Response To Greenberg: Reasons Why Herbalife Paid Felon Barry Minkow $300,000

At the beginning of the current short attack on Herbalife (HLF), CNBC's Herb Greenberg asked Herbalife this question in his May 2, 2012 article titled- "Why Did Herbalife Pay Felon Barry Minkow $300,000?: Greenberg" In the article, Greenberg raises serious questions including the below excerpts which certainly would have made a lot of investors wonder about Herbalife's management-

"The bigger question: Why would Herbalife have paid him to go away?"

Greenberg seems to answer this question with this simple explanation in that same article-

"Why? According to court documents, Herbalife paid Minkow $300,000 to shut up"

Greenberg then reports Herbalife's response to his questions about Minkow-

"Minkow is a convicted criminal who is back in prison for spreading misinformation for profit through short selling. As we have told the press before, we settled with him to avoid the time, expense and distraction of protracted litigation. Today, however, we are totally committed to using every resource to defend against any misrepresentation by short sellers, their accomplices and associates."

Greenberg also reported about the below taunt by Minkow who must have been pretty confident that he could say anything about Herbalife, and Herbalife couldn't do anything about it-

"He even included a taunting video, with the tagline, "Should this company try to sue us, it's been tried and tossed.""

So I wondered myself why would Herbalife pay Minkow? Here is what I found out. First I researched some information to find out who Barry Minkow really was. He was known to have a very bad reputation and openly admitted he was a liar and a thief per this June 4, 2008 Los Angeles Times article "It's Barry Minkow vs. Herbalife" including the following excerpts-

""Why am I good at what I do? I'm a liar and a thief," said Minkow"

" Shorting the stock is his way of financing his ongoing probe into the company, he said."

"You may remember Barry Minkow as the young San Fernando Valley entrepreneur who was convicted of defrauding investors of millions of dollars in his ZZZZ Best carpet-cleaning company."

From my research it was obvious that Minkow was an unethical person who would do anything to make money and was creating problems for a lot of companies including Herbalife. He was the main character in the 2008/2009 short attack against Herbalife which I discuss in greater detail in my August 27, 2012 Instablog post- "Herbalife Short Attack: History Repeats Itself."

Below are comments made by Michael Johnson, Herbalife CEO as to what Herbalife's management was thinking, per this CNBC 7/31/12 interview with Michael Johnson, Herbalife CEO by CNBC's Jim Cramer and Greenberg, as to the decision not to fight Minkow-

"What's the best for the shareholders?"

"What's the best for the company?"

"Let's not distract ourselves with a lawsuit - he's in prison now as we all know-"

"This isn't worth the time or distraction right now."

Sounded reasonable to me but still left a little doubt in my mind and apparently in Cramer's mind too as per this comment by him during that same 7/31/12 interview as to how he would have handled Minkow-

"Having been involved with lawsuits I would have destroyed him".

So why didn't Herbalife just destroy Minkow? We can all second guess decisions made by management of a company but it appears at the time of the decision they felt that it was much more important to concentrate on the growth of the company than to use their time fighting a small time convict. Anyone that has used our legal system knows that it has a lot of problems and you don't always get the legal outcome you think you will. I personally have fought and wasted a lot of time fighting a legal battle when I knew I was right only to watch a judge totally ignore a signed agreement.

No one can perfectly predict the outcome of any legal case even when you strongly believe you are right. Here are some excerpts from Wikepedia about Barry Minkow-

"Many companies have sued Minkow for making false accusations against them. However, most of the suits have gone nowhere since criticizing public companies is usually considered to be protected free speech."

Before Herbalife's battles with Minkow, Usana Health Services found out the hard way that they wasted their time and even more money by suing Minkow and ended up having to pay Minkow a very large settlement out of court per excerpts from this U-T San Diego article- "Barry Minkow: From scammer, to preacher, to defendant"

"On Feb. 21, 2007, Minkow sent a report to The Wall Street Journal, the FBI, the SEC and Internal Revenue Service, accusing Usana of having an unsustainable pyramid-like structure and charging that it was at risk of having its profits siphoned to Liechtenstein by an owner who had recently moved there."

