24 Ways Herbalife Is Mocking The Regulators

Jul.25.14 | About: Herbalife Ltd. (HLF)

Summary

As I wrote yesterday, sentiment among a lot of Herbalife bulls is that they concede the company is deceptive, but invest because they think regulators are spineless.

So, Herbalife continues business as usual, inclusive of these 24 ways that it's mocking regulators on a daily basis.

Per its own internal strategy documents, Herbalife targets those that live in extreme poverty and who may not have the education necessary to understand they're being defrauded.

This is more than an investment thesis, these are ethical and moral wrongdoings that need the full on attention of those smart enough to discern it.

From a personal standpoint, allowing this company to operate does a huge disservice to the country that I have also been a major beneficiary of my whole life.

I think by now it's obvious that the market seemed to shrug off Mr. Ackman's Manhattan presentation on Herbalife's (NYSE:HLF) Nutrition Clubs given earlier this week. I continue to contend that the information delivered in the presentation was rock-solid evidence of a massive business model flaw that's hiding under the Nutrition Clubs that are producing as much as 40% of the company's revenue.

In other words, Mr. Ackman's claims are extremely material to the company, its investors, and regulators. Simply put, if Mr. Ackman is proven right and Nutrition Clubs have to be shut down or modified in the way they operate, it's going to cripple Herbalife's growth - quickly.

As many notable sources have said, the stock's reaction doesn't mean the information he delivered wasn't potent. The Economist ran a piece today suggesting that although Ackman's presentation seemed to fall on deaf ears, it raises some extremely cogent questions. Herb Greenberg, contributor to CNBC and The Street, agreed with this take in a follow-up piece that he penned. Noted investor Whitney Tilson, along with me and other blogger skeptics, all seem to think that underneath it all, the substance of Bill's presentation was incredibly damning.

My money is still on the "saner heads" at the regulatory agencies seeing this.

The stock began its rally at the beginning of the presentation, and it has continued into today, where the stock is now trading around $66. It's surely been a time for monetary success if you're long Herbalife. I even said in my last piece, longs that are making money on the way up are doing so off of my own paper losses. That's fine - I embrace that - that's how the Darwinism behind the markets works. But, that doesn't translate in the slightest to validation of the company's business model.

Increasingly, interestingly enough, it's not even becoming a case about the business model for some bulls. I wrote a piece on Wednesday of this week talking about how some Wall Streeters openly admit the company is deceptive and fraudulent, yet they embrace what is, to them, the "unlikely chance of regulators shutting the company down."

This argument, admittedly, has turned my discontent for Herbalife into an entirely new animal. I share the same disgust with the company as I do for the people who choose to take the easy way out and ignore that it's clearly a fraudulent way of doing business.

It's sickening to me.

The entire argument has now drifted from whether or not the company is a pyramid scheme to whether or not regulators are going to have the fortitude to do something of significance to the company - and, if so, when they are going to do it.

With every day that passes, more and more people are susceptible to being bilked out of their money under the guise of a work-at-home opportunity. With every day that passes, people around the world are working for nutrition clubs without proper pay and protection of labor laws. With every day that passes, Michael Johnson and top distributors get richer from exploiting people that live in extreme poverty. With every day that passes, potential recruits feel forced to consume Herbalife product in order to complete nutrition "Club 100" training. With every day that passes, people that do not have the basic wherewithal to discern Herbalife's pay structure or model makeup are being defrauded without even knowing it.

With every day that passes, regulators are allowing this predatory scheme to perpetuate.

As if I need to tell you, I'm not from the camp that further study is needed. I'm from the camp of "I can't believe regulators could digest what Mr. Ackman said in his presentation earlier this week and not conclude that it's the smoking gun necessary to immediately shut the company down." There are arguably very little-to-zero retail sales at these nutrition clubs. The revenue being produced from them is from the forced consumption distributors must do in order to make it through training to open their own club. These people are paraded around to other nutrition clubs to help other distributors consume their product. These people may not even be interested in the slightest about weight loss.

Forget about the precedent set that recruiting can't make up more than half of the income made from an MLM. Half would be a pipe dream, it appears.

In Herbalife's case, it appears to be all about the business opportunity.

I agree with Mr. Ackman that Herbalife could be the most brilliantly managed pyramid scheme in history. But, after this week's presentation, I believe it also becomes one of the most obvious pyramid schemes in history.

Who are the regulatory agencies that we know are tasked with investigating Herbalife? We know that the SEC, FBI, DOJ, FTC and two attorney generals offices are currently probing the company. We also know that the Canadian government appears to be looking at the company. For now, let's stick to the U.S. - our own regulatory agencies and their duties to uphold and protect an equal shot at capitalism and the American Dream.

