$HLF Herbalife, SEC Division of Corp Finance, 10-K Disclosures, SEC Division of Enforcement

Well… it’s official. Fueled by speculating day traders, #Herbalife continues to march ahead on misinformation. With very little publicly traded float, Herbalife stock moves up or down, sometimes significantly, based on all sorts of idiocy.

The SEC Comment Letter(s):

There has been chatter about the SEC “clearing” Herbalife after a review of their 2013 and 2014 10Ks and disclosure of these letter letter.  The chatter was so intellectually lazy, I can’t even describe it as analysis.  In layman’s terms, the SEC Division of Corporation Finance was reviewing Herbalife 10-K disclosure for 2013 and 2014.  The SEC asks questions the company cannot dodge.  The company must go on record with a response.  The SEC doesn’t agree or disagree with anything the company says or does, either in response or otherwise.  However, based upon the direction of the questions from the SEC, a company will almost certainly make changes to their disclosures.  (If your Dad sits you down and starts asking questions about last Friday night, which you hadn’t mentioned or you mentioned only partly, you might want to fill in some more detail.  If he then says, “Thanks for the answers” or even “Thanks for being more forthcoming”, that doesn’t mean the hammer isn’t coming down.)

Anyone who has been through this SEC review process knows they don’t say things like…(in the case of Herbalife) “we don’t think you have more than 50% retail sales, we think you’re in violation of the California injunction, we think Pedro Cardoso lied about his Brazil indictment and therefore you’re in violation NYSE rule or he shouldn’t be a Board member, we think you have problems in China and we think the Tirelli Agreement is problematic.”  At this point, the SEC Division of Corporation Finance does exactly as the letter states… encourages the company to make complete and accurate disclosure of all material facts and withholds any decision on enforcement action.  Having had the opportunity to look into the company books and records, and review the disclosures, if they find anything amiss they can/will refer it to the SEC Division of Enforcement.

SEC Division of Enforcement has opened an investigation into Herbalife.  If that investigation was closed by specific letter from the Division of Enforcement, rest assured Herbalife would have held a prime time press conference, put a copy of the letter on their “anti-Ackman” website and been propaganda tweeting it from on high!

There is so much misinformation and intellectually lazy thinking about Herbalife, sometimes I think I’m in a time warp.  e.g. “When the FTC rules on Herbalife….”  The FTC doesn’t rule on anything.  Here’s the thing:  The FTC uses it power (now in use re Herbalife with Civil Investigative Demands) to gather information.  If the FTC Commissioners determine “a proceeding is in the public interest” because the law is being or has been broken, then the FTC goes to a court and asks a judge to temporarily stop the bad stuff (in the case of pyramid schemes, that would typically be: stop the recruitment of new members into any specific program the FTC believes violates the law AND the payment of commissions/royalties/etc. thereon.  That is an important nuance – the FTC doesn’t have to say all of Herbalife violates the law.  They can say, “We are only seeking injunction against specific programs, not an injunction against all the retail customer sales activity Herbalife boldly claims to have!”  That’s what the FTC did with Burnlounge; they just went after the Mogul program.  But interestingly, the appellate judge said (paraphrasing) “the proof was in the pudding.  When the recruiting stopped, the company collapsed.”

I’ve argued that the Sales Leader and Nutrition Club programs (in the aggregate) violate the law.  If the FTC sought to substantially restrict or enjoin the recruitment and/or payment of commissions on those programs, Herbalife would collapse.

In virtually every case where one is requested, a temporary restraining order is granted.  Then a hearing is held to convert the temporary order to a permanent order and ultimately a trial is held, a judge makes a decision, then an appeal.  That is where it gets tricky for the FTC and Herbalife.  The FTC has historically hunted small game and the small quickly fold up their tent.  But Herbalife is an elephant with a multi hundred million dollar war chest and an army of lawyers and lobbyists ready for battle.

The MLM Attorney Kevin Thompson has said the FTC doesn’t have the firepower to go after Herbalife.  I understand his point.  In MLM/Pyramid schemes, if you stay small, you get prosecuted and shut down.  But if you can run the gauntlet and get really big, you can persist in the criminal activity for a very long time.  Herbalife is a criminal racketeering enterprise… and the FTC alone may not be up to the task.

There is also recent chatter/speculation about the FTC “wrapping up its investigation” after the summer.  I don’t understand why this would be perceived as a good thing for Herbalife.

In the most recent 10-Q Herbalife disclosed the Department of Justice has sought information about the company, certain individuals and certain of its distributors.  (Give me a little creative license here.)  Here’s the scenario:  the FTC has used its CIDs to gather information and shared that information with other agencies.  The SEC (both Division of Corporation Finance and Division of Enforcement) has gathered information and shared that information with other agencies.  The SEC Corporate Finance has closed the disclosure review file and made referrals, if any, to Enforcement.  The SEC Division of Enforcement has not closed the file and has gathered enough information.  The FTC has gathered enough information.  Same with whatever state AGs are on the case.  Now… the Department of Justice…

Herbalife and its Top Recruiters (Founders, Chairman, Presidents Team etc.) are akin to the MAFIA.  Together (acting in concert) they run a criminal racketeering enterprise that breaks laws up and down the FTC, SEC and States.  Any one of those agencies or States could put a stop to it.  But the Department of Justice is on the case.  And they are the big dog.  The fact that the stock has rallied from $30 to $55 in the face of disclosure that the DOJ is IN FACT requesting information from the company AND Top Recruiters is (again, in the infamous words of Dan Loeb) preposterous.  But then again, as Co-Conspirator/Top Recruiter Geri Cvitanovich said at the Extravaganza to a room full of aspirational recruits, “It’s the Herbalife version of reality.”

One side note: It’s morally wrong to support an illegal enterprise.  Providing capital, however temporary and in whatever form (debt or equity), is providing support.  It undermines the function of secondary markets by depriving capital to other productive enterprise.  It undermines capital markets and society.  Not only is it right for participants to root out illegal and corrupt enterprise, it is their duty as participants, if they can find a profitable way to do it.  It is nonsense to criticize Ackman, in the same way it would be nonsense to criticize Markopolos.  In any event, Herbalife has been surrounded by a mob of amoral and immoral speculators for as long as it’s been in existence.  That’s nothing new.  Herbalife attract them like bees to a honey pot.

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