Both sides continue to smear each other and dig in their heels, as I learned from several recent conversations. Ackman told me, “I am 100 percent convinced that Herbalife is a global pyramid scheme. We think it is a criminal operation.” Herbalife’s chief financial officer, John DeSimone, told me in response, “I am 100 percent convinced Bill Ackman is wrong. I think he has gone beyond the legitimate role short sellers play and crossed an ethical boundary.” Both promised, “More evidence is coming.”
Plenty of pyramid cases are easy to resolve. A simple chain-letter-like arrangement, whereby new recruits pay cash upstream hoping to get more cash from their own downstream recruits, is manipulative and blatantly violates the law. The same is true of multilevel schemes that require large up-front payments for sham products. Conversely, Tupperware, which compensates its independent sales force based on carefully tracked retail sales, appears legitimate.
But what about cases in the middle, where people are motivated partially by wanting to consume a product and partially by the prospect of receiving money by building their own network? Regulators struggle with these grayer areas, where fraud can be camouflaged. The legal tests are confusing and inconsistent. Jeffrey Babener, a leading lawyer for multilevel-marketing firms, says they are like Supreme Court Justice Potter Stewart’s test for pornography: “I know it when I see it.”
Consider the so-called 70 percent rule, an industry standard based on a 1979 finding that Amway was not a pyramid scheme in part because it required distributors to sell at least that percentage of the products they received each month. Herbalife’s version is limited to products a member “holds for resale.” But how are regulators to determine how many of the shakes in various members’ basements are for resale versus personal use? Bill Keep, the dean of the College of New Jersey’s business school and a leading expert on pyramid schemes, is skeptical about Herbalife’s approach: “What does this mean? It could vary from 0 to 100 percent.”
Even one of the most obvious tests for an illegal pyramid scheme—whether a business is “unsustainable”—is problematic. Simple chain letters and the like inevitably fail when the pool of new recruits evaporates. But the risk with established companies is different: not so much that they will die, but that they will commit fraud while they are alive. Herbalife’s pyramid structure, whatever you might think of it, has been sustainable. The company has been in business for 34 years. Even though each year the company loses about half the people who have qualified for bonuses, it has so far been able to replace them. Ackman and Herbalife officials disagree about whether it can continue to do so.
Certainly, some Herbalife recruits have received unrealistic promotional materials from top distributors, such as the video of a member named Doran Andry driving a red Ferrari and talking about his nearly $100,000-a-month income. The company recently began disclosing financial information to prospective members; in 2013, only 704 U.S. members received more than $100,000 a year (not a month) from the company, and the vast majority received less than a few hundred dollars. But even now, Herbalife’s disclosures do not differentiate revenues from profits, or say how expensive it is to run a distributorship.