The goal of this article is to review some new evidence and news in the Herbalife story, as well as to make the case that company insiders/top distributors may have already indirectly admitted the company is a deceptive pyramid scheme fraud.
Up front, a reminder of what a pyramid scheme is: a company where recruiting and recruitment drive sales moreso than retail sales of the product. Simple.
Evidence Straight from the CEO and a Top Distributor
With that in mind, we have seen new evidence that has been released over the last couple of weeks, when a video of CEO Michael O. Johnson speaking in 2005 was released. This was the same video that had been reported on by the New York Post earlier this year. I had the audio of Mr. Johnson’s speech up on SoundCloud, but it was removed with 5 minutes of me releasing this article on Friday morning. A YouTube version of this video has also been removed by the company, prompting QTR and others to ask, what happened to transparency?
I have rehosted the audio file on my site, under 17 U.S. Code § 107 – Limitations on exclusive rights: Fair use.
Here it is:
I believe the damning nature of these admissions is telegraphed by how vehemently the company seems to be trying to scrub the internet of it. If the company believes this clip from a much longer video is deceptive or devoid of context, I would encourage them to release the entire video so that the public can make up their own mind. Here’s what Herbalife’s CEO says (my emphasis in bold):
“It’s the recruiting, meaning bringing new distributors into our company, which is the most vital part of our bloodstream. We bring new distributors in, we grow. It’s that simple. It’s that simple. And the company has built its whole reputation, its whole life, on recruiting.
Our top dogs, Greg calls them The Hunters out there, our Hunters, our top distributors, our Chairman’s Club, our Pres. Team, they’re professionals at this [pointing to the word “Recruiting” on the slide behind him].
Nobody can do it better.
You get next to Alan Lorenz and he’ll recruit taxi cab drivers and busboys and waiters and everybody… He doesn’t care who it is and, boom!, he’s got ‘em in this game. Right away, he’s got everybody. How long he’s got ‘em is another question, but he’s got ‘em in this game [again pointing to the word “Recruiting” on the slide behind him]. And that’s what this company built itself on.
The recruiting tactics…very positive for the most part…sometimes led people down a false road. $4,000, jam it into ‘em, buy an instant distributorship, load that product in. See ya! Good luck! Credit card bill comes, spouse says, “Ahem, how are we gonna pay this? You didn’t sell the stuff that’s in the garage, that’s in the pantry, that’s out there. What are we gonna do?” Well, we could return it to the company. And you know it, in our marketplaces where our recruiting heavy…is very heavy [again pointing to the word “Recruiting” on the slide behind him], and we don’t have a balance of business, we got issues.
So what happens today? Today what are we? Today, we’re recruiting. We’re still a recruiting company, and we’ve got to never not be this [again pointing to the word “Recruiting” on the slide behind him]…”
(more on Alan Lorenz here)
Yet the media and critics of the bear case continue to ask questions like, “When are we going to see the smoking gun? Where’s the proof?”
With MLM companies, when the focus is primarily on the recruiting, it’s a pyramid scheme. Don’t want to take it from me, the FTC, the SEC, and other critics of the company? Maybe Judge Judy is more along your lines (“it’s an illegal pyramid scheme”)? Or perhaps Penn & Teller (“it’s bullshit”)? Or maybe one of these hyper attentive Mary Kay distributors can clear it up with some prepared answers they’ve had ready since long before a question was even asked?
Fraud in 2000 is Fraud in 2008 is Fraud in 2015
Longs and supporters of the company have tried to make like this piece of evidence does not matter because it is from 2005 and because, admittedly, it is taken from a speech where Mr. Johnson is talking about reforming the business. Would it be helpful to have the context of the rest of this video? Sure. I encourage whomever has the whole thing – especially the company – to release the full video. But the question for regulators is whether or not, in talking about reforming the business, Mr. Johnson is legally making admissions about how the business has/is run. It is very similar to the Gratziani video where, in speaking about how to reform the business, top distributor Stephan Gratziani makes a number of startling admissions about the company, like:
“We sell people on a dream business, that they can make it. Yet deep down inside, what do we really know? Yeah. We know that the reality is that most of them aren‘t going to make it.” (Video 1, 1:00:16.)
“Who wants to bring their family into a struggle to make it? Who wants to bring their family into an eventual deception?” (Video 2, 7:20.)
“We tell people, hey, you know, sign on the dotted line, you know, start working from home, it‘s going to be unbelievable, you‘re going to have this incredible life. . . . So there really is this situation or this level of inauthenticity that‘s there.” (Video 2, 8:28.)
“The Herbalife business model is based on distributors purchasing volume from them. . . . The Herbalife business model, at this point in time, is not based on customers purchasing, it‘s based on distributors purchasing volume.” (Video 2, 14:34.)
“[S]uccessful people in retailing in our business, it‘s a very small percentage. (Video 2, 28:08.)
Do these admissions hold less water because they’re being made in the context of good faith? Mr. Johnson and Mr. Gratziani are describing a pyramid scheme in their own words. They are describing Herbalife.
So you have a top distributor and the CEO admitting on video that the company has major problems, is deceptive, and has an emphasis on recruiting. Now, we look to see if the marketing or compensation plan has changed meaningfully since then. Surprise, surprise – it has not, and this little known agreement that keeps the gravy train running for distributors may be why.
You can read more on this in an article I wrote called “Has Herbalife’s CEO Known All Along?“
There are camps that believe this type of behavior no longer exists in the company, and there are those who have done the research and know otherwise. I pointed this out in my last article where I specifically mentioned lead generation. The CEO of the company reportedly called lead generation “the source of many evils” in 2005, yet the company did not cease lead generation until 2013, after Mr. Ackman had made his presentation.