Each of these agencies has their own part in stopping the Herbalife deception. What makes Herbalife applicable to each of these agencies? Let's look at what these agencies are supposed to uphold, via their websites. I'll note where I believe Herbalife "crosses the line" in red. While the FTC would certainly take the lead, due to Herbalife's deceptive and unfair business practices - the SEC has a case, due to executives making false and misleading statements. The DOJ and FBI are likely tasked with looking at things like conspiracy to commit mail fraud. All bodies have a case, because Herbalife falls under the definition of a pyramid scheme.

The FTC:

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The SEC:

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The FBI:

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The DOJ:

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I like that last part where it states "all Americans". It doesn't say anything about people that don't speak English, people with no formal financial education, or people who are easily deceived. It says, "all Americans".

With so many people caught up in the specifics of what was said this week, the overall picture has been ignored. I went back and found some new skeptical points, and combined them with what I learned from this week's presentation. This is what I came up with. So, without further ado, here's my 24 different ways that Herbalife continues to mock the regulators that are probing them with every day it's still in business.

1. Insiders Are Blatantly Hitting the Exits

Let's talk about, first and foremost, the timing of Herbalife insiders selling stock.

As Mr. Ackman pointed out earlier in the week this week, Herbalife insiders had never been in a rush to dump their stock before allegations of being a pyramid scheme came about. Not until the allegations of the company being a pyramid scheme started coming to light did the selling accelerate and spread to both directors and officers of the company.

As this slide below shows, directors and officers have sold more than $22 million in the last three months, compared to just $1 million in the 15 months prior to PSQ's original thesis that was presented in December of 2012.

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This raises a couple of questions, namely:

  • What's with the timing of these sales? Why now?
  • If the company is operating 100% legally and insiders want to prove that, shouldn't they be sending that message by buying on the open market?
  • Again, if the company is operating legally, why sell now? The company trades at an extremely low forward P/E ratio, and its growth is exploding on paper. Michael Johnson and others certainly don't need this extra money, so why not show some solidarity with common shareholders until Herbalife's valuation is fully ripe and the company has been exonerated? Doesn't Michael Johnson think this will be a $100+ stock after the FTC exonerates him?

2. The Company is Fleecing Those That Don't Understand the Complexity of the Business Model

This is a big deal from the FTC's standpoint.

If everyone that signed up as a distributor had to demonstrate that they have full knowledge of how everything in Herbalife's business model works with the clarity that Mr. Ackman has uncovered, the company would likely go out of business tomorrow. But, that's not the case, and the company relies on this obfuscation to pad its business model from distributors, regulators, and the common public.

Yes, I'm a Herbalife skeptic, short, and bear. But, I assure you I could sit toe-to-toe with anyone on the issue and debate it forever (short of anyone at PSQ, who likely have me beat). I know Herbalife's filings like the back of my hand. I have much of the evidence committed to memory at this point. This is no doubt the highest amount of due diligence I've done on a company since I've started investing. And I've committed my funding it to accordingly.

It's this level of due diligence necessary to uncover the layers of the Herbalife confidence game. Most people don't have time to do this level of research, others don't care. That's fine. However, when the people like Mr. Ackman point out things they've found through their dutiful grind consisting of thousands of hours of due diligence, they should not fall on deaf ears. Presenting tons of information doesn't make Ackman arrogant or a "know it all"; it makes him diligent in his research.

The reason that Ackman's presentation was so laborious and long this past Tuesday was a product of how enormous and complex Herbalife's business structure is. You can say the same for when Shane Dinneen came on stage to analyze Herbalife's compensation system during Ackman's original thesis. Both of these items are too long and too complex for most people to understand. For those that could understand it, they don't have the time to comb through it.

Herbalife then uses the fact that most people can't figure out these things on their own (it took Dinneen a year of working on nothing but Herbalife, and he's brilliant) to fleece them out of their money. People that don't understand the system that they become part of don't even know what is inherently fraudulent about Herbalife, its pay plan, or its Nutrition Clubs. They know the simple tasks of doing what the company says and following those in your upline.

The company takes advantage of what people don't understand, and that falls directly under what regulatory agencies like the FTC are out to prevent.

3. The Company Makes Absurdly Ridiculous False Income Claims

This may seem like something we've covered over and over again by now - but it's definitely one item that sticks out in the forefront of my mind as insulting to regulators. The company's top distributors, including John Tartol who sits on the board of directors, have told people that anyone can make $100k/month as a distributor. Other top distributors have made claims of millions. Expensive cars, mansions, and living the high life, they tout.