"Usana eventually sued, saying that Minkow's attack was "riddled with exaggerations, half-truths, and plainly false statements." Usana suggested that Minkow's goal was "not only to devastate USANA..., but also to line Mr. Minkow's own pockets.""

"But because of laws protecting critics of publicly traded companies, there was little Usana could do."

" U.S. District Court Judge Tena Campbell in Usana's home state of Utah ruled that Minkow's criticism of Usana was protected as free speech. Campbell said Usana could still sue Minkow for stock manipulation but that an out-of-court settlement would save both parties "the cost and inconvenience of protracted litigation.""

"Usana agreed and settled out of court. Although both Usana and Minkow were barred from discussing the settlement, sources close to the lawsuit say Usana paid Minkow a substantial sum to stop his attacks. Usana's stock rose 7 percent the day the case was settled, showing exactly how much shareholders had feared the Minkow effect."

Now with the success from making money from an out of court settlement, Minkow continued his efforts to obtain money from large publicly traded companies including Herbalife who found themselves with very few options but to settle, per excerpts from this U-T San Diego article- "Barry Minkow: From scammer, to preacher, to defendant"

"Over the next several years, Minkow went after a series of other network marketing firms, including Herbalife, which sells diet products, and NuSkin, which makes skin-care goods. In some of these cases, a pattern emerged:

Step 1: Minkow fires a barrage of accusations against a company.

Step 2: As share prices decline on the bad news, anyone who is shorting the stock - whether Minkow or his hedge fund friends - makes a quick profit.

Step 3: The company denies or downplays the charges and either sues or threatens to sue.

Step 4: As the company confronts the costs of litigation and the uphill challenge of attacking Minkow's free-speech rights, it arranges a private out-of-court settlement. Sources close to the litigation say that in several cases, the settlements ranged from $100,000 to $300,000.

Step 5: Minkow agrees to stop making accusations and occasionally backtracks on his previous charges.

After all of my extensive research about Minkow icluding his involvement in the 2008/2009 short attack against Herbalife which actually raised the same exact issues as the shorts are bringing up currently and which he instigated, I came to the conclusion that several companies including Herbalife were caught between a rock and a hard place when it came to dealing with his false lies and accusations.

Unfortunately, since our legal system makes it extremely difficult to win battles against people like Minkow, I believe Herbalife's management made the right decision to pay Minkow the $300,000 and to instead concentrate on growing Herbalife's business. Herbalife was able to increase their revenues from $2.4 BILLION in 2007 to $3.5 BILLION in 2011 while dramatically increasing their profits and EPS per their 2011 Annual Report.

My final thoughts are that it's easy for reporters and shorts to raise questions about difficult decisions made by Herbalife's management as well as "what if this or what if that happens" type questions to create doubt in Herbalife's shareholders minds but here are the current indisputable facts as discussed in my prior article- "Herbalife Shorts' Problems Could Be Great Buying Opportunity For Longs" for the case against Herbalife shorts -

1. All of Einhorn's questions have been answered by Herbalife and the Direct Selling Association. Einhorn has not disclosed either a short or long position in Herbalife. Einhorn has not made one public statement critical of Herbalife or even asked for additional information from Herbalife since his May 1st appearance on Herbalife's investor conference call.
2. No one has presented any information as to the existence of a real SEC investigation of any type concerning the business activities of Herbalife.
3. No one has presented any information as to any review or ongoing investigation activities by the FTC currently against Herbalife.
4. Not one investment reporter has disclosed any new information (all reports have only included previously publicly known information) as to any ongoing problems with Herbalife's business since Einhorn's May 1st appearance.
5. Before and after May 1st, Herbalife's business has continued to grow at a dramatic rate. No one (Einhorn, investment reporters or shorts) has presented any case as to why Herbalife's business will slow down in the near future.
6. For the year as of July 31st, Herbalife has repurchased $428 million worth of stock and has announced another $1 BILLION share buyback plan.

One final thought, since apparently CNBC's Jim Cramer has changed from recommending Herbalife because of Herbalife's payment to Minkow per this 8/8/12 video "Lightning Round" (see video at 2:50), I would hope that he would reconsider that decision after reading or hearing about the information in this article.

Disclosure: I am long HLF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.