When the Wolves Bite

by Scott Wapner

  “I had been through this with other companies,” Ramey said. “There was one I covered where they were in a three-year purgatory where they couldn’t do anything. They couldn’t provide earnings, they couldn’t file, and that would be very, very bad for Herbalife.”10

  Though Ackman claimed it would be difficult for Herbalife to get another “big four” accounting firm on board, it actually didn’t take long, relatively speaking, for the company to find another firm. On May 21, Herbalife announced it had hired PricewaterhouseCoopers to replace KPMG as its new auditor, which sent shares up 4 percent.

  Two months later, shares would get an even bigger jolt.

  On Wednesday, July 31, 2013, just after 11 a.m., I jumped on TV with news of yet another big-name investor getting involved. According to a source, George Soros’s namesake firm had taken a large position in Herbalife—“one of its three biggest positions,” I reported.

  Shares exploded 10 percent higher, in heavy trading, to more than $65 per share.

  Soros was the legendary investor who had famously broken the Bank of England on September 16, 1992. Soros had bet heavily against the British pound, forcing the government to withdraw the currency from the European Exchange Rate Mechanism, or ERM. It had thrown the Sterling market into chaos and transformed the Soros name into a thing of legend. He’d pocketed $1 billion on the trade on a day that became known in the United Kingdom as Black Wednesday.11

  Now, some wondered whether Soros was looking to take Ackman down in a similar fashion. The elder statesman had all but retired from managing other people’s money in 2011. However, he kept a mild interest in the firm’s investments, leaving most of the critical decision making to a group of younger, hungrier portfolio managers.

  One such investor was Paul Sohn, who’d graduated from Yale, studied economics, and had a top-notch pedigree in the hedge-fund business, working for Mark Kingdon and Soros disciple Stanley Druckenmiller, who was considered a god in his own right.

  Sohn had started at Soros the first week of January in 2012, taking charge of two of the firm’s portfolios—his own, which could comprise any investments he wanted, and the firm’s biggest and most important Best Ideas fund, which he comanaged. The Best Ideas portfolio was mostly made up of concentrated positions, a few at a time, worth a few hundred million dollars each.

  Sohn hoped to grow it and looked to hire an analyst to help him do it. Following a series of interviews, Sohn had whittled the talent pool down to three finalists and gave each a specific stock to analyze.

  The stock was Herbalife.

  Sohn had never invested in the company before but knew bits and pieces of its history and the controversies that had followed it over the years. It wasn’t until Ackman showed up on the scene that Sohn decided to take a much closer look.

  “When the Ackman thing happened, I thought it was worth dusting off again,” said Sohn. “So I watched his presentation and like everyone else thought it was very convincing. He presents well and tells a good story.”

  While Sohn waited for the final analyst candidates to present their findings on Herbalife, it was ironically the company’s own actions, during their rebuttal on the tenth of January at the Four Seasons Hotel, that proved seminal in his decision to buy the stock.

  “A mental game-changer for me was the company’s response,” Sohn said. “I watched this thing and it was to me—it was as convincing as the Ackman presentation. But even if you thought both were convincing what stuck out to me immediately was there were many lies of omission and commission in the Ackman report. They had clearly annoyingly manipulated charts and manipulated data in a way that to me was a big red flag.”

  Buoyed by what he’d seen, Sohn immediately began an in-depth dive into Herbalife.

  “The first big thing we did was commission a survey. And we basically asked 20 questions to a statistically significant number of Herbalife users and Herbalife distributors—thousands.”

  Sohn set out to debunk the core of Ackman’s claims—that Herbalife preyed on thousands, if not millions, of unsuspecting people, mostly lower-income Hispanic immigrants who had joined with the idea of making big money but were left financially destroyed in what amounted to an elaborate scam.

  “The initial short thesis was this is essentially a Ponzi scheme. No one is making any money off of it and everyone does it for the business opportunity,” Sohn said. “There are no real customers. It’s illegal.”