How can SEC Enforcement sit back and not think it's a disgusting breach of fiduciary duty when someone on the Board of Directors comes out and says something like this:

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Why not go for the gold, John, and pitch them on $1 billion?

How can regulators sit idly by as this person makes these claims while sitting on the Board of Directors of the company? Perhaps this is the reason that there was a piece out yesterday suggesting that the company's officers were having trouble finding someone to underwrite them D&O insurance.

Tartol's been saying things like this since the days he was running "Success Connection", the now defunct lead generation scheme.

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"If John can do it - YOU CAN TOO!"

The only problem? John knows it's unlikely that you will come anywhere near this.

4. The Company Turns a Blind Eye to Absurd False Medical Claims

This again, is another case that has been made in the past. However, it's important to mull over once again, because it's so much of the heart of the issue.

For 30+ years, Herbalife has been moving product by making health claims that are questionable at best, blatantly illegal and fraudulent at worst. For more on this, you can read my article titled, "The Outrageous Claims That Fuel Herbalife".

For our purposes today, let me just say it's commonplace for distributors to promise that Herbalife products can treat cancer, acne, gout, PMS, allergies, skin conditions, IBS, lupus, and a whole host of other problems that not only can it not treat, but need to be addressed by a real doctor. What do people without health insurance, too poor to see a doctor, think of when they see this in a Herbalife pitch?

In "Herbalife, The Lies Among Us...", I profile President's team member Rene Porcile and his recent efforts to take down his false medical claims from his website. Rene considers himself to be a 20-year Herbalife success, and like many other members, he's built that success from telling people things like Herbalife products can treat lupus, mono, post-chemotherapy, lyme disease, and menopause.

This is absolutely disgusting and outrageous behavior.

We even saw on ABC's Nightline that distributors were telling people that Herbalife products cured brain tumors. When Des Walsh was asked whether or not this practice was pervasive in Herbalife, he gave a rock-solid, muck-filled, "I don't believe so", which he stated in a manner as if he was asking a question back to Brian Ross, who may have the non-BS laden answer.

The company knows exactly what its distributors are doing.

5. The Company Targets Those in Extreme Poverty, and the Proof is in the Internal Documentation

Speaking of disgusting, outrageous behavior - how about the slides at the beginning of Mr. Ackman's presentation that contained leaked Herbalife internal strategy documents?

A lot of people were making fun of Mr. Ackman for breaking down into tears about 2 hours into his presentation earlier in the week. If you look at this Herbalife case from a humanitarian side, it's tough not to. We now have internal Herbalife strategy documents that prove that Herbalife is going after the poorest, most desperate people in the world.

It's moving into countries with GDP under $2,000.

It's targeting people that make less than $5 a day.

Look at the picture below that was sourced from Herbalife's own internal strategy document. Those two children are two potential Herbalife distributors, according to Herbalife's internal team. That's who the company sees as customers.

If that's not enough to make you tear up, you're not much of a human being.

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6. The Company Calls These Marks "The Bottom of the Pyramid"

Of course, lest we forget, Herbalife has a brilliant term for these people we just spoke about. They call them, "the bottom of the pyramid" - certainly an interesting term for a company that's being accused of being a pyramid scheme. I wonder why that is.

Again, here's more of the internal strategy documents that Mr. Ackman presented that were leaked from a Herbalife whistleblower.

Speaking of which, do you think Herbalife is wondering just exactly how many internal whistleblowers there are? Are the shredders working overtime after Mr. Ackman's last presentation?

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Herbalife's own internal documents also show that the company willingly goes after those who have fallen on hard times and are economically struggling. Need more income? Sure, just cut us a check for your last $3,000. Don't have it? Do what once successful lead generation seller and now bankrupt Michael Burton said and throw it on a credit card.

You're now using the U.S. economy's credit to buy into a false dream. If the FBI shouldn't see this as a threat to the U.S. economy, as they're said to defend in the above "About Us" photo, I don't know what is.

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7. It Makes Ackman Look Alone on the Short Side of the Trade and in His Critiques, When He Isn't

One of the other common misconceptions is that Mr. Ackman is the only person that is critical of this company and on the short side of the trade. This could not be further from the truth. Forget about me for a second and let us identify some of the other smart, notable critics that seem to agree with Mr. Ackman.

Fund manager Whitney Tilson has also been outspoken about his critique of the company. ValueWalk, The Wall Street Journal, and others all reported after Ackman's presentation that Tilson was even more confident in his position. I spoke to Tilson in person just hours after the presentation, and he confirmed this with me. CNBC contributor Herb Greenberg has also been critical of the company, in both his CNBC produced documentary on the company, as well as in the articles that he writes about the company.

