Top 10 Fallacies Regulators Face In Herbalife Case

by: Matt Stewart


Pershing Square has Drawn Attention to Herbalife.

Regulators Must Sift Through the Evidence to Arrive at a Conclusion.

Discarding Fallacies Will Uncover the Truth.

If there is one thing you have to say about the Herbalife (NYSE:HLF) story it is the following. It takes bravado to tackle a publicly traded company that has a $6 billion market cap and argue that it should be worth $0.

The second thing that you have to say is that this kind of allegation inevitably draws out all kinds of enemies and apologists.

If I put myself in the seat of various regulators around the country, I think it is fair to state that this case is certainly politically charged. In no way, shape or form should regulators be seen as doing Mr. Ackman's bidding. In like manner, I would assume regulators would not want to be seen as doing Mr. Icahn's nor Mr. Stiritz bidding. One way or another here, an already wealthy person is destined to get wealthier. This reality is somewhat of a side show to the central questions regulators must analyze.


  • Does Herbalife operate an illegal distribution model?
  • Does the company sponsor an endless chain?
  • Does the company conspire with its independent distributors to deceive business opportunity seekers?
  • Are business opportunity seekers defrauded by the Herbalife marketing plan and its modus operandi?
  • Does the company and its executives commit securities fraud?
  • Is the company in violation of anti-trust laws?
  • Is the company and its CEO Michael Johnson the de facto head of a criminal organization?

These are, indeed, serious questions with serious consequences. De minimus, one would expect that any investigation by regulators will be anything but cavalier.

Still, as cops on the beat, regulators have a duty to society to make sure that the law is applied and applied equitably. If Herbalife and its Chief recruiters are breaking the law they should be prosecuted accordingly. If not, they should be exonerated.

In this article, I would like to argue that the kinds of issues that shouldn't be considered are the following list of fallacies about Herbalife.

A fallacy is an argument that uses false reasoning. An example might be:

  • John has red hair.
  • John is a fast runner.
  • Red heads are fast runners.

Clearly, the logic falls down.

Longs who defend Herbalife seem to make a number of arguments in defense of the stock. Regulators should, summarily, cast many of these arguments aside as they are fallacies.

Fallacy #1

Herbalife has been around for 34 years. How can it be possible that Herbalife is not a legitimate company if it has been around for 34 years? How could regulators possibly prosecute a company that has been around for so long?

A. To state that Herbalife has been around for 34 years is a statement of fact. To state that this fact makes it legitimate is a fallacy. Evidence of longevity is just that, evidence of longevity and not evidence of legitimacy.

Bernie Madoff ran a Ponzi scheme for years before getting caught. Jim Bakker ran a ministry for years before being taken down as a fraud.

Fallacy #2

Herbalife is a public company. How is it possible that a public company can be operating illegally? Herbalife can't be illegal because it is public.

This fallacy is easy to discredit. Historically, there have been numerous examples of major publicly traded frauds where investors lost all of their capital due to the illegal activities of the company's board members and executives. Two companies spring to mind. Enron and Bre-X Minerals.

Evidence that Bre-X and Enron were frauds does not make Herbalife a fraud too - that is stating the obvious. Still, Herbalife's status as a publicly traded entity also seems irrelevant in a quest for the truth.

Fallacy #3

Bill Ackman is an evil short seller who is making a reckless bet to destroy a company that, according to Mr. Icahn, employs "lots of Spanish people". This fallacy is obvious to see and is called argumentum ad hominem. If you can't argue the facts tabled in an argument you attack the person making the argument.

Herbalife has an obvious problem with this approach as it applies to Mr. Ackman. The company's PR strategy is to bash Bill Ackman ad hominem til the cows come home. Unfortunately, Mr. Ackman actually has gravitas as a successful investor, a historically successful short seller in the case of MBIA, and an individual who engages his team at Pershing Square to conduct a mountain of due diligence on each investment thesis.

Regulators must obviously see how Herbalife's attacks on Mr. Ackman seem both defensive and evasive. Alternatively, the company could simply disclose the retail revenues and profitability enjoyed by its network of 3.9 million distributors. Shame, there seems to be "no visibility".

Fallacy #4

Credibility by Association or The Halo Effect. Herbalife employs this fallacy with great effect. The idea is simple. If I wrap enough credible people around my incredible business plan perhaps my business plan will be accepted as legitimate? Herbalife has obviously employed this approach in spades since Mr. Ackman launched his allegation. How many high-profile Latinos have been hired? How many millions in fees are being paid to consultants or politically connected people? How stunningly odd for a company that makes a simple nutritional supplement to need all of this firepower in the halls of justice. One would think that if you were actually legit you would want to return that kind of capital to shareholders instead.

