FTC moves against Herbalife, but leaves a question: Why is this company still allowed in business?

But where are the distributors' mansions? Herbalife got some of the faithful to turn out for a pro-company demonstration in downtown Los Angeles last year.

By Michael HiltzikBusiness Columnist

July 18, 2016 2:30 PM PT

The legal complaint and settlement with Herbalife unveiled Friday by the Federal Trade Commission answers several questions about the Los Angeles-based nutritional supplement marketing company, but leaves the most important question wide open.

The answered questions involve Herbalife’s business model. The FTC says in its complaint, filed Friday in Los Angeles Federal Court: Yes, Herbalife’s business model is deceitful. Yes, the company has misrepresented itself as a nutritional supplements company, when what it’s really selling are business opportunities, the value of which it has consistently and grossly exaggerated. And yes, it’s a ripoff; or to put it in the FTC’s language: “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.”

Herbalife is going to have to start operating legitimately.

— FTC Chair Edith Ramirez

That section outlaws “unfair or deceptive acts or practices in or affecting commerce.”

The FTC’s findings about Herbalife, in other words, couldn’t be clearer. The agency extracted a $200-million settlement from the company, along with a promise to straighten up and fly right. (The sum is a pittance, compared to Herbalife’s revenue and profits.)

“Herbalife is going to have to start operating legitimately,” FTC Chair Edith Ramirez said Friday, “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.”

So here’s the unanswered question: Why is the FTC allowing Herbalife to remain in business? The answer, sadly enough, looks to be money. Reading between the lines, Herbalife has become too rich to shut down.

It’s not as though the agency is powerless to act against pyramid schemes, which is what Herbalife has been alleged to be. Last August, the FTC shut down Vemma Nutrition Company, a Phoenix multilevel marketing outfit it said was targeting college students and recent college graduates. The agency froze Vemma’s financial accounts and got it placed in receivership.

The FTC alleged in its lawsuit that Vemma’s business model “depends upon recruiting individuals to participate in Vemma as Affiliates and encouraging them to purchase Vemma products in connection with such participation, rather than selling products to ultimate-user consumers.”

Here’s how the FTC described Herbalife’s model: “[Herbalife’s] compensation program incentivizes not retail sales, but the recruiting of additional participants who will fuel the enterprise by making wholesale purchases of product.” The FTC said that Herbalife’s “program does not offer participants a viable retail-based opportunity.”

Is there a material difference between these two assertions? Not that we can tell. Yet the FTC called Vemma “an unlawful pyramid” and Herbalife merely as a “multi-level marketing company.”

The details in the FTC’s complaint against Herbalife are damning. It enticed individuals to sign up as “distributors” of its products by plying them with testimonials from previous recruits who talked about transforming themselves from near-bankrupts to earners of six figures or more a year hawking Herbalife inventory. Its promotional material bristled with “pictures of big houses, fancy cars, cash, and boats.”

In truth, the FTC observed, the vast majority of Herbalife distributors don’t make “anything approaching full-time or even part-time minimum wage.” Of the more than 680,000 distributors counted by Herbalife in 2014, only 205, or 0.03%, earned more than $600,000. And they earned most of their money by recruiting new distributors, not by selling product.

In 2013, shortly after hedge fund manager Bill Ackman launched a painstakingly detailed attack on Herbalife’s business model, paired with a $1-billion short bet on the company’s stock, Herbalife changed its pitch. Rather than promoting itself as a business opportunity for the little guy, Herbalife began asserting that some three-fourths of its distributors weren’t in it for the career, but merely to get a chance to buy Herbalife products at a distributor’s discount. The FTC didn’t fall for it. It says that many recruits start out as wanna-be business successes, but fail, and that more than 75% of Herbalife’s products are bought by people “clearly pursuing a business opportunity.” Just not a good one. (Ackman has been proved mostly right about Herbalife, though he’s lost as much as $500 million on his short bet, according to some observers; he was counting on the company’s stock falling to zero, but it closed Monday at $64.78.)

One striking difference between Vemma and Herbalife is size: Vemma was collecting about $200 million a year in revenue when the FTC went after it. Herbalife, which has been treated indulgently by government regulators almost since its founding in 1980, last year reported profit of $339 million on net sales of $4.5 billion.

That sort of wealth buys a lot of influence. Enough to keep the words “pyramid scheme” out of a federal regulator’s lawsuit, for example.

Herbalife has not been shy about putting its connections on public display. For years it boasted of its close connections with UCLA Medical School, which as we reported in 2013 it exploited to give its nutritional shakes and other products the veneer of scientific credibility. The company kept medical school faculty members on its payroll and promoted its ostensibly altruistic contributions toward the school’s Mark Hughes Cellular and Molecular Nutrition Lab at the medical school’s Center for Human Nutrition. Herbalife contributed $1.5 million in cash, equipment and software to the lab from 2002 to 2013. (The lab is named after Herbalife’s founder, who died in 2000 after a four-day drinking binge — not the greatest advertisement for the healthful, active living Herbalife claims to promote.)

The FTC’s complaint implies that the luminaries who have been trotted out by Herbalife to attest to its integrity should hang their heads in shame. Among them is former Secretary of State Madeleine Albright, who seems to have sold her soul to lobby for Herbalife internationally.

“I wouldn’t be here if I weren’t proud to be associated with Herbalife,” Albright told a company gathering in Europe in 2013, “and Herbalife wouldn’t be operating in more than 80 countries if it weren’t satisfying customers wherever it goes.” (See video.) Albright touted Herbalife as a paragon of “corporate responsibility and community service,” and as an “ethics-driven company.”

What does she think now? We queried Albright’s consulting firm, Albright Stonebridge Group, but haven’t received an answer.

In addition to the $200-million penalty the FTC extracted from Herbalife, it’s forcing the company to restructure its marketing pitch, its distributor compensation, and its treatment of the lowest level of aspirants. Herbalife will have to knock off the intimations that joining up will result in a “lavish lifestyle” and drop the images of opulent mansions and personal helicopters that beckoned to the unwary. It will have to connect the compensation of top-tier agents — those tiny few who make big money from lower-level distributors — to retail sales, not to potentially bogus purchases, especially by the distributors themselves. Recruits will be allowed to get their money back from purchases of products or distributor promotional packages for up to a year.

Will this hurt Herbalife? It’s questionable. Some say that forcing the company to make its money from actually selling its nutritional supplements to retail buyers will be its death knell, since a small percentage of the product actually goes to such customers.

It’s also possible that Herbalife will cry all the way to the bank. The stock market treated the $200-million settlement as a triumph for the company, sending its shares up nearly 10% Friday after the FTC settlement; they also gained about 9% in May, after the company disclosed the pending penalty in a quarterly report. The company already has pointed out that the FTC settlement applies only to its activities in the U.S., and those account for only 20% of its net sales. So it’s free to continue its old model in the rest of the world.

Its chairman and chief executive, Michael O. Johnson, said in a release that the FTC settlement, along with a second deal with the state of Illinois, “are an acknowledgment that our business model is sound.” If that’s not thumbing his nose at government regulators, what is it?

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