Dan McCrum of the Financial Times Alphaville also seems to have embraced the skeptical views of the company.

White-collar criminal expert Sam Antar, in his interview with me recently, also is critical - so much so that he called multilevel marketing a "classic fraud", shared skeptical views, and called Herbalife the "worst form of predatory capitalism".

Bill Keep also is extremely critical of Herbalife and its business model. Who is Bill Keep? Mr. Keep is known as one of the foremost authorities and experts in multi-level marketing and pyramid schemes. He was used as an expert witness for the Department of Justice in U.S. vs. Gold Unlimited. In addition, he assisted the SEC in the largest pyramid scheme case ever prosecuted in 1998. Then, in 2002, he was published with Dr. Peter Vander Nat, who is the FTC's resident expert on pyramid schemes. You've no doubt heard Mr. Vander Nat's and Dr. Keep's piece referenced in many of the Herbalife articles on this site.

It would seem Mr. Keep knows a bit about business. Oh, yeah, and he's also the dean of the school of business at the College of New Jersey.

So, despite what the media shows, Ackman is not alone. And those riding with him are cut from the same persistence cloth that Mr. Ackman is. Come exoneration or damnation for Herbalife, these critics are likely to continue to be outspoken on the issue.

8. Herbalife is Plundering Its Balance Sheet of Equity that Could be Used for Reparations

This is a really important one.

The company recently suspended its dividend in order to make capital available for its recent buyback. While this may seem like a good idea to those long the company, it could also easily be a ploy to be able to have control over the company's stock price for the short term. This is the SEC's territory. They need to be asking questions of when and how Herbalife is buying back its own stock, on top of looking at potential collusion against Ackman in order to catalyze a short squeeze.

The other travesty about this is that the company is using equity that could otherwise be used to satisfy the billions of dollars in reparations that it seemingly owes former distributors who have been bilked out of money under the guise of the business opportunity. This is why many skeptics push for regulators to halt the company and freeze its assets sooner, as opposed to later.

Never mind the fact that insiders are selling their stock into the buyback; this is capital and assets that regulators should be focused on freezing or maintaining, so that if the company is found to be a pyramid scheme, it can be used to satisfy court judgments, pay off the company's debt covenants, and make some distributors somewhat whole once again.

9. The Company Has Made Misleading Statements and Claims in Filings and on National Television

I'm not a securities lawyer, but last time I checked, you simply couldn't make false and misleading statements in order to deceive people of your business. And, you definitely can't do it a bunch of times over. That's listed in one of those regulatory "About Me's" above. Just as a refresher in this area, this was Des Walsh's original answer when the question of retail sales first came up during a 2012 conference call. Remember?
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He basically said, "the company has no idea".

Then, Herbalife carefully "omitted" what Des said in its 8-K.

This is called lying by omission, in my opinion. Not sure how that 8-K made it past any securities lawyer, especially when the point in question was extremely material.

Then, Michael Johnson went onto CNBC and gave his answer to this pesky question.

But, then he comes out to say that 90% of distributors are buying their own product? That's almost the inverse of what he said in his first interview. Which one is it?

This now makes sense. It's people being paraded around in Nutrition Clubs. Johnson was trying to lean on his Club 100 consumers and use them as an example. He probably actually misspoke the first time, but his amended statement is now rendered useless by what Ackman revealed this week. Yes, they're technically distributors, but they're not consuming for the discount, nor are they consuming to lose weight. They're consuming because it's part of the Club 100 education plan. The Club 100 education plan is what makes uneducated people feel like they're getting some sort of real-world education, when the company is actually fleecing them into being garbage disposals for Herbalife product.

Now, it's up to the regulators to determine whether these are misstatements or not. These look like downright lies to me.

10. Herbalife Excludes Ongoing and Active Legal and Marketing Expenses from EPS

There are a couple of places where Herbalife pulls some "aggressive accounting", as Mr. Ackman put it yesterday. One is with the exchange rate it's booking its Venezuelan business. The other is the reverse-engineered "Hourly Consulting Pay" figure that seems to allow the company to execute a pure MLM model illegally in China.

