Is Big Pharma RICO a DOJ Blueprint for Herbalife?

It would be wise to study and understand the web of inter-related business practices between Herbalife and its top recruiters because an enormous amount of Herbalife’s future and fate is riding on them.  In this post (about 2/3rd of the way down) I laid out a case that 90% or $5.4 Billion of Herbalife’s enterprise value is attributed to the 1,050 or so Founder’s, Chairman’s and President’s Team members recruiting prowess.  I say recruiting prowess, because they don’t retail any product.  They are the primary recruiting engine that propels Herbalife.  Here are some of the top recruiters and a description of their business practices.  If you dig down into the footnotes, you will find many of them are inter-related, work together and coordinate their activities.  Prosecutors call that conspiracy.  Herbalife has tried to run most of this criminal conduct “off the books” under the guise of “independent” distributors.  That is a gross misrepresentation of the facts.

Here’s how it works “in practice”.  Up until recently, the vast majority of top recruiters income was not from the Herbalife pay plan but from business builder tool scams.  e.g. John Tartol is one of the highest ranking recruiters – a 1982 vintage – he signed up right under Mark Hughes, the founder.  In 2013, after 31 years, Herbalife paid Tartol $3.3M from the pay plan.  That is a great amount of money for anyone, but don’t be fooled into thinking that’s all John Tartol is gaining from the Herbalife scam.  Tartol has been around since the beginning with Mark Hughes.   (I left out the periodic discretionary Mark Hughes bonuses.  They’re nice to get, but don’t move the needle for top recruiters anyway.)

Because of the attention Bill Ackman recently shined on the business builder Tool scams, Herbalife had to shut them down.  Don’t under-estimate how serious a blow that is for top recruiters.  They may have been phasing Tools out anyway, as Nutrition Clubs were on the rise, but the abrupt closure is nonetheless a significant pinch.  Nutrition Clubs are now also in the spotlight for their dubious practices.  These are the real cash cows for top recruiters.  Top recruiters sign up about 250,000 new Supervisors (marks) each year at Extravaganzas or Nutrition Clubs, which in turn head home very enthusiastic to recruit an average of 10 new participants each.  That’s how they replace the churn every year.  The enormous value of the top recruiters (the 50 Founder’s/Chairman and 1,000 President’s Team) is that they get an average of 250 new Supervisors each, who in turn get 10 new Members each.

Those 250,000 Supervisors are big believers and stay in the program between 12 and 24 months, investing far more than average, sometimes tens of thousands, not just buying shake mix.  If top recruiters sell just 30% of the new Supervisors (75,000 of them) just 2 Internet Leads per week @ $100 each that is $750M per year!  That Internet Lead scam is as big as the Herbalife pyramid scheme.  It is the quid pro quo Mark Hughes made with his top recruiters.  Mark Hughes sells shake mix stapled to a pyramid scheme and the top recruiters who push it for him sell bogus business builder tools to the same marks.

In order to understand this, think about Herbalife not as a publicly traded corporation, but as Mark Hughes individually, because he used to own 100% and Herbalife is distributor #1.  It is the top of the pyramid.   When Carl Icahn buys stock in Herbalife he is fully aware that he is bypassing the entire hierarchy of the pay plan and jumping right into a fractional ownership in distributor #1.  Forget about telling recruits to work their way up the pay plan – just tell them to buy stock in HLF!  (Of course, if you told all the recruits that the fastest way to the top of the plan is to buy stock, you’d have no recruits or customers, you’d have a stock scam, which is pretty much what we have anyway.)

The people who Mark Hughes brought in to sell the plan between 1980 and 1985 – the mega recruiters – knew they were going to make him (meaning Herbalife) disproportionately rich by the mechanics of pyramid pay plans; much the way the Under-bosses know they are going to enrich the Boss in the Mafia.  So the Mafia Boss is constantly divvying up lucrative rackets to balance power and greed.

