Is Herbalife a Pyramid Scheme, the Target of Market Manipulation, or Just a Good Gripping Yarn?

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Australian money manager John Hempton has called the battle between investor Bill Ackman and nutritional supplement company Herbalife “hedge fund porn.” There is indeed something vaguely obscene about the ongoing drama, but the plot is much richer — and more interesting — than that of the typical skin flick. The Ackman/Herbalife tussle is probably more accurately compared to a Russian novel: complex and full of moral ambiguity. Here’s the backstory. Last month Ackman, CEO of the hedge fund Pershing Square Capital Management, explained to an investment conference in Manhattan why he had recently made what is essentially a $1 billion bet that Herbalife is a pyramid scheme that’s bound to collapse or be shut down by the Federal Trade Commission (FTC). The allegation is a function of the fact that, like companies such as Amway and Avon, Herbalife is a so-called multilevel marketing (MLM) firm. This basically means that it not only sells products to consumers through a network of sales representatives — who receive commissions on those sales — but also that it rewards them for recruiting additional sales reps and gives them a cut of any sales made by those they recruit. MLM firms in general, and Herbalife in particular, have long faced accusations that they are essentially pyramid schemes — unsustainable business models that will eventually collapse when new recruits can no longer be found to form the ever-growing base of the pyramid structure. Herbalife and other multi-level marketers often use ad campaigns that suggest one can attain financial independence by joining their teams of network marketers. And this can come off as pretty sleazy, as anybody who takes just a few minutes to examine the situation realizes that the vast majority of people who get into the business aren’t going to make much money at all. (Even if you discount Ackman estimate that 98.9% of Herbalife distributors make $475 or less per year before expenses, Herbalife itself says that only 9.85% of distributors average more than $7,354 in gross annual compensation.) For this reason alone, I would warn people to proceed with extreme caution

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