On February 27, 2015 the SEC announced a little noticed pyramid scheme prosecution. You can find the press release here and the indictment here. While it is small game (I’ve previously said here (around the 8th paragraph) that the FTC, in particular, has a history of hunting small game pyramid schemes, and so does the SEC) this one is significant for the following reasons:
1. I believe it is the first time the SEC has prominently prosecuted both the company/executives and top recruiter/promoters. Connecting this to Herbalife, we need to go back to when Mark Hughes overdosed, the company was rudderless, adrift and for sale. Sales were stagnant or declining. But the price was right. JH Whitney and Golden Gate Capital paid approximately 4-6x Ebitda, contributing about $200 million of equity. In order to underpin the deals turnaround and growth, they made Top Recruiters their defacto partners (they are not “independent contractors” as the company would have the world believe) by sealing what is referred to as the Tirelli Agreement, etching in stone, among other things, the “6% Infinity Bonus”. This 6% additional expense would not be paid by Herbalife, but added a new bogus Shipping, Processing & Handling charge was passed on to new recruits. The Tirelli cut the “Mega Recruiters” (Founders, Chairman & Presidents Team) in for 6% of Certain Revenue and turned them loose around the world to recruit millions and millions of new victims. And recruit they did. Over the years they found myriad ways to take advantage of every new advanced technology, including the Internet, to lure unsuspecting victims into their web and separate them from their money.
It is important to note the Tirelli Agreement cannot be modified without the approval of a majority of the Presidents Team and above (it’s a perpetuity for Top Recruiters. Meaning: if we build Herbalife into a juggernaut and you cash out, the company can never change the deal on us!) And the Mega Recruiters did make JH Whitney and Golden Gate Capital rich – their most wildly successful deal. Within 2 years JH Whitney and Golden Gate paid themselves a dividend almost equal to their entire equity investment, substantially mitigating their capital at risk. (Remember, 2004 was a more benign regulatory environment, but it is still a pyramid scheme, so it’s a hot potato.) Shortly thereafter they flipped the company to the public, and in short order sold all of their stock for well over $2 billion in profit. Of course they sold it all… these are not eating sardines, these are trading sardines. (Carl Icahn just got stuck with a mouthful of these nasty sardines. That what you get when you’re selfish and greedy.)
2. In the SEC complaint referenced above, the pyramid scheme did some curiously similar things to Herbalife: (1) targeted Latino communities, (2) established a network of leading promoters (that’s why I elaborated on the Tirelli Agreement above), (3) recruitment surged through social media to promote “business meetings” (Herbalife, in its various iterations was all over the Internet), and (4) promoters also set up “storefronts” or “training centers” to attend presentations. (akin to Nutrition Clubs)
Of particular note… the SEC sought to freeze and repatriate foreign assets. (The suggestion that Herbalife can simply truncate its U.S. business and liability is idiotic.)
The SEC must understand that Herbalife and its Top Recruiters are far more sinister and egregious in their criminal conspiracy and racketeering compared to the tiny pyramid scheme they shut down in February 2015. I’m comforted to know the SEC understands the nature of these crimes and particularly how the Top Recruiters conspire with the company and management to pull off the scam. I’m more comforted to know the Department of Justice, with their big giant elephant gun, is also on the case.