It has been reported that Herbalife is close to settling the class action lawsuit known commonly as Bostick v Herbalife. Bostick would have been just another cost of doing business but for Bill Ackman’s 50 million candlepower flashlight. Immediately after Ackman entered the scene, Herbalife hired the inflated celebrity (from at least one high profile case he lost) named David Boies who would make certain that Ackman never got his hands on any discovery material from the Bostick case. Beyond that, Bostick was a game of chicken – every day the plaintiff holds out for more money, the lottery ticket may become worthless if the government steps in and shuts down the whole charade (I’ve said repeatedly that the entire capital structure of Herbalife, senior and convertible debt included, is worthless because of the multi-billion unrecorded claims regulators will enforce on behalf of victims); but the plaintiff knows Herbalife will never let this go to discovery and trial, so they keep pushing forward in order to drive the settlement value up.
The case started as Dana Bostick, then in June added 4 more distributors, three of the 5 claiming they lost more than $10,000 each. Here’s the problem for Herbalife: if they went through discovery all that juicy discovery information comes out into the light, not just potentially to Pershing Square but more directly to investigators and regulators. And all sorts of negative things become part of the public record. In addition, if the case had gone to trial, it might have ended up with language similar to 2009 Herbalife v Ford when nobody seemed to notice or care, but most certainly would today. This is what the California circuit court had to say in a 2009 case involving Herbalife and a group of distributors (Ford) sued each other and Ford claimed Herbalife was an illegal pyramid scheme:
“In Webster v. Omnitrition Int’l, Inc., 79 F.3d 776 (9th Cir. 1996), a case with facts very similar to the facts in issue here, the Ninth Circuit explained that the definition of “endless chain” under section 327 “is equivalent, if not identical, to” the test for illegal pyramid schemes established in In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975), aff’d mem. sub nom., Turner v. F.T.C., 580 F.2d 701 (D.C. Cir. 1978). Omnitrition, 79 F.3d at 787. (emphasis added)
“[t]he satisfaction of the second element of the Koscot test is the sine qua non of a pyramid scheme: “As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.” (emphasis added)
“79 F.3d at 781 (quoting Koscot, 86 F.T.C. at 1181). In other words, the central inquiry under the second element of the Koscot test is whether there is a sufficient nexus between retail sales and the bonus compensation Supervisors are eligible to receive.” (emphasis added)
“The California Court of Appeal similarly has recognized that “compensation for recruitment based upon sales to the recruits . . . is what makes [a marketing plan] a chain scheme under California law.” People v. Bestline Prods., Inc., 132 Cal. Rptr. 767, 789 (Ct. App. 1976). Thus, a sales and marketing plan may be found to violate section 327 if it offers compensation for recruitment based upon sales to downline recruits, because such a plan “increase[s] the certainty of deception by diverting” distributors’ focus from retail sales to the recruitment of new distributors.” (emphasis added)
“Moreover, in the Court’s view, Herbalife’s entire business model appears to incentivize primarily the payment of compensation that is “facially unrelated to the sale of the product to ultimate users because it is paid based on the suggested retail price of the amount ordered from [Herbalife], rather than based on actual sales to consumers.” (emphasis added)
Needless to say, now would not be a good time for any court in the U.S. (particularly a California central district court) to be saying Herbalife is or looks like an illegal pyramid scheme. So, settling the case, and attempting to mitigate their U.S. distributor fallout/liability is clearly the best option for Herbalife. The alternative could have been a class of 1.5 million U.S distributors, with 250,000 estimated Supervisor damage claims averaging $10,000 (based on 3 of 5 named plaintiffs) and 1.2 million regular-ole-member damage claims of $180 (for the 6 months) = $2.7 Billion damages. Any way you look at this, a negative result could have easily been a multi-hundred million to billion dollar claim or judgment, debt covenant violations. Losing Bostick could have crippled Herbalife.
I suspect this is the beginning of an increasingly narrow set of escape options. The Bostick settlement amount will likely not appear material on the surface, but what it represents underneath the surface is far more important. The noose is tightening on Herbalife and will continue over the next 12-15 months, if not sooner. They will run out of options.
Herbalife is a predatory criminal racketeering enterprise. It is run by a Mob Boss named Michael Johnson, 50+ Under Bosses (Founder’s and Chairman’s level Top Recruiters) and 1,000+ Capos (President’s Team members). There will come an interesting psychological moment, when denial is shattered, and they realize nothing they say or do will prevent it from all crashing down. (Criminals need denial to survive. The one’s who eventually get honest, can describe the moment they new it was all over.) Herbalife has been getting away with their crimes for a long time, but morning always comes.