Money laundering is a process where money earned through criminal activity is washed through a legitimate business to give the impression that it has been earned legitimately. Herbalife's list of "Who's Who" in the Latino world who are now on the payroll gives off the stench of reputation laundering. Regulators should easily see how the veneer of legitimacy is both deliberate and cynical.

Fallacy #5

The company is so profitable, how could it possibly be illegal? By now, the answer to this fallacy should be obvious. The reason why Herbalife shareholders make so much money and earn outrageous returns on invested capital is because money is confiscated from participants trapped at the bottom of the pay plan, aggregated, and transferred to those at the top.

It is because of the high churn rates, perennial recruitment, and the negative ROIC at the bottom that the players at the top of the scheme make such super-normal returns.

Why else haven't Herbalife competitors tried to compete away this delicious profit pool? Why isn't Herbalife being knocked-off in this industry that has such obviously low barriers to entry? Why is it legitimate enterprises aren't copying HLF's formula for success?

Ask the execs at FHTM how that biz plan worked out...

Fallacy #6

The company has retail customers and so can't possibly be illegal. I will call this the Hempton Fallacy or the False Choice. Of course, Herbalife is going to have retail customers. Of course there may be customers who see some intrinsic value in the product. What does any of that have to do with whether or not business opportunity seekers get victimized or whether product is sold outside the network?

Let's review. Herbalife sponsors an endless chain of recruits to sell its product. Too many mice chasing not enough cheese means that many mice will starve. Profits in the Formula-1 economy disappear for marginal distributors as pricing collapses and volume is scarce. The end result is preordained - those who try to sell F-1 and are late to the party get victimized whether a product is consumed by anend-user or not.

Recall, "The Retail Question" table by Dr. keep and Dr. Vander Nat does not preoccupy itself solely with Retail Sales. The model also asks the question, how much contribution margin is earned, is it enough to pay for upline rewards and overhead? Can everyone in the distribution chain make a fair ROIC or not?

Judging by the churn in the Herbalife Salesforce, the answer to this question seems an obvious "No".

Fallacy #7

Herbalife is simply "Too Big to Fail" or if you prefer "Too Big to Prosecute". The fact that the company has been able to proliferate for 34 years and span the globe should make it no more or less illegal than if it had started-up last week as a de novo. Size really shouldn't matter in the end as the facts are applied to the mechanics of the pay plan.

Fallacy #8

The stock price is going up lately. The company can't be illegal. Ben Graham captures the nonsense embedded in this fallacy in a straightforward way. "In the short run the stock market is a voting machine. In the long run it is a weighing machine."

Today's stock price reflects investors individual guesstimates of the PV of HLF's Future cashflows aggregated into a market clearing price. As further evidence materializes, the price of this security will change accordingly. Herbalife at $64 is not evidence of its legality. It is only evidence that certain investors seem indifferent, on some level, to the range of regulatory risks that the company now faces.

Here is a historical chart of MBIA which should serve as a reminder of the risks of placing too much stock in this kind of fallacy.

Fallacy #9

Regulators haven't done anything for years. They surely won't act now. This argument fails to take into account that regulatory regimes are dynamic. The FTC has many new Commissioners including Ms. Ramirez, the SEC has a new Chairwoman who is exceedingly long on integrity. The DOJ and the US Attorney has a long and prolific history prosecuting white collar crime. Anyone who assumes that a regulator long deceived is unlikely to act ethically out of fear that observers might ask "Why now?" likely underestimate these individuals quest for integrity and justice.

Fallacy #10

The Caveat Emptor Fallacy. "This is America. People take risks all the time what's the harm if somebody wants to risks $3k to start a business?" This fallacy should be equally obvious.

It is illegal to deceive people to risk their financial, human and social capital in pursuit of a confidence game that rigs the outcome in favor of the recruiter. Supporting a business opportunity fraud's ongoing operation is not a testament to the philosophy of Ayn Rand and free market, libertarian economics. Rather, it is an effort to support a criminal initiative that distorts our free market economy in a most sinister way.

To close, Pershing Square's main website is called The reason is obvious. An analysis of the facts should lead regulators to a just conclusion on the question of Herbalife' legitimacy.

As for this list of fallacies?

Inevitably they should be given little to no weight at all in order to arrive at the truth.

Disclosure: I am short HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.