Is Herbalife a pyramid scheme? Billionaires bicker, FTC punts

Last Updated Jul 15, 2016 5:27 PM EDT

Herbalife's (HLF) federal settlement may have resolved the U.S. government's questions about the company, but for the billionaire investors who have spent years bickering over the nutritional supplements vendor, the feuding continues.

Herbalife's agreement with the Federal Trade Commission had noted shareholder activist Carl Icahn, who owns the largest stake in the company, crowing that the pact vindicates his contention that the multi-level marketing firm is not a pyramid scheme, as critics have claimed.

"The FTC settlement announced today, coming after a two-year investigation also concluded that Herbalife is not a pyramid scheme -- a conclusion that obviously vindicates our research and conviction," Icahn said in a statement.

But the agreement did specifically weigh in on hedge fund manager Bill Ackman's claim that Herbalife is, in fact, a pyramid scheme. Ackman, who has bet against the company's stock and waged an aggressive public relations campaign to turn other investors against Herbalife, also predicted that the firm would eventually founder under the weight of the FTC deal.

"While it appears that Herbalife negotiated away the words 'pyramid scheme' from the settlement agreement, the FTC's findings are clear," Ackman's fund, Pershing Square Capital Management, said in a statement on Friday afternoon. "We expect that once Herbalife's business restructuring is fully implemented, these fundamental structural changes will cause the pyramid to collapse."

Although Herbalife shares surged following news of the settlement, Ackman also expressed confidence that his $1 billion wager against Herbalife shares will eventually prove lucrative.

Under the FTC settlement, Herbalife agreed to pay $200 million to consumers and to restructure its business in the U.S. The deal resolves the FTC's claims that Herbalife misled hundreds of thousands of people who enrolled to sell the company's products.

Herbalife claimed people could ditch their jobs and earn thousands of dollars each month selling its supplements, even though the overwhelming majority earned very little or even lost money, the agency said.

"I can't say $200 million encapsulates all of the harm," FTC Chairwoman Edith Ramirz said in a news conference on Friday. "But it provides meaningful relief for distributors who lost the most money."

The settlement requires Herbalife to revamp its compensation system so that it rewards retail sales to customers and eliminates incentives that reward distributors primarily for recruiting, the FTC said. It mandates a structure in which success depends on whether participants sell Herbalife products as opposed to buying them.

"It's a warning shot to Herbalife evangelicals who get on stage and talk about 'this is the opportunity of a lifetime.' You're going to have to prove that you're selling actual product," said Peter Cohn of Height Analytics.

Asked repeatedly by reporters whether the FTC had determined that Herbalife is not a pyramid scheme, as Icahn contends, Ramirez declined to endorse that view, saying the regulator's "focus isn't on the label."

Cohn likened the FTC news conference to one held earlier in the month by the FBI director, James Comey, where he recommended no criminal charges against Hillary Clinton for her handling of classified information while secretary of state. "He (Comey) essentially exonerated her (Clinton) but made some very damaging accusations. Chairwoman Ramirz went point-by-point all the nasty things that Herbalife has done over the years while taking a complete pass on are they guilty of being a 'pyramid scheme'," the analyst said.

In fact, the FTC's action and statements bolstered many of the assertions by Ackman, who began campaigning against Herbalife in late 2012. Pershing Square has spent more than $50 million in an effort to show Herbalife to be a pyramid scheme.

Separately, Illinois Attorney General Lisa Madigan announced a $3 million settlement with Herbalife to resolve complaints about false and misleading claims that lured people into a multi-level marketing scheme. A spokeswoman said Madigan's office had received about 400 complaints against the company.

The new rules only apply to sales in the U.S., which account for only 20 percent of Herbalife's revenue.

And, while the company has cleared a major hurdle in the U.S., one analyst said the rest of the globe could pose future problems. "Europe and other parts of the world might jump in and try to regulate the company as well," said Jim Corridore, an analyst at S&P Global, which maintained a hold opinion on Herbalife shares.