  Sohn spent $25,000 to commission a survey in both English and Spanish to make sure it was an accurate representation of Herbalife’s customer base. The survey’s first question, posed only to Herbalife distributors, read, “Would you recommend becoming an Herbalife distributor to family and friends?”

  78.4 percent responded yes, with only 5.6 percent saying no, and the rest maybe.

  Next, surveyors asked users of Herbalife products, “Would you recommend them to friends and family?” Again, the results were overwhelming.

  62.1 percent said yes, with only 4.4 percent saying no.

  The next item got to the heart of one of Ackman’s chief accusations—that most who joined Herbalife for the business opportunity lost money.

  “Would you say you have made money, lost money, or broken even as an Herbalife distributor?” they asked.

  42 percent responded they had made money, and 21 percent reported breaking even, with 12.7 percent saying they had lost money. In addition, 71 percent said they had lost weight either temporarily or permanently because of Herbalife products.

  “So, the answers that were coming from thousands of distributors just seemed to completely debunk the short thesis,” said Sohn.

  Even though he was convinced he’d done enough work to annihilate Ackman’s assertions, Sohn wasn’t quite ready to put hundreds of millions of dollars or more into the stock. He wasn’t one to jump in without thinking carefully. He also knew of Ackman’s reputation and track record as an investor, which constantly hung in his mind.

  “I said we had done enough to know that the short thesis is wrong, but you know, he must know something we don’t know. Ackman must be playing some cards that we don’t know because otherwise this is crazy. I mean, that survey cost us $25,000. He committed a billion dollars without doing a similar survey?” Sohn asked rhetorically.

  So Sohn did even more work on the company.

  In early May, in the first of several trips out West, he flew to Los Angeles to meet face-to-face with Herbalife CEO Johnson and other company executives in one last “smell test” before going in.

  On May 17, 2013, convinced that Ackman’s claims were askew, Sohn slowly started buying Herbalife shares at an average price of $40.44.

  Three weeks later, Sohn walked into a Midtown Manhattan steakhouse for a so-called ideas dinner. The oft-held events brought hedge-fund managers or their top portfolio managers and analysts together, often in a restaurant’s private room, to pitch investment ideas over expensive slabs of beef and pricy Cabernets.

  Alongside the other men in the private room that night was a familiar face: Bill Ackman.

  Sitting inside a clubby and dark-lit room, Sohn kept his Herbalife news to himself, pitching a tax-related stock called EM-Tech Co. instead while waiting for Ackman’s run of the table. One after another, the analysts in the room pitched their ideas. When it came around to Ackman’s turn, Sohn grabbed his pen, ready to take notes on anything he had to say about Herbalife.

  Sohn was left disappointed. “He didn’t even pitch Herbalife,” said Sohn. “He pitched Howard Hughes Corporation.”

  Sohn stayed silent, but others in the room weren’t letting Ackman off that easy.

  “Then the rest of the dinner was all about Herbalife. All these other guys were very interested. It was very fanboyish—and I just clearly knew I was the only one at the table who knew anything about Herbalife other than Ackman, but I just kind of held back, and I asked him a couple of questions, and his responses were such that I remember thinking to myself ‘The Emperor has no cl
othes,’ like he truly knows less about this than I do.”

  But Ackman did know something that neither Sohn nor anyone else in the room that night knew. According to Sohn, “He pull[ed] out his Blackberry and sa[id], ‘I’m going to read you a letter. It’s coming from Linda Sánchez and it’s going to take the company down,’ or something like that.”

  Linda T. Sánchez was a congresswoman from California who Ackman said had sent a letter to the Federal Trade Commission the day before, urging the regulator’s chairwoman, Edith Ramirez, to investigate Herbalife.

  “Dear Chairwoman Ramirez,” the letter, dated June 5, 2013, began.

  “I am writing to express my concern about the marketing and business practices of Herbalife, Ltd. In particular, I am troubled by allegations that this company may be harming consumers especially those from our country’s most vulnerable populations. Given the FTC’s mission to investigate claims of fraud and potential pyramid schemes, I encourage you to investigate this matter. I have confidence that such an investigation will provide clarity to consumers and I expect you to aggressively pursue it in a timely manner.”12

  How Ackman had gotten the letter, which he quoted from word for word, was anyone’s guess.

