Herbalife Agrees to $200M Settlement with FTC Over Pyramid Scheme Allegations

You've probably heard of the nutritional supplement company Herbalife. Heck, the chances are high that half of your Instagram followers are pitching the company’s suite of products.

For years, Herbalife was a towering example of multi-level marketing (MLM) -- or, to those who say they were burned by the company’s business model, a pyramid scheme. The company retorts that its weight-loss products helped people live far more healthier lives and inspired social value by corralling people into what the company described as “nutrition clubs.” To that end, Herbalife vigorously denies that it is a pyramid scheme and says it is a legitimate MLM.

The company’s slick marketing collateral, along with its stately headquarters in Los Angeles’ Century City business district, impart a legitimate business with $3.8 billion in annual revenues. But many former “distributors” allege it is not.

For years, people complained that the supposed $59 start-up fee can actually spike to as much as $4,000 to launch that coveted home-based business. Many claimed that only a few distributors could make money, and they did so by recruiting other sales reps, to whom they would sell Herbalife products and therefore score commissions.

The complaints snowballed to the point that the Federal Trade Commission (FTC) launched an investigation, which concluded last Friday.

Under an agreement reached in a California federal court, Herbalife will pay $200 million to people who say they were victimized by the company’s moneymaking marketing campaigns. And in Illinois, the company acquiesced to a $3 million settlement with the state’s Attorney General Lisa Madigan. That separate agreement will compensate Illinois residents who say they were misled into taking part in Herbalife’s expensive multi-level marketing scheme.

In addition to reimbursing consumers who say they suffered financially from participating in the company’s sales programs, Herbalife also agreed to revamp its business model. Sales reps who pitch the company’s products will no longer be rewarded based on how many people they recruit. Instead, they will be incentivized based on how many products they actually sell. Herbalife’s tactics and promises of living are what infuriated many former sales reps and sullied the company’s reputation for years.

“The inconvenient little secret about Herbalife,” wrote FTC attorney Lesley Fair in a blog post, “[is] the small number of distributors who actually made money made it not by selling products to people who wanted the company’s powders, pills, and potions, but rather by recruiting others to serve as distributors.”

What the settlements with the FTC and Illinois Attorney General’s office did not accomplish, however, is to label Herbalife a “pyramid scheme.” And that omission is what sparked Herbalife to crow victory in a press release shortly after both decisions were reached last Friday.

The company insisted that the FTC’s allegations were “factually incorrect,” and said it only agreed to the settlement because of the negative press and litigation costs that resulted from the investigations. In addition to paying financial damages and changing its incentive programs, Herbalife said it would improve its product and sales training, reclassify its employees, and extend the time during which a new distributor can return its introductory membership pack.

The settlement, in which the FTC appeared to describe Herbalife as a pyramid scheme without using that dirty word, exasperated many analysts. One of them, Matt Levine of Bloomberg, noted that the agency shut down another MLM, Vemma, which had an operation similar to that of Herbalife’s.

In addition to Herbalife, the company’s lobbyists, which Politico says include Oglivy and Democratic lobbyist Heather Podesta, can also consider themselves winners. So can the MLM industry at large, which critics say targets vulnerable consumers who are looking for gainful employment but see few options — which is also why organizations from Uber to Trump University have found lucrative opportunities by taking the advantage of desperation.

Owners of the company’s stock can also consider themselves victors. Herbalife shares, despite a recent stretch of stagnant performance, are on an overall upward trend this year. After the FTC announced the settlement, the company’s stock price soared 8 percent on Friday.

One of the biggest losers in the wake of the settlements is hedge fund manager Bill Ackerman, whose campaign against the company has long been a thorn in Herbalife’s side. In 2012, he released a presentation that attacked the the company’s business practices and shorted approximately $1 billion worth of the company's stock. Ackerman highlighted what he called Herbalife’s duping of consumers into falling for its alleged get-rich-quick scheme. And it brought even more negative attention to the company.

As the company disclosed it had overestimated its new member growth figures, Ackerman continued his four-year attack against Herbalife. On a CNBC panel in May, he offered this advice to the company’s employees: “I’d go find another job.” Despite Friday's announcement, Ackerman’s Pershing Square Holdings is still defiant, and issued a statement predicting that Herbalife’s restructuring “will cause the pyramid to collapse.”

That could happen as the terms of the FTC settlement involve more than issuing refunds to disgruntled former employees or, in technical terms, independent contractors. Over the next several years, 80 percent of the company’s sales have to be to new customers, and Herbalife also agreed to be audited to ensure the new compensation plan is actually followed. Based on how the company generated sales in the past, it is in for a tough slog for the rest of this decade.

Image credit: Philafrenzy/Wiki Commons