Why The FTC Has To Shutter Herbalife

| About: Herbalife Ltd. (HLF)
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Herbalife CEO faces a prisoner's dilemma.

US regulators must be wary of his escape routes.

Sound public policy requires a shutdown.

Yesterday, Michelle Celarier published a piece in the NY Post revealing how Vemma plans to proactively modify its pay plan to prevent inventory loading (the purchase of product to secure advancement in the pay plan/to qualify for recruiting rewards).

Recall, for Herbalife (NYSE:HLF) distributors to qualify for recruiting rewards they must acquire SUPERVISOR status. This incentive encourages recruiters to encourage their downline recruits to strive for the brass ring. If you're not a SUPERVISOR in Herbalife's world you are nothing.

If you are Herbalife CEO Michael Johnson, undoubtedly you are reviewing your strategic options going forward as you contemplate the reality that you are now being investigated by not only the FTC but also the SEC and in all likelihood state regulators too?

Handicapping your set of outcomes seems quite the prisoner's dilemma.

If you do nothing, like King Canute the FTC tide may wash you away entirely. If you hope the FTC may negotiate with you versus shut you down, you may be in for a shock when the restraining order is issued.

If you proactively modify your pay plan like Vemma, you puncture the heart of the goose that lays the golden eggs for your company. The demand for Formula 1 untethered from the perverse behavior of those chasing SUPERVISOR status is likely to collapse. Also, what do modifications to the pay plan say about the fraud you have been operating for years and years and years? Does this kind of move play into the hands of the Bostick class action suit? If you aren't doing anything wrong, why bother changing?

There is also likely a third option the company is considering. This option is perverse and cynical and self-serving and it is an option that the FTC must be wary of.

Q. What if Herbalife sacrificed its US business to protect its pyramid scheme in the rest of the world?

What if Herbalife modified its pay plan here in the USA voluntarily while tempting global regulators to chase them internationally?

Q. Is this the kind of outcome the FTC would like to see? Should the FTC be comfortable with the USA exporting shake mix from US soil to perpetuate a global confidence game?

There are a number of war rooms at work in the Herbalife saga. No doubt Mr. Ackman has a war room, the company has a war room, the board has a war room, the FTC has a war room, Mr. Icahn has a war room. Maybe even Mr. Stiritz and Mr. Ramey have a war room too? Who knows?

Within each war room, participants are gaming the probabilities, reviewing the cards they hold in their hands, and reacting accordingly to the data as the flop and the turn card (FTC investigation) now sit on the table.

Another round of betting is about to unfold here.

Q. What will the river card bring?

Who has the most "outs"? Who has the made hand? Who is chasing a draw?

Only "the dealer" (FTC) knows what will happen next.

I would like to submit the idea that the FTC has a global responsibility here in the case of Herbalife. If Herbalife is causing harm here domestically to US residents, citizens, and undocumented aliens, then de facto the company is also causing harm worldwide. Negotiating for changes to the pay plan domestically would seem like an avoidance of a moral obligation to eradicate fraudulent operations from the global landscape.

If I was Mike Johnson right now, I would be trying to figure out avenues of escape from the FTC's investigators.

My favorite move by Mr. Johnson so far was the decision to change the name of their junior distributors to Members. Of course, the nomenclature change changed absolutely nothing about the way the pay plan functions for these junior "Members". These folks still pay a fee to join the plan, still have the right to resell product and still have the right to recruit. Has he fooled the FTC? Doubtful.

Undoubtedly, the following options have been and will continue to be considered too.

Option 1 - Swim towards Amway. Herbalife's legal advisors no doubt concocted the company's devious Gold Standard Guarantee. It is unlikely regulators will be fooled by this veneer of legitimacy that does nothing to prevent recruiters from relentlessly promoting the climb to SUPERVISOR.

Option 2 - Stand defiant. This option amounts to challenging in court the idea that an "ultimate user" can't be a participant in the pay plan. This seems like a very silly approach to me. If the FTC issues an injunction, your doors are shuttered while you appeal the case. This could take years and will kill your business in the interim. Besides, the case law simply isn't on your side. Webster v. Omnitirtion makes this point clear. For Koscot to have teeth, personal consumption doesn't get counted as a retail sale. Nor are the other MLMs in your industry sympathetic to this view. Even Nu Skin (NYSE:NUS) has a Consumer Network that is not allowed to resell and/or recruit new people. Nor do the members of the Consumer Network have to pay a premium for product/buy their discount v. other distributors.

Option 3 - Force changes on your distributors. The problem you have here is twofold:

a) you can't make changes without the cooperation of the salesforce.

b) you've been telling the salesforce that the pay pan is legit, so, why would they agree to change a legitimate pay plan? How do you legally execute a change without the consent of your salesforce?

Poor Mr. Johnson

Option 4 - Sacrifice your US market

This seems to be part of the bull case. Kerrisdale Capital, for example, seems to think that it will be viable for Herbalife to operate globally even if the US business is shut down, that the FTC's teeth will not pursue a global remedy, and that Herbalife will be allowed to function jurisdiction by jurisdiction in the future.

My hope is that the FTC commissioners are paying attention to this dynamic and factor it in when they begin to weigh the evidence v. Herbalife that results from the formal investigation.

Herbalife has major problems with its business model. Even Carl Icahn says they have issues with their marketing.

-exaggerated earnings claims

-price discrimination

-recruiting focus, off-book lead generation programs, etc.

The dossier of evidence the FTC will have in its possession will be robust if it doesn't exist already.

The only question that remains is: "What will they do with it?"

Q. Is the world a better place with or without Herbalife?

Shake mix is ubiquitously available the world over. The Herbalife product is undifferentiated, expensive, and perfect substitutes are in ample supply. Weight loss seekers would be unimpaired if the FTC shut down Herbalife.

Business opportunity seekers who currently misallocate their capital in pursuit of a dream that is actually a nightmare would be well-served if this cynical pitch was removed from the global economy.

Regulators would be well-served by establishing some bright-line guidelines around direct selling to prevent future abuses of low-income, minority groups in the USA and abroad. Killing price discrimination outright would be a good start!

Consumers are always well served when economic activity is regulated such that all participants are treated fairly and equitably.

The FTC has to shutter Herbalife, not just in the USA but the world over. This company has proven itself to be a deceptive marketer for over 30 years and it continues to avoid implementing changes to its marketing plan that would actually promote legitimate retail sales while also advancing the interests of their distributors.

Endless chains are hardly benevolent to hard-working entrepreneurs.

Make no mistake, the Herbalife war room will continue to angle for a river card that will leave them with the best hand.

This outright belligerence should only be rewarded with a definite and aggressive restraining order that shuts the pay plan down the world over.

Why? True justice demands it.

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.