For much of its nearly 16 years as a publicly traded company, the multilevel marketing firm Herbalife has ridden atop a business model that government regulators have described as “deceptive.”
The regulators have set forth how Herbalife has misled its investors and “victimized ... hundreds of thousands of hard-working consumers” suckered by the company’s claim that joining up as Herbalife sales agents would set them on the path to almost unimaginable wealth.
And on Friday, the government said it extracted an admission from the company that “Herbalife approved the extensive and systematic corrupt payments to Chinese government officials over a 10-year period” between 2007 and 2016 to advance its business interests in China.
Herbalife agreed to pay a U.S. penalty of more than $123 million to settle the China allegations. That’s on top of the $200 million it agreed to pay via the Federal Trade Commission in 2016 to 350,000 consumers who had lost money trying to sell Herbalife products.
Herbalife approved the extensive and systematic corrupt payments to Chinese government officials over a 10-year period.
U.S. Dept. of Justice
Yet despite all that, perhaps Herbalife deserves our grudging gratitude: By managing to stay in business despite years of such allegations, the company has demonstrated the sheer inadequacy of white-collar law enforcement in America, and perhaps pointed the way to making it better.
I asked Herbalife to comment on the latest development, but representatives offered only to respond off the record, which I turned down.
Herbalife, like other multilevel marketing firms, typically has functioned by intimating to consumers that as distributors, they can become rich selling its products at retail. In fact, the distributors’ income derives from recruiting rewards based largely on wholesale purchases by other people they recruit as sales agents.
Most people in these chains never even come near the riches the companies tout as available to anyone.
In practice, most of these chains run out in fairly short order. Only a minority of sales agents make any money at all, and only a tiny handful become truly successful. The FTC had asserted in a lawsuit filed in Los Angeles federal court that 80% of Herbalife’s sales distributors failed to recruit any sales agents and therefore received no recruiting rewards.
Among those who did recruit others, more than 43% received no rewards because their recruits didn’t buy enough. Even among the top 13% of performers, the FTC said, more than half collected average gross rewards of less than $300 in 2014. Nevertheless, Herbalife recruiting materials were festooned with “images of expensive cars and opulent mansions.”
As we observed at the time of the 2016 settlement, Herbalife had by then become simply too rich to shut down. The FTC had no difficulty going after smaller multilevel marketing firms such as Vemma Nutrition, which the agency put out of business by freezing its bank accounts and placing it in receivership.
But Herbalife was more than 20 times the size of Vemma. It was — and is — so big that government fines and penalties that look big in absolute terms are only a pittance in Herbalife terms. The $200 million extracted by the FTC in 2016, for instance, was less than 5% of the company’s $4.5 billion in revenue that year.
As for the $123-million penalty announced Friday, Herbalife says it already accounted for the sum on its balance sheet as of the quarter ended June 30. Therefore, it says, “There will not be any additional impact on the company’s results of operations.”
When even massive fines and penalties fall within a company’s cost of doing business, their capacity to shake management into flying right are, at best, dilute.
Herbalife’s influence is nothing to sneeze at. Back in 2013, hedge-fund operator Bill Ackman launched a spectacular public attack on Herbalife, charging that something was deeply wrong with a company that parlayed a dubious business model, overhyped products and an almost invisible research and development program into increasing profits.
Ackman backed his charges with what he said was a $1-billion bet that the company’s stock would eventually fall to zero.
Instead, Ackman roused investor Carl Icahn to support Herbalife with a stake that eventually reached about 25%. The fight between the two investors got intensely personal, and Ackman’s expectations that federal regulators would shut the company down were dashed by the FTC settlement. Ackman eventually had to bail out.
Earlier this month, Icahn sold $700 million of his shares, or about 42% of his stake, though he remains the company’s biggest shareholder.
The real problem with the government’s approach to cases of corporate wrongdoing is its inclination to reach a settlement of allegations without forcing a company to absolutely come clean.
The FTC settlement is a perfect example. The agency reached the $200-million deal by allowing Herbalife to sign without admitting or denying the allegations, the most common formula.
That leaves only the allegations, which are damning in their own terms. The FTC said, in effect or explicitly, that the company had misrepresented itself as a nutritional supplements company, when what it was really selling are business opportunities, the value of which it consistently and grossly exaggerated.
The FTC’s allegations filed in Los Angeles federal court left no doubt that it concluded that Herbalife had been ripping people off: “Consumers have suffered and will continue to suffer substantial monetary loss as a result of [Herbalife’s] violations of Section 5(a) of the FTC Act.” (That’s the section that bars “unfair or deceptive acts or practices in or affecting commerce.”)
FTC Chairwoman Edith Ramirez said after the settlement that “Herbalife is going to have to start operating legitimately.” That would mark a real change, she suggested.
To some extent, perhaps it did. Herbalife’s come-on to distributors today says that they can earn money “selling Herbalife products that you buy at a discount” or “sponsoring someone who either sells Herbalife products or purchases them at a discount for their own or household use.” It specifically says that distributors “cannot earn money simply for recruiting or sponsoring someone.”
That brings us to the government’s China allegations, which are that Herbalife paid bribes to Chinese officials to “promote and expand” its business in that country, and falsified accounting records to hide the bribes. These have a civil component — a case brought by the Securities and Exchange Commission alleging that the company’s disclosures misled regulators and investors — and a criminal component, brought by the Dept. of Justice.
The SEC settled its case in September by extracting a $20-million payment but allowing Herbalife to settle without admitting or denying its allegations. The settlement announced today raises that to $67 million.
The criminal case looks sterner. For one thing, Herbalife admitted to some of the allegations. As the DOJ says, these include the admission that the company “approved the extensive and systematic corrupt payments to Chinese government officials” over 10 years, and “maintained false accounting records to mischaracterize these improper payments as permissible business expenses.”
The break the company received, however, is that the DOJ’s case is wrapped up in a “deferred prosecution agreement,” through which the criminal charges will be dropped, with prejudice, if it demonstrates good behavior through the end of 2023.
Whether that’s an appropriate outcome for a case that, as federal prosecutors said, involved 10 years of conduct by “high-level employees,” is debatable. Prosecutors said they gave Herbalife credit — including a 25% reduction from the maximum penalty — for cooperating with its investigation, coming clean and firing or disciplining the employees and executives who orchestrated the scheme.
On the other hand, it did go on for a decade during which the importance of the China market to Herbalife’s fortunes was on the rise. Whether one can say that Herbalife has skated on this behavior is open to debate. But there’s no debate that its punishment could have been greater, and if it was, the likelihood that Herbalife will repeat its bad conduct will be lower.
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