According to a report yesterday by the New York Post, the network marketing giant has cut a deal with FTC that includes payment of a fine but not a complete overhaul of the company’s business model. There has been no official confirmation from FTC, though it has been reported in the media since February that the two sides were in settlement talks.
Probe began in 2014
FTC confirmed in 2014 that it had launched an investigation into Herbalife’s business practices. Like other multilevel marketing companies, Herbalife pays distributors commissions on sales made by members of their “networks,” i.e. the people they have recruited directly into the business and the people those initial recruits bring in. The rub is in how that model is put into practice. If the ultimate goal is to sell products to end users, FTC has generally turned a blind eye to MLMs. But if the primary (or sole) goal of the operation is to recruit new members, and if the primary source of revenue is the collection of initiation fees and/or the sale of goods or services to people within the network as opposed to consumers in the wider society, the business starts to look like an illegal pyramid scheme.
Practices such as paying for leads on new recruits, offering bonuses on how many recruits a distributor has in his or her network, and structuring product discounts and commission levels in such a way that distributors end up with large amounts of unsold inventory are some of the things that blur these lines. Herbalife has been accused of these transgressions at one time or another.
The company has also come under fire for its advocacy of “nutrition clubs,” which are business venues opened by distributors. In this model, which the company said came from an idea put forth by a distributor in Mexico, the individual distributor opens up a retail location at his own risk as a venue for product sales and for building his organization. The criticism of this practice, leveled most vociferously by activist investor Bill Ackman, who has taken a huge short position on Herbalife stock, is that many of these distributors are unsophisticated in the ways of business and receive little training or support from the company. These distributors, many of whom are from minority communities, can end up on the hook for a lease for underperforming retail space, or so the criticism goes.
Addressing the criticisms
Herbalife, for its own part, has attempted in recent years to address some of these criticisms. It has become more transparent about how many distributors actually sell enough products to earn commission checks (a minority) and what the size of the average monthly check is—about $1,300. And it has altered some other rules about how distributors are compensated.
Former FTC chief economist Peter Vander Nat has said that the commission needs clearer rules about what constitutes an illegal pyramid scheme. As matters stand, the process of determining this is so long that its “deterrent effect is insufficient,” Vander Nat has been quoted as saying.
Despite Ackman’s attack, which began in 2013, Herbalife has prospered in the meantime. The company reported $4.5 billion in revenue in 2015. Its share price spiked after the preliminary news of the FTC settlement, rising to more than $64 a share. Herbalife is the world’s largest network marketing company that focuses solely on dietary supplements and functional foods.