This article by another Seeking Alpha contributor points out what is farcical about Herbalife's accounting tactics:

Next, Herbalife's guidance excludes "the impact of expenses (primarily for legal and advisory services) relating to the company's response to information put into the marketplace by a short seller." That short seller is, of course, Bill Ackman. The fact that the company is spending so much money on publicity to counter somebody's opinion, instead of just proving him wrong with retail sales logs, is a bit odd. Since apparently this cost is so high that it has a material effect on the results to the point where the company wants to separate it out, isn't this a real expense for the operations and a real cost of doing business and generating revenue? If it's not, why bother fighting Ackman and wasting shareholder money? If it is vital to the business operations, then it is a very real expense. Companies like Herbalife, legitimate or not, legal or not, are always going to have their critics. Should McDonald's not count its marketing response to Taco Bell's breakfast launch in its guidance? Of course it should count it all.

Finally, Herbalife's guidance excludes "expenses related to a FTC inquiry." Again, these are important expenses that may be ongoing for years and are vital to sustaining Herbalife's business operations, revenue creation, and profitability. They are very real expenses that involve real cash and are ongoing. They are a cost of doing business, and Herbalife shouldn't exclude them and neither should investors.

I won't pretend to know exactly how much these ongoing "one-time" costs will be, but I don't think investors should take Herbalife's guidance or even "adjusted" earnings numbers seriously.

So yes, it's non-GAAP and stated that way - but a cogent point is made nonetheless when The Specialist asks, "Companies like Herbalife, legitimate or not, legal or not, are always going to have their critics. Should McDonald's not count its marketing response to Taco Bell's breakfast launch in its guidance?"

11. The Company Appears to be Breaking the Law in China - Big Time

If Ackman's "Herbalife in China" event had been viewed by as many people as this previous event, I don't doubt the company would be under far more scrutiny than it is in China right now. China is a major part of Herbalife's growth, and needs to stay intact for the company to continue growing the way that it has been. China has a very different set of rules and regulations for MLMs than those that exist in the US - a notably stricter set.

The presentation Ackman gave on Herbalife's operations in China basically pointed out how the company is executing a pure MLM model in a country where the U.S. method is illegal. Here's a quick rundown of how the company appears to be skirting the rules, with some sections sourced from my original China article.

As a "business representative" in China, you're issued retroactive credits in accordance with how much product you purchase. (i.e. you purchase the items at full price, the company kicks you back what your discount is supposed to be after the fact - like a rebate). The baffling thing is that the group that helped Ackman present the Chinese research (OTG Research) claims that Chinese people refer to this as "pay", when in essence, it's really their money just being funneled back to them. Oh, yeah, and it's taxed. So, you're buying the product up-front at full price, selling it for full price, waiting on the difference to get mailed back to you, which you're then taxed on.

Finally, to advance to "distributor", you need to - you guessed it - accumulate more volume points. This is done by having people in your downline purchase items, which then again puts the emphasis on recruitment. The "distributor" rank has 5 subsets, the highest of which requires you to be purchasing $1.19 million worth of product per month, on an ongoing basis. The second-highest of which requires you or your downline to be purchasing $472,800 worth of product per month, on an ongoing basis.

As Ackman joked on the call, it can't just be one very obese person that makes it to these levels. You need a substantial recruitment initiative and a massive downline.

Another way that distributors make money is through "Hourly Consulting Pay". HCP is a Herbalife term, and it's the way Herbalife skirts the rules in China. It's not based on consulting, nor is it based on hours - interesting. HCP is based on commissions from downline sales and bonuses through downline sales.

By calling it "Hourly Consulting Pay", it allows the company to publicly talk about its pay tiers without fear of recourse from the rules. HCP is a reverse-engineered figure that is made up of fictional hours.

A company so brazen in its approach in a country where pyramid sales are so scrutinized makes it seem as if the company is operating legally, when at its root, it may not be.

When Chinese law is applied to the way it operates in China, it becomes really quite clear that the company could be, at best, stepping into some grey areas, and at worst, blatantly breaking the law.

Pershing then goes through the SEC filings of Herbalife, breaking out and systematically dismantling the way the company accounts for all of this mess in its public filings. I'd encourage you to watch the call at length, especially if you're a certified public accountant (NYSE:CPA) or have previous public disclosure experience with regards to financing. The way the company books all of its China "royalties" is baffling. What we find out is that China's royalty numbers are derived almost exactly the same way as they are in the U.S. - as a percentage of retail sales.

Ackman then goes on to point out that he thinks Herbalife is purposely trying to hide the fact that China royalties move in lock-step with the amount of retail product sold, and he encouraged PwC to take another look at this specifically.

12. The Company Appears to Reward Deception

John Tartol, current Board member, has made his millions deceiving people.

He assures people that it's possible that they can make millions as Herbalife distributors.

