Herbalife agrees to pay $200-million settlement and change its business practices

Herbalife Ltd. agreed Friday to pay $200 million and change its business practices to settle federal regulators’ claims that it falsely told people they could quickly get rich by selling its weight-loss shakes, teas and other supplements.

The Federal Trade Commission issued a stinging rebuke of the Los Angeles-based company’s business model, saying in its complaint that Herbalife had misled people into becoming its distributors or its members with videos and brochures showing mansions, fancy cars and boats and telling them they could quit their jobs.

The “overwhelming majority” of distributors “earn little or no money,” the government said. And many have lost thousands of dollars after being encouraged to lease space to set up “Nutrition Clubs,” where people pay a daily fee to drink a protein shake and tea.

“Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make,” said FTC Chairwoman Edith Ramirez, “and it will have to compensate consumers for the losses they have suffered.”

The company, which had revenues of $4.47 billion last year, said Friday that it disagreed with many of the FTC’s allegations, but had decided to settle to avoid “the financial cost and distraction of protracted litigation.”

Herbalife said it had also agreed to pay $3 million to settle an investigation by the Illinois attorney general’s office. The two settlements resolve all active investigations against Herbalife, the company said.

“The settlements are an acknowledgment that our business model is sound and underscore our confidence in our ability to move forward successfully,” said Herbalife Chief Executive Michael O. Johnson. “Otherwise, we would not have agreed to the terms.”

The FTC’s investigation began in March 2014 after billionaire investor William Ackman claimed that Herbalife was operating a pyramid scheme.

Ackman’s hedge fund, Pershing Square Capital Management, bet more than $1 billion that Herbalife’s share price would fall, by selling the company’s stock “short.” He followed that with a relentless campaign against Herbalife’s business practices, in videos and in personal presentations to investors.

Herbalife executives bitterly contested Ackman’s claims, saying the company’s business model is sound and compares to that of Tupperware or Amway.

With the FTC settlement falling short of Ackman’s claims that the company should be shut down, Herbalife’s shares soared on Friday by nearly 20%, before falling back and closing at $65.25. That was a gain of 10% over the previous day’s closing price.

The FTC charged that the company’s compensation system was unfair because distributors were rewarded more for recruiting others to join and purchase products than they were for selling products as a result of actual demand for them.

The agency said Herbalife must change its system so that at least two-thirds of the rewards were based on retail sales of products that were tracked and verified.

The FTC said that at least 80% of sales must be to legitimate end-users or the current compensation must be reduced.

“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,” Ramirez said.

The agreement also stops the company from misrepresenting how much people can earn or from claiming they can “quit their job” and enjoy a lavish lifestyle by selling Herbalife products.

The settlement applies only to Herbalife’s sales in the U.S., or about 20% of its operations.

The agency said the average amount that more than half the distributors, known as “sales leaders,” earned in 2014 was less than $300.

Those members who created a Nutrition Club spent an average of $8,500 to open the business, but 57% reported making no profit or losing money.

In 2012, Herbalife said 3,700 clubs were operating in North America, mostly in the U.S. Herbalife said the clubs drive 30% to 35% of its U.S. product purchases.

Club operators are encouraged to pass out flyers on the street and at their children’s schools, inviting people to visit.

The idea originated in Mexico, the complaint said, where the club was supposed to be a neighborhood gathering place promoting health and wellness. Instead, the clubs operate “primarily as a tool for recruiting new members,” the agency said.

“Many club owners incur thousands of dollars in expenses … that they are unable to recover,” the complaint said.

“The days when I would earn a living cleaning houses are behind me,” said a distributor in a Spanish-language brochure used until 2013, “because now we are fully dedicated to our prosperous Herbalife business.”

Part of moving forward involved an announcement by Herbalife on Friday that billionaire investor Carl Icahn was granted the right to increase his holdings in the company to nearly 35%, from the current limit of 25%.

Icahn holds about 18.3% of Herbalife’s outstanding common stock.

“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,” Icahn said.

“Obviously, we are still here,” he said.

Antonio Wright, a pastor and Herbalife distributor in Stafford, Va., said he planned to continue to sell the company’s products, which have helped him lose weight.

“It will not change what I’m doing,” he said, of the settlement. “I knew it wasn’t a pyramid scheme.”

Puzzanghera reported from Washington and Petersen from Los Angeles.

[email protected]

Follow @JimPuzzanghera on Twitter

ALSO

Trade group promises stricter scrutiny of payday loan ads

Venture capital deals slow amid doubts about augmented reality’s reach

Drivers win $5-million settlement in latest victory against trucking companies

UPDATES:

2:26 p.m.: This article has been updated with additional details and background.

8:35 a.m.: This article has been updated with information about the Federal Trade Commission’s determination regarding allegations that Herbalife’s business practices were an illegal pyramid scheme.

This article was originally published at 7:45 a.m.