by Scott Wapner
You, perhaps more than anyone else in the world, can stop this madness. I respectfully ask you to fulfill the responsibility you assumed as the FTC Chairwoman and protect these victims.
Thank you for giving this serious consideration.
Sincerely,
Bill
Just fifteen days later, desperation was turned into deliverance.
On February 25, shortly after the market closed for the day, Herbalife revealed in a regulatory filing that it was in discussions with the FTC about resolving the twenty-two-month probe. The company said possible outcomes included “a contested civil complaint, further discussions leading to a settlement which could include a monetary payment and other relief or the closure of these matters without action.”2
What few knew at the time was that the FTC had approached Herbalife the prior December, sending the company a formal complaint that did everything but call it a pyramid scheme.
When CEO Michael Johnson read it, he was shocked, believing the inflammatory and damning allegations made by the FTC’s attorneys were not only a hit on the company itself but also a personal attack on his stewardship. The forty-two-page document, listed as Case Number 2:16-cv-05217 and filed in the United States District Court Central District of California, said Herbalife had operated while engaging in “deceptive and unlawful acts and practices,” singling out the claims distributors had made about the wealth they’d earned through selling the company’s products.3
Page by page, it attacked the company’s compensation model, which went to the heart of the pyramid-scheme charge, saying Herbalife “does not offer participants a viable retail-based business opportunity” and that it “incentivizes not retail sales, but the recruiting of additional participants.”4
It claimed that “the overwhelming majority of Herbalife Distributors who pursue the business opportunity make little or no money and a substantial percentage lose money.”5
In one such instance, the complaint targeted a testimonial video that had been included in every new distributor’s “starter pack” until January 2013. Called “Design Your Life,” the video told of the expensive cars and “opulent” mansions some had attained.
“A year exactly after I started the business, my checks went up to $7,080, and that was the month I went on vacation, and came back, and got that $7,000 check! So, it’s been amazing,” said one testimonial.6
“The first nine months of really getting going, I had made a quarter of a million dollars,” said another in one of the eleven pages documenting what the FTC called “misleading income representations.”7
Not only did the document attack the claims of exorbitant wealth, it said “the overwhelming majority of Herbalife Distributors who pursue the business opportunity do not make anything approaching full-time or even part-time minimum wage because promised retail sales to customers simply aren’t there.”
Further, it said, “Half of Distributors whom the Defendants designate as Sales Leaders (those who were eligible for discounts on their purchases) average less than $5 per month in net profit from retail alone, and half of these Distributors lose money.”
The nutrition clubs Herbalife had said were neighborhood meeting places to discuss health and wellness were, according to the FTC, “primarily a tool for recruiting new members rather than as a method for profitably retailing Herbalife products.”8
The regulator summed up its case with four counts of violations of Section 5 of the FTC act, including; Unfair Practices, Income Misrepresentations, False or Unsubstantiated Claims of Income from Retail Sales, and something called Means and Instrumentalities, which covered the “false and misleading” promotional materials new members had been given.9
“Fuck them,” Johnson said after reading it.
Alan Hoffman, the PR man who had been a federal prosecutor before the stints with Vice President Biden and PepsiCo, read the complaint too and thought it was just plain nuts—far from the company he had joined the previous fall.
Openly fuming, Johnson knew he had two choices—begin negotiating a settlement with the government or go to court and fight the case before a jury. Johnson preferred the latter, as did Des Walsh, the company’s ever-optimistic president and the closest liaison to Herbalife’s important distributor base—the ones who’d be most affected by the FTC’s demands.
Icahn wanted to fight too, telling Johnson he thought Donald J. Trump was likely to become the next president of the United States and would usher in a more sympathetic regulatory environment that could benefit Herbalife.
Ackman barely had time to celebrate the news. Valeant was once again front and center for the wrong reasons. Shares had dropped into the low $80s after yet another attack by Mrs. Clinton on drug pricing—this time targeting Valeant directly, putting Ackman back on his heels.
On March 1, he once again turned to the media to try to put a positive spin on Valeant.
“We expect much of the uncertainty will be resolved in the relative short term, hopefully over the next few weeks,” he told me in a live interview.10
The timing couldn’t have been worse. Just two weeks later, on March 15, Pearson told Wall Street analysts during a conference call that it was cutting its outlook and wouldn’t file its annual report with the SEC. If that weren’t enough, Valeant incorrectly stated in a press release the amount of its adjusted profits, which only added to the uncertainty.11
This time, investors simply threw in the towel.
Valeant shares fell 51.5 percent to $33.51 in a flush few had ever witnessed. That day’s slide alone cost Ackman $1 billion on paper.
Desperate to do something, Ackman sent a letter to his investors as the stock was cratering.
“We are going to take a much more proactive role at the company to protect and maximize the value of our investment,” Ackman wrote. “We continue to believe that the value of the underlying business franchises that comprise Valeant was worth multiples of the current price. Getting to those values, however, will require a restoration of shareholder confidence in the management and governance of the company.”12
Some were now wondering whether Valeant, whose stock had now lost 90 percent of its value, could even survive.
