We discussed three issues in our first report on Herbalife (NYSE:HLF). The report focused on the company's violation of a California Court order, the Belgium pyramid scheme ruling and the suspiciously high packaging fees levied on distributors.
Since Bill Ackman's presentation on December 20th, Herbalife has, to no one's surprise, been on the defensive. CEO Michael Johnson made some phone calls last week that he might just end up regretting. Here's a timeline of the chain of events, with further discussion surrounding the seriousness of these potential violations.
On December 20, 2012, noted hedge fund titan Bill Ackman accused Herbalife of being a pyramid scheme during a presentation that lasted over three hours. Ackman's presentation was attended by reporters and investors and it was streamed live on the Internet.
In a press release dated December 24, 2012 Herbalife announced it will host an Analyst and Investor Meeting in New York at 9:00 AM EST on January 10, 2013. The press release notes that "Senior management will discuss the company's business in detail" along with a "comprehensive response to investor questions on its business model." This is being done in response to Ackman's presentation and pyramid scheme allegations.
Pressure for Johnson to take action intensified Friday as Herbalife's shares slid 19% to $27.27. The stock has dropped 36% since Ackman first said Wednesday that he was shorting the stock. It's down more than 60% from its peak this year.
With investors punishing his company's stock for a third consecutive day, the top executive of Herbalife Ltd. sought to reassure shareholders Friday [December 21, 2012] that his company is not a pyramid scheme. Working from the firm's tony headquarters in downtown Los Angeles, Herbalife chief Michael Johnson telephoned institutional investors, including fund managers at Fidelity, disputing highly publicized criticism from prominent New York hedge fund manager Bill Ackman.
As of July 31, 2012, Fidelity's various funds [collectively] held 17.1 million Herbalife shares.
On December 24, 2012 (half trading day due to Holiday) 19.287 million Herbalife shares traded; ending down 4.44% from the previous day.
Regulation FD Violation
On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure of information by publicly-traded companies and other issuers. Regulation FD provides that when an issuer discloses material nonpublic information to certain individuals or entities-generally, securities market professionals, such as stock analysts, or holders of the issuer's securities who may well trade on the basis of the information-the issuer must make public disclosure of that information.
According to the LA times, Johnson's telephonic conversations with institutional investors, including a fund manager at Fidelity, consists of "disputing highly publicized criticism" [Bill Ackman's allegations and presentation].
Herbalife, including but not limited to Johnson, will not reveal Herbalife's version of the facts "disputing highly publicized criticism" [Bill Ackman's allegations and presentation] to members of the public, including any institutional investors not called by Johnson on Friday, until January 10, 2013.
Discussion of Regulation FD and Rule 10b(5) Violations
Johnson had direct telephonic conversations with a fund manager for Fidelity and an unidentified number of other institutional investors.
We have no way of knowing what information was given by Johnson to these large holders of Herbalife's shares. However, it would seem clear to any reasonable person that Johnson withheld any material information from Fidelity and the unidentified other institutional investors that had the potential to cause these entities to dispose off their positions in Herbalife.
In the aforementioned December 24, 2012 press release, Herbalife noted that "it has retained Moelis & Company as its strategic advisor." It is noteworthy that Moelis & Company are prominent in the field of Leveraged Buy-Outs ("LBO").
Johnson may have hinted (to Fidelity and the unidentified institutional investors) that Herbalife is planning an LBO; which may have nudged these institutions into holding their positions in Herbalife. Because Herbalife has concealed the actual conversation Johnson had with Fidelity and the unidentified institutional investors, we have no way to determine what non-public material information Johnson disclosed to these entities.
According to the LA Times article (note # 3 in the timeline above) Michael Johnson telephoned institutional investors, including fund managers at Fidelity." Did Johnson call all institution investors that maintain long positions in Herbalife; or, did Johnson select specific institutional investors (perhaps based on their Herbalife holdings)?
Even if Herbalife issues an 8K revealing the fact that these private conversations occurred on Friday; since these conversations were telephonic (as opposed to written) the public will never know the specific back-and-forth conversations between Johnson and the fund managers.
Bill Ackman has publicly stated that he intends to hold his short position (20 million shares, according to Ackman) until Herbalife goes to zero. I believe that the total short position on Herbalife is about 24 million shares.
We know that Johnson called the institutional investors for the purpose of "disputing highly-publicized criticisms" of Herbalife [Ackman].
Perhaps Johnson's conversations with these institutional investors fell on deaf ears.
On December 24, 2012 (in a half day of trading) a little less than 20 million shares traded. We can reasonably assume that Ackman was not participating in the market [Herbalife] today. It is not unreasonable to suspect that either Fidelity or one of the other unidentified institutional investors who Johnson spoke with on Friday may have (either alone or collectively) represented a majority of the 20 million shares traded.
Johnson is bound by the rules and regulations of the SEC, including but not limited to Regulation FD and Rule 10b(5).
The other area of concern is that Herbalife has concealed the identity of the institutional investors (other than Fidelity) who were the recipients of Johnson's non-public material information.
While we are on the topic of Herbalife's regulation FD violations, let's talk about Tim Ramey
Tim Ramey, a Senior Analyst with DA Davidson, has covered Herbalife for many years. DA Davidson makes a market in Herbalife securities.
Only five days ago, Tim Ramey was on CNBC defending Herbalife. The disclosures flashing on the screen (at around the 4 minute mark) indicate Ramey receives non-investment banking compensation from Herbalife. Ramey also admits that he is a distributor for Herbalife. Ramey has stated in the past that the only reason he signed up as a Herbalife distributor is to be a recipient of the emails Herbalife routinely send its distributors. We believe Ramey. We also believe Ramey when he says he never has, and never will, participate as a distributor with Herbalife.
Notwithstanding the fact that Regulation FD expressly prohibits Herbalife from disclosing "material nonpublic information to securities market professions, such as stock analysts" --Herbalife provides Ramey will distributor emails which emails disclose information in connection with Herbalife that is not available to members of the public.