Herbalife to pay $200M, but avoids more serious charge

Last Updated Jul 15, 2016 9:43 AM EDT

NEW YORK - The Federal Trade Commission is closing an investigation of Herbalife (HLF).

The Cayman Islands company agreed to fully restructure its U.S. business operations and pay a $200 million settlement over allegations that it deceived consumers, but it avoided more serious charges that it was operating as a pyramid scheme.

Herbalife shares surged nearly 10 percent, to $59.36, in premarket trading.

Under the settlement, Herbalife Ltd. will have to rework its compensation system so that retail sales are rewarded, and scrap incentives that reward distributors for recruiting.

"This settlement will require Herbalife to fundamentally restructure its business so that participants are rewarded for what they sell, not how many people they recruit," FTC Chairwoman Ramirez said in a statement.

Herbalife, which uses independent distributors to sell its products such as dietary supplements and skin creams, said in February that it was in discussions with the FTC about resolving an investigation into "unfair or deceptive acts or practices."

The settlement amounts to a black eye for hedge fund manager William Ackman, head of Pershing Square Capital Management. He has shorted Herbalife shares, betting that they would fall, and waged a high-profile pubic relations campaign to persuade other investors that the company is vulnerable.

Still, the settlement also represents a setback for Herbalife. Under the agreement, Herbalife must stop paying distributors of its products to recruit other members, an important element of the multi-level marketing company's business model. The FTC called that compensation structure "unfair."

Many Herbalife distributors quit after finding themselves unable to make money, the FTC concluded after a two-year probe.

"Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices," Ramirez said.

Herbalife, whose market capitalization is $5.5 billion, must pay $200 million to compensate consumers who lost money after buying large quantities of the company's products. The FTC said it would provide guidance on how to seek repayment at a later date.

"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," said Herbalife CEO Michael Johnson in a statement.

The company took issue with the FTC's findings, calling many of its claims "factually incorrect." Herbalife said it settled the case to avoid the possibility of protracted litigation, saying it "simply wanted to move forward."