The Federal Trade Commission has determined that Herbalife is not a pyramid scheme, but the nutritional supplement marketer will still be required to pay $200 million to consumers and "fully restructure" its "unfair" business in acomprehensive settlement, the federal regulator said Friday.
Buoyed by the agreement that enables the company to continue operations under a new structure, investors sent Herbalife (HLF) shares nearly 18.6% higher to $70.39 in morning trading.
The settlement caps a two-year investigation by the FTC, which probed Herbalife over accusations that the company's main focuses less on retail sales of products than on on bringing in increasing numbers of new sales people who were deceived into believing they could reap substantial profits by selling diet, nutritional supplement and personal care products.
The newcomers, alternately titled distributors or members by the company, were encouraged to recruit others, with promises they would profit from a share of the product sales made to those they they brought in to advance Herbalife's marketing program.
A 42-page complaint for a permanent injunction filed in California federal court said Herbalife and its corporate entities "represent, expressly or by implication, that Herbalife distributors are likely to earn substantial income, including significant full-time or part-time income, from pursuing a retail-based business opportunity."
In reality, the company's business structure "does not offer participants a viable retail-based business opportunity," the complaint charged. Instead, Herbalife's compensation program "incentivizes not retail sales, but the recruiting of additional participants who will fuel the enterprise by making wholesale purchases of product," the complaint alleged.
The settlement will require Herbalife "to fundamentally restructure its business, so that participants are rewarded for what they sell, not how many people the recruit," FTC Chairwoman Edith Ramirez said in a statement.
"Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices," said Ramirez.
The $200 million payment will include compensation for certain consumers who purchased Herbalife products. Specifics of the repayment plan will be determined later, the FTC said.
Herbalife was not particularly contrite over the outcome.
"While the company believes that many of the allegations made by the FTC are factually incorrect, the company believes settlement is in its best interest because the financial cost and distraction of protracted litigation would have been significant, and after more than two years of cooperating with the FTC's investigation, the company simply wanted to move forward," Herbalife said in a statement.
Herbalife executives had told investors in a conference call in May that they were close to a deal with the FTC that would cost an estimated $200 million.
The settlement likely marks a significant loss for billionaire hedge fund investor Bill Ackman, who publicly accused Herbalife of operating as a pyramid scheme. Ackman's Pershing chief Square Capital Management invested $1 billion in a short bet against the company's shares in 2012, when they traded around $47.
Pershing Square did not immediately respond to a request seeking comment.
Still, the FTC blasted Herbalife for exaggerating the earnings most of its sellers reap and said Herbalife agreed to pay for an independent auditor to monitor its business practices.
Only a "small minority" of distributors make "a lot of money" on Herbalife sales, the FTC said, and most abandon the business within the year.
Owners of Herbalife's Nutrition Club brand invested an average of $8,500 to launch their operation, but 57% broke even or lost money, according to an internal survey revealed by the FTC.
Herbalife said it had agreed to compensate distributors based on retail sales and to require business plans and a one-year waiting period before a distributor can launch sales, among other changes.
"Many of the terms agreed to were either already being contemplated by the company or are extensions of practices already in place and will be implemented over the next 10 months," the company said.
The company also announced Friday that activist investor Carl Icahn and his company, Icahn Enterprises, had been given the right to increase their collective stake in the company from a maximum of 25% to a maximum of 34.99%. They currently hold about 18.3%.
Icahn will continue to control five of the Herbalife board's 13 seats.
Separately, Herbalife said it had agreed to a $3 million settlement with the Illinois attorney general.
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