Herbalife has rewarded him with discretionary "Mark Hughes" bonuses, in addition to a seat on the company's Board of Directors. He's become a millionaire many times over and a Herbalife board member whose pay plus stock-based compensation was over $3 million last year.

Does Herbalife offer positive reinforcement to people who deceive to bring in more distributors? It's outrageous.

'Nuff said.

13. Herbalife Seems to Operates Under All 7 SEC Mandated Facets of a Pyramid Scheme

Here's an easy one for everyone to figure out - a while back, the SEC listed 7 things that make up a pyramid scheme. This is an excerpt from what the SEC has laid out; for the full text, you can click here:

When considering joining an MLM program, beware of these hallmarks of a pyramid scheme:

  1. No genuine product or service. MLM programs involve selling a genuine product or service to people who are not in the program. Exercise caution if there is no underlying product or service being sold to others, or if what is being sold is speculative or appears inappropriately priced.
  2. Promises of high returns in a short time period. Be leery of pitches for exponential returns and "get rich quick" claims. High returns and fast cash in an MLM program may suggest that commissions are being paid out of money from new recruits rather than revenue generated by product sales.
  3. Easy money or passive income. Be wary if you are offered compensation in exchange for little work, such as making payments, recruiting others, and placing advertisements.
  4. No demonstrated revenue from retail sales. Ask to see documents, such as financial statements audited by a CPA, showing that the MLM company generates revenue from selling its products or services to people outside the program.
  5. Buy-in required. The goal of an MLM program is to sell products. Be careful if you are required to pay a buy-in to participate in the program, even if the buy-in is a nominal one-time or recurring fee (e.g., $10 or $10/month).
  6. Complex commission structure. Be concerned unless commissions are based on products or services that you or your recruits sell to people outside the program. If you do not understand how you will be compensated, be cautious.
  7. Emphasis on recruiting. If a program primarily focuses on recruiting others to join the program for a fee, it is likely a pyramid scheme. Be skeptical if you will receive more compensation for recruiting others than for product sales.

Herbalife fits all of these. I prove it in an article that I released months ago.

For more on this, read my article "Forget Belgium, Here Are 7 Reasons That Herbalife Fits The SEC's Definition Of Pyramid Scheme".

This is the SEC's own criteria - so where is the SEC now?

14. The Company Doesn't Appear to have Disciplined Its Top Distributors Who are Clearly Guilty of Deceit

In addition to deceit, you can add lead generation and potentially mail/wire fraud.

As far as we know, perpetrators like the ones listed on herbalifepyramidscheme.com have all escaped out of this scheme unscathed, thus far.

Herbalife has yet to report any discipline taken on its top distributors. Not only have the regulators certainly not stopped them, the company doesn't seem to have taken any action with regards to them, either.

15. We Now Know Almost for Certain that There is Extremely Little Retail Consumption of Product

With Mr. Ackman's shellacking of Nutrition Clubs this past week, we get an astonishing view of how little actual retail consumption of the product is actually taking place. We know that some product is being consumed by people that want to lose weight - but the question was always how much. Neither party could seem to pin down how much was going where. Now, we seem to know that true retail consumption seems to be an extremely small pocket of individuals - far less than necessary in order to operate as a legal MLM, for sure.

We knew before that inventory loading was going on in order for distributors to reach the volume points necessary to achieve SUPERVISOR - and then to have the right to make money off of recruiting.

Now, we know that the consumption going on in the Nutrition Clubs - which make up 30%-40% of Herbalife's revenues - seem to be completely fraudulent and also a product of another crafty method of getting lower-income people to SUPERVISOR through other means than a $3,000 lump sum.

These people are "consuming" their way, $5 at a time, to SUPERVISOR.

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16. Herbalife Pays for its Credibility

Herbalife rolls out Madeline Abright or Dr. Ignarro when it needs to give itself the cloak of legitimacy. It does the same thing with footballers David Beckham and Lionel Messi. There is no doubt these people do not have a true understanding of how this business model works - and there is also no doubt they are being paid a handsome fee for lending their name to the company's product and model.

Behind each endorser, we'd likely see payments akin to the ones that Mr. Ignarro has received since 2003:

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Does the company have any endorsers that aren't distributors and aren't being paid by the company? Good question.

17. Herbalife Can't Get Decent Financing From Banks, Who Are Likely Nervous About the Company's Ability to Repay

Remember Herbalife's last financing a while ago?

