It may be the deciding round in one of the most bitterly fought battles on Wall Street. On Friday, the Federal Trade Commission announced it reached a settlement with Herbalife, the multilevel marketer of nutrition shakes and supplements and the target of a three-and-half-year campaign by activist investor William Ackman to prove it is a pyramid scheme. Herbalife has agreed to pay $200 million and to implement a series of restructuring moves that amount to a drastic overhaul of its current business model, but it avoided being labeled a pyramid scheme by the regulator.
The settlement appears to be yet another setback for Ackman, whose Pershing Square Capital Management has staked its reputation, and $1 billion, on a short bet against Herbalife. Ackman maintained that Herbalife is a pyramid scheme that makes its money from recruiting distributors, who ultimately lose money, than it does selling products and that regulators would eventually shut it down. Ackman lobbied for the FTC to investigate the company, declaring that Herbalife shares would one day go to zero.
On the contrary, investors sent the company’s shares trading up nearly 12 percent at mid-day Friday on the news that the company was not deemed a pyramid scheme. (The shares closed at $65.25, up nearly 10 percent from the previous day’s close.) Pershing Square’s flagship fund is already down approximately 20 percent this year, following a more than 20 percent decline last year.
On the other hand, the FTC didn’t exactly give Herbalife the all-clear. In its complaint, the FTC alleged that Herbalife deceived its distributors into thinking they could make money strictly by hawking its wares, when in fact the only real way to make money was by recruiting new distributors into the company to buy inventory. Under the terms of the settlement, Herbalife has agreed to change how distributors are compensated so that it rewards retail sales to end customers, to implement a new compensation structure that will be based on product sales to customers and not distributors themselves, and to pay for a compliance auditor who will monitor Herbalife’s adherence to the provisions of the deal for the next seven years. This essentially means that going forward, the company will have to make most of its money selling shakes and vitamins and not by recruiting new members to buy inventory.
“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,” FTC Chairwoman Edith Ramirez said in a statement announcing the settlement. “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.”
In the statement, the FTC says Herbalife currently promises potential distributors they will make so much money they will be able to quit their jobs and can pull in thousands of dollars a month, but in reality most of them end up making little or no money.
For example, the FTC said in its complaint that more than half of Herbalife’s distributors made an average of just $300 for 2014. And according to Herbalife’s own survey, distributors who operate its Nutrition Clubs spent an average of $8,500 to open the clubs, and fully 57 percent either made no money or lost money. The FTC said that the few distributors who do make money do so from recruiting new distributors, regardless of whether those new members can sell the inventory they have to buy.“Finding themselves unable to make money...Herbalife distributors abandon Herbalife in large numbers,” said the statement. “The majority of them stop ordering products within their first year, and nearly half of the entire Herbalife distributor base quits in any given year.”
This was the crux of Ackman’s high-profile and hard-hitting campaign, which began in December 2012 with a three-hour presentation and which has been the subject of a televised spat on CNBC with Herbalife investor Carl Icahn, a documentary premiering at this year’s Tribeca Film Festival, and a slew of slickly-produced videos detailing Ackman’s allegations, which he couched in the language of a social justice campaign. Ackman focused particularly on Herbalife’s recruitment of Latino members, many of whom are immigrants.
Meanwhile, Herbalife announced it is allowing Carl Icahn to increase his ownership stake to 34.99 percent of the company’s shares, up from a previous maximum of 25 percent. Icahn currently owns approximately 18.3 percent.
While the news doesn’t look good for Ackman today, he is not exactly conceding defeat. If the changes the company is forced to make end up hobbling its profits, Ackman could win in the long term.
But for now, Herbalife and Icahn are taking the victory lap. Herbalife said that while it disputes many of the FTC’s allegations, it wanted to settle to put the matter behind it, and noted that the provisions of the settlement only apply to its U.S. sales, which account for 20 percent of its total.
Icahn said of the settlement, “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 against the Company by Bill Ackman where it was alleged more than once that the Company would be shut down. Obviously, we are still here.”
Finally, some good news about hedge fund performance. Hedge funds returned 2.15 percent on average in the second quarter, following a fourth straight month of positive performance, bringing their year-to-date return into positive territory at 1.36 percent through the end of June, according to London-based data tracker Preqin. But don’t break out the Bollinger just yet: These figures represent the worst first-half performance for hedge funds since 2008, when the financial crisis began in earnest, according to Preqin.
The data tracker also said macro strategies fared best in June, adding 1.15 percent for a year-to-date gain of 3.18 percent. Credit strategies returned 0.44 percent last month and are up 2.53 percent for the first half, while multistrategy funds, the only other strategy to report gains in June, added 0.40 percent for the month.
Funds-of-hedge-funds now manage more than $840 billion in assets, but this figure excludes the large advisory businesses that many of these firms have launched since institutional investors began going direct, data tracker eVestment said in its latest annual report on the funds-of-funds industry. Funds of funds now comprise 28 percent of total assets invested in hedge funds, down from half of the industry total at the end of 2008. Meanwhile, management fees have declined since 2010, falling from 1.24 percent on average to 1.18 percent, and performance fees have come down since 2011, falling from 8.98 percent on average to 8.10 percent. The investment vehicles have also become more concentrated, with the median number of hedge funds in funds-of-funds portfolios falling from 24 in 2014 to 18 in 2016.