On March 18, Pearson tried to quell the concerns, telling his staff the company wasn’t going bankrupt.
“I want to apologize directly to each of you for the distractions this intense scrutiny is causing you,” he wrote.13
The apology was little consolation to Ackman, whose Pershing Square Holdings continued to suffer thanks to the nearly 60 percent plunge in Valeant alone. Through the end of April 2016, the vehicle was down 18 percent, with at least eight of his positions in the red for the first quarter.14
Whether Herbalife could provide a boost was far from certain. Even the company wasn’t sure of what was going to happen. With the debate over whether to fight or settle raging behind the scenes, Herbalife and the FTC began secret negotiations, with company representatives making dozens of visits to Washington, convinced the commission was preparing to call Herbalife a pyramid scheme.
On May 2, Ackman let it be known during a live interview with me where he was placing his bets.
“If you find yourself as a Herbalife employee today, my advice is that you should leave the company because this is not going to be a good thing on your resume,” he said snidely. “I’d go find another job.”15
Rarely had Ackman directly addressed Herbalife’s actual employees, whose actions and futures were ultimately at the center of the debate. But Herbalife’s Hoffman was waiting and quickly shot back in a statement: “After spending hundreds of millions of dollars and having a negative return on his investment, maybe it is just time for Bill to move on.”
Then, on May 5, Herbalife gave Ackman and everyone else a better idea of where things stood, both with the business and with the FTC’s investigation. The company reported better than expected earnings, raised its guidance for the year, and revealed it was closer than ever to a resolution.
> “While there are a number of open issues, those discussions have progressed to an advanced stage and the range of outcomes now includes litigation or settlement,” the company said in a statement. “If a settlement is reached with the FTC, it would likely include injunctive and other relief as well as a monetary payment with our best estimate of a payment being $200 million.”16
Shares surged on the news to more than $66 per share,17 as investors figured a hefty fine, even in the hundreds of millions, was way better than a shutdown.
Ackman tried to do his part to make sure the punishment was more severe.
On May 24, at 12:14 p.m., Ackman again emailed the FTC’s Ramirez to press his case.18
“Herbalife will never change its business model regardless of what it promises the FTC it will do in a settlement,” he wrote in one passage. “The fact that the board keeps Johnson on as CEO speaks to how pervasive the corruption is at the board level.”19
As summer fast approached, everyone, including Ackman, wondered when a final decision would actually come.
Herbalife tried its best to tip the scales in its favor.
The company met with former FTC economists and lawyers, producing charts and documents to support its case. It held face-to-face meetings with each of the three individual FTC commissioners in an attempt to make its case and, hopefully, sway their votes.
In the meantime, Herbalife’s litigators prepared for a fight in court.
The company had even prepared a marketing campaign to surround the battle, should one occur, producing commercials and print ads ready to run in international newspapers and on television. Since only 20 percent of Herbalife sales were in the United States, the company knew it had to protect its turf across the globe.
The strategy of going to trial was risky. Going through a long and protracted spectacle could not only hurt business, it could also open up a can of worms during the discovery process. Did Herbalife really want hours of those disturbing testimonial videos, even if they were outdated, playing in a courtroom for the world to see?
There were intense battles within the executive ranks over what to do—a debate that continued outside among Herbalife’s cadre of lawyers and paid consultants. Ultimately, the company decided that settling and trying to move forward was the best strategy.
With the decision made, Herbalife CFO John DeSimone, along with Hoffman the PR man, General Counsel Mark Friedman, and his deputy, Henry Wang, traveled to Washington on the weekend of July 9 for last-minute discussions with the FTC. CEO Johnson remained back in Los Angeles to prepare for what could be a turbulent week ahead.
With a settlement deal in hand, the Herbalife team returned to California to wait for word of an official announcement.
Whether word got to Ackman beforehand that a decision was getting closer, or it was just a coincidence, on July 13, Ackman let go one last barrage of emails to the FTC’s Ramirez.
At 3:45 p.m., in a two-page note, Ackman said, “I have been told that the FTC is reluctant to litigate in light of Herbalife’s high powered lawyers, but I am puzzled as to how our taxpayer financed government does not have the resources internally and/or externally to shutter a blatant fraud. This fraud cannot be allowed to continue. It is an embarrassment to our country.”20
At exactly 12:30 a.m., Ackman sent another email, this time about Herbalife’s distributors.
“Herbalife cannot survive without its distributors fraudulent conduct. As such, the company is highly incentivized to promote rather than police this kind of conduct,” he wrote. “Until the incentives change, Herbalife and its distributors will never change.”21
Ackman concluded:
“Herbalife should be shut down for being a pyramid scheme. The fraud is massive, blatant and ongoing. Litigating to stop Herbalife will also have a dramatically positive effect on the behavior of other MLM’s whose distributors are operating fraudulently.”22
Finally, forty minutes later, at 12:40:12 a.m., Ackman made one last push, urging Ramirez to watch the videos Pershing Square had made to prove its case that distributors were repeatedly making false claims.
