what is called a short sale on the company. In other words, Ackman has placed a bet that the company’s stock will falls below a certain price within a certain period of time. If that happens, Ackman could make a considerable amount of money. This has lead to some speculation as to what Ackman’s true motives are.
So what is a pyramid scheme? According to the Federal Trade Commission, the hallmark of a pyramid scheme is that it promises investors large and quick returns based, not on the selling of real products or an actual investment, but simply on the recruiting of other members to the scheme. But the simple fact of having a product for sale doesn’t necessarily mean that it is not a pyramid scheme. Many schemes will include a product that is simply there to mask the fact that the primary source of money is recruitment.
For it’s part, Herbalife has continued to push back against Ackman’s accusation of being a pyramid scheme. On the company website, Herbalife promotes the value it brings to both the customers that use their products and to those who have chosen to sell their product through featured videos and written testimonials. In their FAQ section they stress that they are not a pyramid scheme do to the fact that “compensation to members is based solely on product sales and not on the mere recruitment of other Members.”
In a written statement in response to the civil investigation demand, Herbalife says that it welcomes the investigation in to whether or not it is a pyramid scheme in order to finally put to rest the large amount of misinformation about the Herbalife.
By Dan Reyes