  Sohn wasn’t swayed.

  “I didn’t know who Linda Sánchez was,” said Sohn, “but I went back and did a little more work. You know my conclusion after that dinner was there is no big smoking gun here. It was after that dinner where I really started to buy.”

  Over the next couple of weeks, Sohn quietly built his position, purposely keeping it under the 5 percent threshold that would have required an SEC filing, alerting everyone on Wall Street he was buying the stock.

  On July 22, 2013, inside a Manhattan seafood restaurant for another hedge-fund event, Sohn went in search of more feedback. Once again, the conversation moved around the room until it was Sohn’s turn to speak. “My idea is Herbalife,” he said to the eighteen or so others who were around the table. Sohn made it clear he’d done weeks’ worth of work on the company and could easily and thoroughly disprove Ackman’s case.

  “I was kind of hoping to get some pushback—you know, part of the reason you pitch something like that is that maybe there’s something you hadn’t seen or hadn’t been a part of. But I didn’t get much pushback.”

  What Sohn wasn’t hoping for was for his position to get leaked.

  Nine days after the dinner, through sources not related to Sohn or Soros, I broke the news of the position.

  The headlines were juicy.

  New York Post reporter Michelle Celarier, who’d been following Ackman’s Herbalife investment since the beginning, reported that Sohn had been going around town telling other hedge-fund managers that “George Soros broke the Bank of England, he can break the back of Ackman.”13

  While the anecdote may have sounded good, Sohn swears it never happened. In either case, Ackman was incensed at the idea. The day after the news became public, Celarier wrote that Ackman intended to file a complaint with the Securities and Exchange Commission over suspect trading in Herbalife. It was a direct reference to the Soros stake.

  Specifically, the Post report claimed Ackman said he was told by others that Sohn had tried to recruit other investors by pitching Herbalife to hedge-fund managers, promising to soon report a 5 percent stake in the company.

  “There were people working together to try to squeeze me out,” Ackman said. “How many times did Icahn go on TV and say this could be the mother of all short squeezes? That was a call to action for every trader to buy the stock.”

  On Monday, August 5, Ackman officially filed his complaint, but Soros and other long investors were becoming the least of his worries.14 Days earlier, Herbalife had reported the best quarterly results in its history. Earnings and revenues surged past expectations, leaving CEO Michael Johnson gushing on the conference call.

  “We’ve never been more confident about our business, and as a result, we raised our guidance for the third time this year. The new guidance range points to 2013 being another record year with double-digit top and bottom line growth,” he said.15

  Herbalife shares rose 5.8 percent to $64.05 in after-hours trading when the results were released, after having already jumped a few percentage points during the regular trading session.

  Later that month, Ackman tried to turn up the heat on Herbalife again, writing a two-page letter to the company’s new auditor, PwC, and its two chairmen, Dennis M. McNally and Robert E. Moritz. In the note, which was accompanied by fifty pages from Ackman’s original Herbalife takedown, Ackman warned the firm of what could happen if his thesis about the company was true.

  “If we are correct that Herbalife is a pyramid scheme and PwC fails to accurately inform investors of this risk, PwC may incur substantial liabilities in the event of the company’s failure,” Ackman wrote. He also questioned the firm’s independence, noting it had done “non-audit” services for the company.16

  “We look forward to hearing from you and are available to respond to any questions that you may have,” Ackman concluded.

  Herbalife responded that it stood by its prior financial statements, but the company’s best defense continued to be its surging stock. Herbalife shares, which Ackman had blasted into the $20s toward the end of 2012, was now up more than 80 percent for the year.

  Ackman knew he needed to turn up the heat, so he grabbed his best suit and headed to Washington, DC.

