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FBI joins FTC in investigating Herbalife's business practices

By Hank Schultz , 22-Apr-2014
Last updated on 22-Apr-2014 at 20:43 GMT

Network marketing giant Herbalife is under renewed pressure with the news that the Federal Bureau of Investigation is looking into the way the company recruits new distributors.  This comes on the heels of an investigation by the Federal Trade Commission into the company’s business model.

The news of the FBI investigation comes from a report from the Financial Times. Reuters news service quoted unnamed sources that said the investigation has been underway for some time but there has been no offical comment from the FBI on the matter.  Herbalife declined to comment except to stand on earlier statements in which the company asserts that it believes it is in compliance with all relevant laws.

A pyramid?

Criticisms of Herbalife’s business model (and presumably the basis of the investigations) swirl around whether the company is operating a pyramid scheme.  Network marketing companies have been operating in the United States for many decades, and deciding whether such a marketing structure (also called multi-level marketing) is a pyramid scheme hinges on how distributors are compensated.  Is their paycheck dependent on sales of products by themselves and their downline distributors?  Or do they make money primarily by bringing in ever more new people, with sales of products or services mere window dressing to camouflage this underlying dynamic?

Herbalife has consistently maintained that its business model is designed first and foremost to sell nutritional products, and to offer a business opportunity to distributors to sell products through their own indedpendent organizations. The company has sought to bolster this view by adopting a corporate messaging policy based on the concept of  ‘daily consumption.’  This underlies the company’s recent innovation of nutrition clubs (started first by a distributor in Mexico) in which distributors lease store front spaces as places to encourage customers to buy and consume products on site.  Chief among these products is Herbalife’s biggest seller, a line of meal replacement shakes.

Real product or service

Another key point for regulators in making this determination is deciding whether a company is offering a legitimate product or service. On this score there seems to be little concern for Herbalife. Other than criticisms that the products may be overpriced, there have been few assertions that the company’s shakes and nutritional supplements are shams. Herbalife has sought to bolster the science backing and regulatory compliance of the products in recent years with a string of high profile hires, including Vasilos Frankos, PhD, from the Food and Drug Administration,  Andrew Shao, PhD from the Council for Responsible Nutrition and Stephen Dentali, PhD of the American Herbal Products Association.  Shao recently made a presentation to the 13th Annual Oxford International Conference on the Science and Regulation of Botanicals in Oxford, MS, part of a company push to engage more fully in communities within the dietary supplement industry.

Herbalife’s stock price has been pulled back and forth as high-profile activist investors have taken big positions—both long and short—on the company’s stock. Bill Ackman, principal of the investment firm Pershing Square, has taken a $1 billion short position on the company’s stock and has said on numerous occasions that he believes the company’s stock price will go to zero.  Carl Icahn, on the other hand, has a big long position on the stock and now controls five of the company’s board seats.  The company’s stock price topped $80 in early January before dropping on the announcement of the FTC probe and tumbled further with the FBI news. Nevertheless, the stock price in up from about $38 to more than $58 over the last 12 months.

The vicissitudes of the stock market and the troubling news of the investigations have so far had no effect on the company’s financial peformance. Herbalife recorded a record $4.8 billion in revenue last year and is now operating in 90 countries.

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