January 28, 2013 8:48 pm

Herbalife hit as regulator spooks investors

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Shares in Herbalife dropped as much as 11 per cent in volatile trading on Monday as regulators said they were taking action against an illegal pyramid scheme that in fact involved a different company.

The move caused jitters among investors in the nutritional supplement company which is under attack from Bill Ackman, the short seller.

Mr Ackman has called Herbalife a pyramid scheme, and made a $1bn bet against the value of its shares. He has also urged regulators to investigate the business model of the direct seller of sports drinks and vitamin pills.

Shares in Herbalife began falling during the morning when investors learnt the Federal Trade Commission was to hold a news conference later in the day to reveal action against a pyramid scheme which at that stage it did not name. They rebounded when it emerged that the commission was targeting Fortune High Tech Marketing, a Kentucky direct seller which is unconnected with Herbalife. Later shares began to fall again.

The FTC said that Fortune High Tech was a pyramid scheme with 100,000 members, 99 per cent of whom did not make money.

Investors have been involved in a fierce debate over Herbalife’s future and the willingness of regulators to examine its business model.

On Friday Mr Ackman and his bitter rival, billionaire Carl Icahn, clashed over Herbalife in a live television interview.

Herbalife has denied Mr Ackman’s allegations, and said it is “a legitimate company with legitimate products and legitimate consumers” – a key legal test to distinguish a pyramid from an acceptable multilevel marketing scheme.

Several investors, including Dan Loeb, the hedge fund titan behind Third Point, have bought depressed Herbalife stock on the argument that regulators are unlikely to spring into action on the urging of a self-interested billionaire.

In a letter to his investors, Mr Loeb called Mr Ackman’s short thesis “preposterous”. He said: “It rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for over three decades, and will shortly awaken (at the behest of hedge fund short seller) to shut down the company.”

Mr Loeb, whose hedge fund disclosed an 8 per cent stake in Herbalife earlier this month, said that since 1997 the FTC had brought 13 separate cases against alleged pyramid schemes.

Fortune High Tech said the FTC had won a temporary injunction against the company that it intended to contest. “This is a process, and we will be defending ourselves vigorously,” it said.

The FTC declined to comment on Herbalife. Speaking about pyramid schemes in general, Steve Baker, director of the FTC’s midwest region office, said: “The question is: are they really selling product outside the network?”

The legal test for a pyramid scheme is that distributors are rewarded for recruitment rather than selling product, and that most of them lose money.

Mr Ackman has claimed that the “substantial majority” of Herbalife distributors lose money after taking into account expenses such as shipping fees and sales materials.

Herbalife, which was founded in 1980 and has operations in 80 countries, says that many of its so-called distributors are actually customers seeking a bulk discount.

At the close, Herbalife shares were down just over 8 per cent at $40.02. That compares to a low of $26 in December, after Mr Ackman made a presentation of his short thesis, and an April 2012 high of more than $73.

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