  11

  THE LOBBYIST

  On Wednesday, October 2, 2013, two impeccably dressed men walked into the Dirksen Senate Office Building on Second Street in northeast Washington, adjacent to the United States Capitol. They cleared through security and, briefcases in hand, headed down one of the long and hallowed hallways, counting off the numbers that marked each entranceway until they arrived at office number 225.

  Bill Ackman and his longtime legal confidant, David Klafter, weren’t classic K-Streeters—the consultants hired by large companies to influence policy decisions in Washington, known for having their offices on K Street—but their lobbying mission was no less important. Ackman and Klafter had come to see Senator Edward J. Markey’s staff with one goal in mind—to press their case against Herbalife with hopes the Massachusetts senator would join their cause.

  Markey was a liberal lawmaker who’d been elected to Congress in 1976 and had a history of consumer advocacy, even when it came to nutrition companies. Markey and other Democratic senators had previously targeted fourteen energy drink makers over their labeling in a report titled “What’s All the Buzz About?” In the paper, Markey and the other senators had written, “It’s time for energy drink makers to stop masking their ingredients, stop marketing to kids, and start being more transparent with their products.”1

  It was the reason Ackman and Klafter had sought out Senator Markey in the first place—they figured he’d listen. Ackman was also desperate for a catalyst to get the stock moving lower again after Icahn’s untimely arrival had reset the narrative and sent shares surging in nearly a straight upward line.

  The strategy to take the fight to DC had begun in earnest earlier that year. On Monday, March 4, 2013, Ackman and Shane Dineen had descended on Federal Trade Commission headquarters at 600 Pennsylvania Avenue to meet with the senior staff of Edith Ramirez, the FTC’s chairwoman.

  Carrying with them a distilled version of the original presentation from December 2012, Ackman and his team funneled into a conference room and began their pitch. As Dineen and the others walked staff members step-by-step through their research, Ackman grew more and more impatient.

  Finally, he erupted.

  Ackman began chiding the group on how they’d let Herbalife operate illegally—he alleged—for so long and how the government had a duty to stop it. Ackman’s intensity and dogged determination were on full display.

  But the aggressive tactic backfired.

  FTC staffers were put off by Ackman’s aggression, and he quickly sensed that the heavy-handed showmanship w
as a mistake. Ackman would leave the FTC building unconvinced that the regulator would ever take action, especially to appease what she perceived as a preachy hedge-fund billionaire.

  Ackman wasn’t getting the fast-track action he wanted, but it didn’t mean he was about to end his campaign. If anything, he was ready to step it up. Since one of the central charges Ackman had made in his original presentation was that Herbalife defrauded low-income Hispanics, Pershing Square launched a secretive grassroots guerrilla campaign to create a groundswell in those communities.

  Pershing blanketed consumer groups they figured would be favorable to their cause. They met with the National Consumers League (NCL), the League of United Latin American Citizens (LULAC), and the Hispanic Federation, which bills itself as the nation’s “premier Latino nonprofit membership organization” in the United States.2

  It didn’t take long for their efforts to bear some serious fruit.

  On March 12, 2013, the NCL’s executive director, Sally Greenberg, wrote a four-page letter to Edith Ramirez, urging the FTC to investigate Herbalife.

  “We believe that only the Federal Trade Commission has the resources and expertise to investigate these claims and determine whether Herbalife is, in fact, an illegal pyramid scheme rather than a legitimate multilevel marketing business,” said the Greenberg letter.3

  The NCL said it had met with representatives of both Pershing Square and Herbalife and had gotten conflicting points of view, which only muddied its viewpoint. It also seemed to suggest which way it was leaning in its vetting.

  “As these conflicting statements from Pershing Square and Herbalife suggest, it is difficult for the typical consumer, and even for the National Consumers League—which has expertise in this area—to weigh these conflicting claims,” said Greenberg. “We believe this necessitates an investigation of the kind that the FTC is well equipped to conduct. We therefore ask that the FTC launch an investigation to determine whether Herbalife is a legitimate MLM, as the company claims, or a pyramid scheme, as its detractors claim.”4