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I have written a series of articles earlier highlighting the errors in Ackman's Herbalife (NYSE:HLF) thesis. They key argument was Ackman's classification of Royalty Overrides as "recruiting rewards" in his December 20th presentation and February 7th questionnaire was wrong. In my earlier articles, I used a mathematical model discussed in Dr. Peter Vander Nat's paper as well as a common sense argument to point out the flaw. Bill Ackman's Herbalife analyst Shane Dineen then ridiculed Peter Vander Nat's paper saying:

"Fusion Research says our [Pershing's] pyramid scheme analysis is flawed because we don't rely on the economic model in the second half of Vander Nat & Keep's paper. I say Fusion Research's analysis is flawed precisely because it does rely on that model."

He further went on dismissing Vander Nat's model calling it purely "academic" and challenged us to show that it is in accordance with the case law. Here are his words:

"On the other hand, the model in the second half of Vander Nat & Keep's paper is purely academic. I would challenge Fusion Research to point to any Final Judgment in any pyramid scheme case law (FTC or otherwise) that employs the term "Advance Retail Commissions.""

The whole point of Shane's above arguments was to mislead investment community in believing that Ackman's classification of the complete Royalty Overrides line item as "recruiting rewards" is in accordance with the case law. This is far from truth.

Here are the relevant excerpts from the Fortune Hi Tech Marketing (FHTM) case which shows how prosecutors classify Royalty Overrides. As long as Royalty Overrides have a basis in genuine sales, they are treated as "Product Commissions" in the court cases and not "recruiting rewards".

(click to enlarge)

Source: Vander Nat's Declaration in FHTM case

Recruitment rewards, on the other hand, are rewards for enrollment that are paid in addition to product commissions.

(click to enlarge)

Source: Vander Nat's Declaration in FHTM case

Bill Ackman and his team have put out a detailed comparison of Herbalife with FHTM on their factsaboutherbalife website. This declaration is on their website as a supporting material for this case. They must have recognized where they are erring. But still Ackman and his team continued their misrepresentation and omission of certain key facts to support their erroneous "short thesis" on Herbalife, which is shameful. To say FHTM was similar to Herbalife is wrong. To say it to create panic among investors is stock market manipulation.

Now before I end the article I would like to clarify some misinformation Pershing's analyst is trying to spread in the market. In his own words:

"Fusion Research assumes that the "basis of [our] pyramid 'proof'" is the economic model in the second half of Vander Nat & Keep's 2002 paper."

This is not correct. All we have said is that Pershing's pyramid proof is based on an erroneous calculation of "Recruitment Rewards" as they have classified the complete "Royalty Overrides" line item in Herbalife's Income statement as recruitment rewards. They have made this mistake in their Dec. 20th presentation, Feb 07th questionnaire and recent comparison of FHTM with Herbalife. Once, Pershing corrects the mistake and do the proper analysis they will find that Herbalife is a genuine MLM company. We, on our part, will continue helping them in getting a better understanding the company and arrive at correct results in our future articles.

Previous articles in this series:

Source: What Bill Ackman Doesn't Want You To Know About The FHTM Case

Additional disclosure: The article was written with substantial inputs from an investor who has a long position in Herbalife.