Herbalife Ltd.’s investigation by the U.S. Federal Trade Commission, a move hedge fund manager Bill Ackman had sought for more than a year, threatens to stem a stock rally that had boosted the shares by more than half.
Herbalife shares fell 12 percent in New York in the two days after the company announced a civil probe into its practices by the FTC. Before the drop, the stock had gained 54 percent since Ackman first accused the company of being a pyramid scheme in December 2012.
For Ackman, the FTC’s move is a rare bright spot in his campaign against Herbalife -- an effort that so far had been the worst investment in the history of his firm. While the investigation isn’t an indication of wrongdoing, it could drag on for months before getting resolved, said Michael Swartz, an analyst at SunTrust Banks Inc. in Atlanta.
“This process is unlikely to conclude any time soon,” Swartz, who recommends buying the shares, said in a note. The FTC probe doesn’t change his view of the stock, though such investigations can take six to 12 months, he said.
Ackman made a $1 billion bet against Herbalife’s shares in 2012 and started working to persuade regulators to shut the company down, saying it misleads distributors, misrepresents sales figures and sells a commodity product at inflated prices. Herbalife has repeatedly denied Ackman’s allegations while winning over such allies as billionaire Carl Icahn and Post Holdings Inc. Chairman William Stiritz.
Those investors’ support has helped boost the shares, foiling Ackman’s attempt to wager against the stock. His firm, New York-based Pershing Square Capital Management LP, said last month that it had lost 49 percent on the investment.
While the fund reduced his equity short bet against Herbalife last year and replaced it with options, Ackman has vowed to take his fight against the company “to the end of the Earth.” The new setup increases his potential gain from a decline in the shares, he said.
Herbalife today rescheduled its annual shareholder meeting to April 29 from April 24, saying the delay allows the company to continue talks with Icahn about potentially adding additional nominees to the board, according to a statement.
In a pyramid scheme investigation, the FTC can negotiate a settlement with the company or file a lawsuit in federal court, where the agency can seek an order requiring it to change practices and refund consumers, said Joel Winston, a former lawyer with the FTC’s consumer protection bureau. Only in cases of “hard-core fraud” does the agency move to shut down a company, he said.
“The FTC is going to have a challenge in trying to prove that this is a pyramid scheme and not a multilevel marketing operation,” said Winston, now a lawyer at Hudson Cook LLP. “Herbalife has done a fair amount to try to put itself into the multilevel marketing category. The cases where they try to shut a company down is where the company is just an absolute fraud.”
The FTC, along with the U.S. Securities and Exchange Commission, had been asked by Senator Edward Markey, a Massachusetts Democrat, to look into Herbalife’s business practices. An advocacy group called the League of United Latin American Citizens also has met with FTC Chairwoman Edith Ramirez to describe alleged abuses by the company. Ramirez told Markey in a letter last month that his concerns were being “carefully considered.”
The New York Times reported this week that Ackman had donated $10,000 to the advocacy group and hired a former aide to Markey as part of his anti-Herbalife campaign.
“Herbalife welcomes the inquiry given the tremendous amount of misinformation in the marketplace,” the Cayman Islands-based company said yesterday in a statement. “We are confident that Herbalife is in compliance with all applicable laws and regulations.”
Pershing Square and Justin Cole, a spokesman for the FTC, both declined to comment.
The investigation will most likely end with Herbalife intact while paying a “palatable fine” and agreeing to stricter controls on its multilevel marketing structure, said Robert Chapman, founder of hedge fund Chapman Capital LLC in Manhattan Beach, California. Chapman, who has been critical of Ackman, owns Herbalife stock and bullish derivative options.
Since 1996, the FTC has brought 15 cases alleging that companies claiming to be multilevel marketers were in fact pyramid schemes, according to Ramirez’s letter to Markey. Last year, the FTC and three states sued Fortune Hi-Tech Marketing, accusing the Kentucky company of being a pyramid scheme that falsely claimed consumers could earn money by selling products.
According to that complaint, people paid fees to become independent representatives and only made money from recruiting new representatives rather than sales of products. The scheme affected more than 100,000 consumers in the U.S. and Canada, the FTC said.
Herbalife sells its vitamins and meal-replacement shakes through a network of independent distributors, each of which earns revenue and incentives based on product sales by them and distributors they recruit.
Ackman renewed his attack on Herbalife earlier this week with a two-hour presentation accusing the company’s Chinese business of violating direct-selling laws.
Icahn, meanwhile, has defended Herbalife. The activist investor disclosed in early 2013 that he’d taken a stake in the nutrition company and would discuss strategic alternatives with its management. Icahn has since increased his investment and is now Herbalife’s largest investor, with a 17 percent holding.
Stiritz, chairman and chief executive officer of Raisin Bran maker Post, is Herbalife’s fourth-largest shareholder. He owns about 7.4 percent of the shares.