Herbalife hit by US ‘pyramid scheme’ probe

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The US Federal Trade Commission has opened a formal investigation into Herbalife, the multi-level marketing company that hedge fund manager Bill Ackman has called a pyramid scheme.

Close government scrutiny of the Los Angeles-based group is the latest turn in a vicious public battle where rival billionaires have bet fortunes on the question of Herbalife’s legitimacy since Mr Ackman’s hedge fund, Pershing Square, unveiled a campaign to put the company out of business in December 2012.

Herbalife sells nutritional shakes and supplements through and to a network of millions of independent distributors in more than 80 countries worldwide. The probe comes after a year in which consumer groups and members of Congress, in both houses, have echoed the call for the FTC to investigate.

Herbalife said it “welcomes the inquiry given the tremendous amount of misinformation in the marketplace, and will co-operate fully with the FTC. We are confident that Herbalife is in compliance with all applicable laws and regulations.”

The company put out a statement confirming the civil investigation following an inquiry by the Financial Times. The FTC acknowledged the investigation but had no further comment. Mr Ackman declined to comment.

Since Mr Ackman accused Herbalife of being a pyramid scheme, shares in the company have traded as low as $27, but recovered to a high of more than $80 in January, as investors have debated the likelihood of regulatory action. Following the statement Herbalife shares tumbled as much as 17 per cent but recovered to be 8 per cent lower at $60.24.

North America represented less than a fifth of Herbalife sales in 2013, but its management and most senior distributors are based in the US.

A pyramid scheme is a business where the majority of profits within the system accrue from recruitment, rather than genuine sales of a product to consumers. Like a Ponzi scheme, a pyramid scheme requires a steady stream of new recruits, almost all of whom will lose money.

The process of investigating potential pyramid scheme behaviour typically takes 12 to 18 months, according to people familiar with the FTC.

The process begins with a review of the company’s commission and compensation structure, to see if it has an inherent bias towards recruitment. The FTC will then look at what safeguards are in place to protect recruits, evidence that these safeguards are enforced and that the company makes substantial sales to customers outside its network of distributors.

The FTC has extensive powers to demand a company under investigation hand over data about its sales and the structure of its network.

The FTC is a civil agency, and may bring civil claims only. It may also work in conjunction with prosecutors at the federal and state levels if it deems criminal fraud charges appropriate. The investigation into Herbalife is at an early stage and may not lead to any action.

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