It was convertible debt that was used to fund the company's buyback. A few of us had written on it, but the most cogent points were made by Matt Stewart and Herb Greenberg, who both concluded that Herbalife went with convertibles because it didn't have access to regular debt financing. Companies usually take on convertibles because they have no other options, not because they're desired forms of financing. They can often be dilutive. From Matt's write-up on the debt:

Convertible debt gives bondholders a unique ability to hedge their position. Because of the conversion option embedded in the note, bondholders can immunize themselves against downside risk by shorting HLF common (in this case, by way of a forward contract/swap). It strikes me as obvious that HLF was unable to raise new debt without offering investors downside protection. Hence, the convertible.

Why would investors want downside protection against capital loss for a company that gushes so much cashflow?

Perhaps concerns over the legitimacy of Mr. Ackman's pyramid scheme thesis have some gravitas?

Consider too the additional expense of the conversion option. Notwithstanding the fact that this note has a 2% yield, there are extra costs layered into this deal. For starters, the capped call contracts are a cost, then there are the underwriting fees, and finally, there is the inevitable redilution to equity holders 5 years hence if the stock trades materially higher. As a short, of course, this does not worry me too much.

Remember Herb's comments from around the same time?

No bank will lend Herbalife money without having a "quick exit" plan.

Regulators should be asking themselves why that is.

18. Nutrition Clubs Appear to Be a Method of Forcing Business Seekers to Consume the Product, Regardless of Whether or Not They Have Intentions of Losing Weight & 19. Nutrition Clubs are Simply Another Obvious Path to SUPERVISOR

Here's the obvious one that came as a result of yesterday's presentation. Nutrition Clubs appear to be nothing more than little miniature pyramids within Herbalife's pyramid. What Mr. Ackman unveiled during his presentation this week was that those looking to start their own clubs - something the company claims anyone can do - are coerced into completing training programs that are endorsed by the company.

These programs are several weeks long, and a big part of the curriculum is making and drinking many, many, many Herbalife shakes. Without consuming, you can't move on in training. Without moving on and "graduating", it's unlikely you can open a successful nutrition club and it's even less likely that others in "Club 100" will parade their recruits around to your club when it comes to feeding time.

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Here's the consumption checklist you must fill out:

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It may not have been as sensationalist as his statements on Monday, but Ackman just seemed to prove that this company does have the equivalent of Enron's fake trading floor - regardless of whether or not the market believes it.

They're parading business opportunity recruits around and making them drink product as part of initiation. That's where all of the product's going, and that's what Mr. Hempton saw when he was doing his personal tour of the clubs.

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Again, it's just one more way of getting you to SUPERVISOR - so that you can then make money from recruiting.

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20. Herbalife Uses the Word "University" in a Questionable Manner & 21. Herbalife May Not Be Abiding by Labor Laws

Part of the company's system to bring people into "Universidad del Exito" is that it makes people (most of whom with no formal education) feel like they've graduated from something of meaning. Distributors that have shelled out enough money for SUPERVISOR get the feeling (with cap, gown, and celebration) like they now have some type of formal education. Videos like this one show people who don't even know that they're being defrauded, as they celebrate.

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Not only is the usage of the word "University" questionable (as you need to meet formal standards to call yourself a university), but the labor laws are also called into question with the amount of work that potential distributors are asked to take on in Club 100 venues.

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22. Herbalife thinks Regulators Won't See the Holes in Its Swiss Cheese-Style "New" Return Policy

As Mr. Ackman pointed out, when products make their way to these clubs, they're often opened and divvied up immediately, which then makes them unqualified for a return. It's also been stated more than once that Herbalife questions and potentially audits the distributors that do return product. Those who are in the country illegally, don't have a great grasp of English, or don't want to ruin their business prospects are not likely to return their product.

If you want a full glance as to why the new return policy is way too little, too late, you can read Matt Stewart's article, "Herbalife's Gold Standard Guarantee Is 'Fool's Gold'".

23. Herbalife Coerces its Distributors to Create Zany Testimonials as Part of the Recruiting Process

We all know that Herbalife tells its distributors to take before and after pictures as part of the testimonials they'll use to push the product going forward. ABC News gave us a brief look into the company's manual that shows how to basically look pissed off for your "before" picture, and happy in your "after" picture. Talk about a microcosm of deception - this is a page right out of the lat night TV infomercials for whatever exercise crap someone feels necessary to peddle at 3AM on a Tuesday. Skinny people pushing out their guts for "before" pictures, fat people sucking it in for "after" pictures - men and women with already ripped abs flexing them under different light with a much nicer tan than in their "before" picture - you know the drill.

Herbalife has continued to do this as part of its new PR campaign. Still want your chance to make millions? We need you to write a new testimonial for our new website.

Can you read that? That actually says, "This Herbalife testimonial was submitted by a Herbalife customer during a competition that awarded prizes for the most compelling story of personal product success."