“One last thought,” he wrote. “If you watch the videos, you will note that the recruiting techniques of each distributor in each video are effectively the same. They use the same terminology and phraseology. They tell the same stories. We have yet to find one which emphasizes retail sales over recruiting.”
Later that day, Herbalife’s board of directors convened and approved the agreement with the FTC, believing there was no way the regulators would go public on a Friday in the middle of the summer, especially with the Republican National Convention about to convene in Cleveland.
But at 7 p.m. that Thursday evening, Pacific time, Herbalife’s counsel got a surprise call from one of the attorneys with the FTC. The news was stunning. The FTC said it was ready to go public and planned to announce the decision in the morning.
Just before 7 a.m. Eastern time on Friday morning, the Wall Street Journal reporter David Benoit emailed Hoffman, saying he had the scoop and was prepared to report the news. He also called Ackman, who was home getting ready for work.
“He says we’re hearing and we’re going to write that Herbalife settled with the FTC for 200 million bucks and found them not to be a pyramid scheme,” said Ackman. “I said OK 200 million bucks… OK… there’s no way the FTC found them not to be a pyramid scheme. Do not run with that story. And they ran with the story.”
At 7:43 a.m., the first headline appeared on the newswires. It was from Dow Jones, which owns the Wall Street Journal.
“Herbalife, FTC Expected to Announce Settlement Friday—Sources” read the flash.
“Herbalife to Pay $200M over Claims of Misrepresentation—Sources” read another. Four minutes later, the final one hit—the one Ackman knew would be crushing to his crusade.
“FTC Determines Herbalife is not a pyramid scheme.”
Herbalife shares surged past $70 a share in premarket trading to a two-year high.
I was in Manhattan that morning, cohosting Squawk Box, when the news broke. I did the first thing I could think of—I grabbed the phone and called Ackman.
“Did you see it?” I asked, frantically hoping for an on-the-record comment at that very moment.
“I’m reading it now,” he said.
“I need something from you, NOW!” I exclaimed—the desperation in my voice evident.
“I’ll call you back in five minutes,” said Ackman as he abruptly hung up to finish reading the complaint.
Five minutes later, Ackman called back.
“The headline is bullshit,” he said. “It’s wrong.… It’s totally wrong. Did you read the complaint?! Did you read it?!… They didn’t say it’s not a pyramid scheme.”
Technically, Ackman was right. At 8:30 a.m., the FTC put out a press release detailing its settlement with the company, making no mention of the words “pyramid scheme.”
The document was damning to say the least.
“Literally, the FTC confirmed every one of our allegations,” Ackman said. “Every one.”
Herbalife had agreed to a two-hundred-million-dollar judgment—the largest fine ever imposed by the Commission, money that would go to customers who’d bought product for the business opportunity and lost money as a result. It also mandated that Herbalife change its compensation structure to reward people based on whether participants actually sold products, not on whether they simply bought the products themselves.
“This settlement will require Herbalife to fundamentally restructure its business so that participants are rewarded for what they sell, not how many people they recruit,” Chairwoman Edith Ramirez wrote in the three-page release outlining the agreement.23
“Herbalife is going to have to start operating legitimately, 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.”24
Shortly after the FTC press release hit the wires, Herbalife released its own, with CEO Michael Johnson claiming victory and sounding defiant.
“The settlements are an acknowledgement that our business model is sound and underscores our confidence in our ability to move forward successfully, otherwise we would not have agreed to the terms,” Johnson said, almost thumbing his nose in the FTC’s face.25
For Ackman, the news was a stunning blow.
He’d held out hope since the beginning, spent tens of millions while pledging to go to “the ends of the Earth” to see to Herbalife’s demise. Now the company he had called a “criminal enterprise” was allowed to keep operating.
Behind the scenes, the Pershing Square team broke into two factions—the media reach, led by Francis McGill, the in-house PR guy, and another group to read through the documents. Ackman told McGill to reach out to news organizations, hoping to get journalists to focus on what the FTC actually said in the complaint, rather than on what it didn’t. They also drafted a statement.
“We expect that once Herbalife’s business restructuring is fully implemented, these fundamental structural changes will cause the pyramid to collapse,” Ackman said afterward.26
Ackman was so convinced he immediately shorted more shares, at $72 apiece.
“It was like the most profitable trade we had in Herbalife stock for some time,” he laughed.
Icahn didn’t exactly see it that way. Just after 10 a.m., the investor released his own statement and trolled Ackman directly.
“The FTC settlement announced today, coming after a two-year investigation also concluded that Herbalife is not a pyramid scheme—a conclusion that obviously vindicates our research and conviction,” he said. “While Bill Ackman and I are on friendly terms, we have agreed to disagree (vehemently) on this subject. Simply stated the shorts have been completely wrong on Herbalife. I have the greatest confidence in Herbalife’s CEO, Michael Johnson, and the entire management team, who have skillfully led the company through adversity, including holding firm against a high-profile PR campaign by Bill Ackman where it was alleged more than once that the company would be shut down.”27