In 2013, those top 50 or so Founder’s and Chairman’s (after nearly 30 years) averaged compensation from the Herbalife pay plan of maybe $3M and the 1,000 or so President’s Team (after 15-20 years) averaged say $250K, which totals about $400M for 1,050 people.  Herbalife (aka 100% Mark Hughes alone) had Pretax Income of 735M!   Here is an observation:  There is no way the Under-bosses and Capos in the Mafia Family are standing for that!  They will whack that Boss in 2 seconds and take his money.  So, the Boss has a solution for the Made Guys (I mean the Founder’s and Chairman’s level):  the Boss gives them other lucrative side rackets, like the $750M+ Internet Tools scam.

This works fine, so long as it doesn’t bring too much heat back on the Family’s main business.  When Bill Ackman put a big fat spotlight on the Tools racket, that was “heat” and Herbalife had to shut the Tools down.  It will be interesting to see how long the Under-bosses and Capos (Founder’s, Chairman’s and President’s Team) can or are willing to hang in there with their cash cows cut off, think about their future, are financially pressured, have mental breakdowns, join another family, etc.  People do desperate things when their money gets cut off.  They have been in the spotlight for 2 years now.  Criminals do not like the spotlight.  It is not good for business.  I hope things are starting to make sense for readers.

Herbalife and top recruiters are not independent of each other.  They are one unit – a well-organized, criminal enterprise, designed and structured to systematically run rackets, just like the Mafia.  Michael Johnson and John Tartol (or any other top recruiter) are as independent of each other as John Gotti and Sammy “the Bull” Gravano.

There is an obvious case to be made that Herbalife’s actions or inaction make them criminally liable for their top recruiters unlawful acts.   This may prove to be a new direction for prosecutors in what has previously not been subject to criminal prosecution.  Herbalife (in fact, the whole industry) has for many years maintained that top recruiters/distributors are “independent” businesses and the company is not responsible for their often rogue and criminal pattern of behavior, notwithstanding how much Herbalife knew or benefited. When bad stuff came to light (and note I added “and came to light”) they cut off the distributor and plead ignorance. It will be interesting to see if that gets passed the Department of Justice and States Attorneys General, particularly in light of recent cases they have pursued and/or prosecuted.

Earlier this year, the Department of Justice began investigating Citigroup’s Mexican subsidiary, Banamex, and how it was defrauded of more than $400 million. It has been reported that the U.S. government may be looking at not just the banks actions, but inaction, to pursue Citigroup for corporate criminal liability. That’s a strange turn of events. One would think Citi was the victim of its own subsidiary, not the criminal. But the DOJ view may be that Citi turned a blind eye to the whole affair in an attempt to profit, even though they eventually suffered.   That same Department of Justice is now investigating Herbalife and could take a somewhat analogous “blind-eye” view with respect to Herbalife’s top recruiters/distributors.

Apparently there are many people (including interviewers on major business news networks) who believe you can flout the law for profit, so long as some third-rate MLM lawyer tells you to just have an agreement with top recruiters/distributors that says they are independent distributors and then claim you didn’t know what they were doing.  That simply isn’t true.  That way of thinking and doing business has become so pervasive with MLMs, and the predatory harm it has caused and continues to cause is so severe, that society needs the government to stop it once and for all.

The Department of Justice has successfully pursued the criminal prosecution of pharmaceutical companies for False Claims and off-label promotion of drugs by “independent” sales reps.  The drug companies had for decades been allowing this racket to go on: sales reps would illegally promote off-label uses to doctors to increase sales and the drug companies reaped enormous profits while denying knowledge of off-label promotion. And every now and then when it came to light, they would claim it was just “rogue sales reps” and cut them off. When the government put a stop to it, Glaxo paid $3 billion, Pfizer paid $2.3 billion (including a record $1.3 billion criminal fine) and virtually the entire pharmaceutical industry was ensnared in a criminal and civil RICO conspiracy. Then came the avalanche of private lawsuits and more billions in settlements.