This is a fallacy of an argument anyway, because if the company stops its illegal practices tomorrow, does that change the last 10+ years where the company deliberately deceived people in order to grow into a $6 billion juggernaut?
Sell side analysts, like Meredith Adler and Tim Ramey seem to think so. They are not only wrong when they assume that deception has stopped, but they are fundamentally wrong in assuming that the past does not matter. Fraud involves deliberate deception. I believe it has been proven that there has been immense intentional deception throughout the course of Herbalife’s life as a business, including the last 10 years.
In a case like this, Mr. Ackman doesn’t matter, the company’s PR machine doesn’t matter, Mr. Soros doesn’t matter, and the sell side analysts do not matter. What matters is the available evidence and what the government’s interpretation of it will be.
Recent Events Signal the End is Near
If you’re not familiar with the Vemma takedown, it’s the FTC intervening and forcing business model changes in one of the largest privately held MLM companies in history. Read the history and the timeline from our friends at Truth in Advertising here.
When one takes a look at the recent business model changes that happened at Vemma as a result of the FTC temporarily halting their business for being a pyramid scheme, I believe it would be foolish to not think this is setting some sort of precedent for what may occur with Herbalife. When you look at the Department of Justice’s recent action and criminal charges brought against nutritional supplement companies for false advertising and deception, I think it would be foolish to say that this is not a potential precedent for the Herbalife case.
The Vemma case was helped by a consumer advocacy group of lawyers named Truth in Advertising. They were even thanked in the FTC’s press release regarding the Vemma case (“The FTC appreciates the assistance of the Attorney General Offices of Arizona, South Carolina, and Michigan, the Tempe Police Department, and the nonprofit organization Truth in Advertising in bringing this case.”) The commission vote to file the complaint against Vemma was 5-0. Truth in Advertising has also been an active and significant critic of Herbalife.
Do I need to continue reading the tea leaves for you?
What is fascinating is that traders would sell off Herbalife to the tune of 10% simply on news that a Department of Justice announcement regarding nutritional supplements was coming – but they then would quickly push the stock back up when it was discovered that this announcement wasn’t about Herbalife. This trading psychology suggests that most people assume a negative decision is coming for the company. The Herbalife announcement is going to come one way or another someday. Five regulatory bodies, when they conclude their investigation, will present their findings and suggest potential action moving forward when the Herbalife case is over. If you are long the stock today, you not only believe that this action will have little effect on the company as it is, but you believe that the underlying business, without the regulatory concern, is healthy. That is also not the case.
Senator Calls Company a Fraud, Earnings Show Business in Collapse
The market’s numbness to this case after three years has been an interesting case study. A couple of weeks ago, New York State Senator Jeff Klein came out with advocate Letitia James and said that Herbalife was “a pyramid scheme that must be stopped”. He also called the company “shameful”. Language from a government official does not get much stronger. If you recall, Senator Markey’s concerns with the company culminated in a letter with questions that were dodged and obfuscated upon by the company. This State Senator has skipped the questions, performed his own research, found that distributors were being misled in October 2015, and presented his findings calling the company a fraud.
Furthermore, when you own this company at $58, you are expecting that the company is going to be able to earn what it is expected to next year, for the next 10 to 12 years. The thought that Herbalife will be operating the same business model, let alone be around 10 to 12 years from now in any similar fashion, is absurd. A Vemma-like change in the company’s business model would absolutely cripple Herbalife. As the government will likely rope in the business model, the fundamentals of the business will continue to deteriorate meaningfully. I also hope the government is looking into Herbalife showing some peculiar resilience to business changes, like in Mexico, where they only saw a small blip on the radar after making massive fundamental changes. I find this very interesting and suspect there is more to the story.
If you looked at the company’s last earnings report, what you see is that many major markets are in year-over-year decline with the exception of China. China is a market that Herbalife started moving into one province at a time years ago, that I now believe to be close to full saturation. When China begins to turn, and when – not if – China growth stops, it is going to ring massive alarm bells for those watching the company. China is an enormous unstable pressure point for this company right now. Not only is China’s current economy unstable, but China has some of the strictest multilevel marketing rules in the world, namely that they basically prohibit the business practice in general. If you haven’t watched Pershing Square’s China presentation, I would encourage you to do so by clicking here.
On top of the fundamentals deteriorating and the outstanding regulatory reviews from numerous government agencies, there are also significant questions that still need to be asked about Herbalife, like:
- Why has the business just collapsed in Korea?
- Why is the company using a term called “active members” on its latest conference call that does not appear in any filings or any previous conference calls and has not been defined?
- Why do so many countries have tax issues with Herbalife?
- Could the IRS be looking into Herbalife?
- Why hasn’t the company used some of it’s cash to pay down debt?
- Why has nobody heard from CEO Michael Johnson on live television or live on a conference call during the question-and-answer?
- Why is the company moving into the soup business?
- Why has George Soros just sold his entire stake in the company?
- Will we find out that Bill Stiritz has sold his stake in the company when it is required that he file in early 2016?
- Why does the media not report on George Soros selling his stake in the same fashion that they reported George Soros taking his stake?
- Why has the media (but for one Bloomberg article) not reported that a New York State Senator has called the company a fraud?
The market has become so numb to the story because it has taken so long that this could be the perfect prescription for a total rude awakening the day that the government acts.