So, it's now not only a pyramid scheme to move product, but they're using their own distributors like rented mules to create testimonials, while they string along on a carrot both a "prize" and the guarantee that this won't be the week they potentially ask for your Green Card.

24. Wall Street Has Now Seemed to Admit That the Company is Deceptive, Fraudulent, and Even "Scum Bags"

In this video, you can scroll to 3:20 seconds in.

What you get there is noted Herbalife bull and hedge fund manager John Hempton, on the record, saying the following about Herbalife:

1. "They're scumbags, but they're the stock market's scum bags".

2. "When does the government care about lower-income people that way?"

That's from a guy who has spent the better part of the last year defending his decision to buy the company's stock.

This ties into what I wrote about yesterday, the insanely irresponsible bull argument for Herbalife on Wall Street: admit it's a fraud, then go long anyway. As I said in my piece, is it any wonder Wall Street gets a pejorative reputation on Main Street?

To Conclude

To conclude, I wanted to offer some personal perspective similar to the way Mr. Ackman did during his presentation.

I woke up this morning and thought long and hard about the 3 hours I spent in the AXA Equitable auditorium a couple of days ago. I thought about a nice lunch I had and how I felt on the way back home, reading the headlines about Mr. Ackman's presentation. I had shrugged them off, sure that regulators were paying attention to what I knew was Mr. Ackman's grand slam of a presentation. I made it home, confident that regulators would be forced to act even quicker now.

I think about Herbalife a lot for someone that doesn't have a relatively massive amount of money in my short. I think about it much more than most other investments, because Herbalife is a clear-cut case of wrongdoing, in my opinion.

I thought about Herbalife this morning, like I usually do when reading the news to see if something is new with the company. I went through my normal morning routine. I made coffee. I glanced at the futures and read the overnight market summary. I argued with Charlie Gasparino on Twitter a little and flipped on my friends at CNBC starting my day with Squawk Box. I sat at my desk and prepared to write a short piece on another company.

But, what I felt today was something so different than I'm used to. When I went to temporarily push Herbalife aside, I felt like you feel when you watch the bad guy get away with murder in a movie - or when you know the killer is right around the corner from the victim and there's nothing you can do about it. I thought about how little the short position I have in Herbalife means to me and how much the right thing being done in this situation truly meant to me.

I flipped on Mr. Ackman's presentation and went back and forth through the company's internal strategy slides. I looked at the pictures that had, at one point, made their way onto a PowerPoint presentation during a meeting where new customers were talked about internally at Herbalife.

This is what I saw.

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I looked at the woman living in the hut, holding her child.

I looked at the shantytown of impoverished people.

I looked at the children in the bottom right.

These weren't Mr. Ackman's images - these were Herbalife's images.

Do they elicit any emotion? They should.

I thought about my life. I'm not a millionaire. I'm not even wealthy. But, because of my beautiful family and my upbringing, I'm debt-free and have a little money in the bank. Some wouldn't even call me a success at this point in my life and career. But, I thought about all the benefits I had growing up with two non-college educated, yet extremely sharp working class parents, and how much I personally was the beneficiary of from this country.

I thought quickly about the great people that have protected me my whole life - my parents, teachers, doctors, policemen, firefighters, EMTs - all the people that made sacrifices for me at one point or another so that I could get an education and be sharp enough to realize basic things, like when not to piss away $3,000 on a pyramid scheme SUPERVISORSHIP. I thought about the taxes I pay and how proud I am to pay the salaries of our heroes that have the courage to do what we don't. I thought about the big people who stood up for the little people.

Then, I was sad. I thought about the people that didn't have the wherewithal to discern these things.

I wondered where the regulators were on this - not to protect me, I obviously know the company is a scheme - but to protect others? I could lose my entire position in Herbalife and still not be worried about it. What I was asking myself was, "What could possibly be taking this long? When is someone going to do the right thing?"

I had a brief moment where I doubted that regulators would step in, and then I remembered how I got to where I was now. Instantly, I was again full of confidence that good would prevail in the case of Herbalife.

Look at this picture again. Again, this isn't my image. This isn't Mr. Ackman's image. This is Herbalife's image.

And this media has the stones to ask why Ackman teared up when talking about the success he was able to find in our country? Did it ever occur that this is more than a trade for him?

"Michael Johnson is a predator.

This is a criminal enterprise.

I hope you're listening, Michael.

It's time to shut the company down."

- Bill Ackman

(All slides sourced from herbalifepyramidscheme.com, except where noted)

Disclosure: The author is short HLF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.