Off-label promotion had gone on for so long, it was such common practice, that nobody in the industry or the investment community thought anyone would ever do a thing about it. Sound familiar? Every day in this twisted world of MLM-morality/legality I hear people acknowledge that Herbalife and its top recruiters are predatory and cross the line, but the government is never going to do anything about it; and if they do, it will be a slap on the wrist.  The cottage industry of enabling MLM lawyers (yes, some of them should be held to account, too) is focused on 30-year-old fronts in this war, but the enemy may be about to attack on multiple new fronts and they are completely unaware, unprepared and exposed.

[Note:  There is one successful and one unsuccessful appeal in the government’s case against drug companies.  Ultimately, as the judge said in the unsuccessful appeal (paraphrasing), “What’s the point of the FDA if sales reps can say whatever they want, think or believe?”  By way of analogy, What is the point of the FTC if pyramid schemes can pop up like mushrooms all over the country, fester for 30 years and become “Too Big to Impale”?]

With respect to Herbalife, there are so many dominoes that can be tipped with devastating effect by State or Federal agencies. If, as or when they are held to account for their violations and/or crimes, Herbalife will be buried in litigation and crumble under their weight.  The ill-advised balance sheet leveraging will prove to be gasoline on the fire.  I wrote a parody about that here.

The pharmaceutical companies survived because they had oodles of cash flow from multiple products that people actually want or need. Herbalife sells Formula 1 and is a business of promotion and a product no one actually wants.  It needs positive momentum and good publicity like oxygen. It has a $6+ billion enterprise value and a pesky $2 billion of debt; $1 billion taken on to buy back stock at the top in a vain attempt to perpetuate an illusion.

The FTC doesn’t need to “dramatically shut down Herbalife” (although that wouldn’t be a bad idea.)  They just need to ask the circuit court for a temporary injunction to stop recruiting Sales Leader/Supervisors and Nutrition Club supervisor-equivalents and paying any/all commissions related thereto because they believe (do not have to be certain) those programs (within the whole of Herbalife) are pyramid schemes.  Herbalife can continue all other retail sales activity.  This is exactly what the FTC did with BurnLounge.  Of course BurnLounge fell apart overnight when recruiting stopped.   Continuing retail sales should be substantial for Herbalife because they have millions and millions of retail customers that buy many billions of dollars worth of product.  (I’m being sarcastic.)  During the temporary injunction of 6-12 months, the FTC gets inside Herbalife (because they are not now inside, they are issuing CIDs from outside) and do a complete and thorough investigation, prosecute the violations (criminally if warranted), levy fines (doesn’t even have to be enough to bankrupt), impose changes to the business model (e.g., rational shipping & handling, flatten wholesale pricing to comply with anti-trust laws, enforce, monitor and track distributor and retail/customer sales and compliance, set dollar limits on distributor personal consumption, properly account for compensation related to “training”, just to name a few.)

The market will bankrupt Herbalife, under an avalanche of litigation, an unsustainable business model, compliance requirements it cannot meet and its own capital structure.

The Nutrition Club expose by Bill Ackman may actually work to the advantage of both other MLMs and the regulators.  It sets Herbalife apart with a unique and different business model, far more egregious in its target audience than others.  The government, therefore, escapes the accusation of “selective prosecution.”  In the wake of Herbalife, the government then implements the necessary reforms.  The net result of which (hopefully) brings us back to the Traditional Direct Selling model, to the days before 1979 Amway, before pyramid schemes ran over the entire industry.

I’m a believer in the intermediate term efficient market hypothesis. But it has been proven over and over again that markets can and do live in sustained states of denial and ignorance, before adjusting to reality, sometimes slowly, sometimes abruptly. I’ve witnessed regulators issue press releases to the market, trying to protect people from themselves and predators, stating “the common stock has no value…” but speculators still go about their business buying and selling.

I’m issuing this warning to investors in Herbalife:  The entire capital structure of Herbalife is worthless because it all has senior, unrecorded claims on it.  Why the government didn’t stop Herbalife from looting the estate with a $1.5 Billion buyback and hasn’t asserted those claims against the company on behalf of millions of victims is beyond me.  EVERY DAY HERBALIFE ADDS 7,500 HUMAN BEINGS TO THE VICTIM LIST.

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