Sliding Down the Pyramid

hedge-fundsA settlement between federal regulators and Herbalife will not shut down the company, as the hedge fund manager William A. Ackman had been urging for the last several years, but it will force the nutritional food supplement company to make major changes in its business practices.

The Federal Trade Commission, in announcing the settlement with Herbalife on Friday, had strong words for the company that call into question some of its longstanding distribution practices. “This settlement will require Herbalife to fundamentally restructure its business so that participants are rewarded for what they sell, not how many people they recruit,” Edith Ramirez, the F.T.C. chairwoman, said in a news release announcing the settlement and filing of complaint in federal court seeking a permanent injunction and other relief against the company. In settling with the F.T.C., Herbalife has agreed to pay $200 million for consumer relief, an amount it had previously disclosed it was likely to pay as part of any settlement. The agreement with the F.T.C. will require Herbalife to overhaul its system for compensating its customers and recording sales of its supplement drinks and other food products.

In the complaint filed in federal court in Los Angeles, the F.T.C. said, “the overwhelming majority of Herbalife distributors who pursue the business opportunity make little or no money and a substantial percentage lose money.” Herbalife, in a statement, said: “We announced a settlement with the F.T.C. that does not change our direct selling business model and will set new standards for the industry. We agreed to the terms and to pay $200 million because we simply wanted to move forward with our mission.” In the statement, Herbalife also took a swipe at Mr. Ackman and his Pershing Square Capital Management, saying it had been “under attack by an intransigent short seller hellbent on a misinformation campaign designed to destroy our company.” Mr. Ackman’s fund bet about $1 billion that Herbalife would be exposed as an illegal pyramid scheme and forced to shut down. He had said he expected the stock to go to zero.

Shares of Herbalife were trading at around $59 on Thursday and were poised to open 9 percent higher. This Wall Street brawl began with a billion-dollar bet.
Then William A. Ackman, the investor who landed the first blow with his bet against Herbalife, escalated the fight. He called the multibillion-dollar nutritional supplements company a “pyramid scheme,” likening its practices to those of the mafia and the Nazis. Mr. Ackman also lobbied federal authorities to bring Herbalife to its knees, an outcome that would reap a windfall for his hedge fund. That effort, it turns out, was only the first round. Now Herbalife, with deep pockets and well-connected political operatives and former prosecutors, is looking to turn the tables with its own no-holds-barred appeal to the government. Over the last year, Herbalife’s lawyers have met in person five times with F.B.I. agents, Securities and Exchange Commission investigators and federal prosecutors, according to people briefed on the meetings, partly to defend the company and partly to condemn Mr. Ackman. Armed with stock charts, the lawyers argued that Mr. Ackman’s hedge fund, Pershing Square Capital Management, used false statements to manipulate Herbalife’s stock downward. One of Herbalife’s latest overtures came in April after Mr. Ackman made a startling claim about Herbalife’s senior management, saying, “We know they have been or are looking to hire criminal defense counsel.” Mr. Ackman attributed his assertion to an unnamed yet “reliable” source. Within 48 hours, Herbalife’s lawyers phoned prosecutors from the United States attorney’s office in Manhattan to argue that his claims were not only false, they were illegal, people briefed on the call said. That same day, the lawyers called the S.E.C. And in a follow-up letter to Andrew J. Ceresney, the S.E.C.’s top enforcement official, they exhorted him to investigate Mr. Ackman’s source.

This behind-the-scenes lobbying, shows that after two years of Mr. Ackman’s walking the halls of Congress and entreating prosecutors, Herbalife is taking a section from his playbook. The counteroffensive — carried out by Democratic operatives, three public relations firms and two law firms stacked with former prosecutors — signals a critical moment in the battle. At this latest juncture, each side has now spent tens of millions of dollars shaping the public narrative — and the federal investigations. Justice Department investigators have subpoenaed and interviewed people who helped Pershing Square publicly attack Herbalife, according to the people briefed on the matter. Pershing Square, which denies wrongdoing, has produced documents for the government, but it has not received a subpoena. The investigators also contacted Herbalife and its distributors about Mr. Ackman’s accusations. Herbalife, which denies wrongdoing, faces inquiries from prosecutors, the Federal Trade Commission and the S.E.C. Yet the dueling narratives from Herbalife and Mr. Ackman have thrust prosecutors and regulators into an uncomfortable position. The authorities are cautious about picking sides, according to people briefed on the matter, and privately conceded that the hurdles to mounting a case against either side were steep. Without government action, a resolution of the fight between Mr. Ackman and Herbalife is unclear. And as each side pulls the levers of power, escalating the animosity while muddying the facts, investors and consumers may struggle to separate fact from spin. While the authorities investigate each side’s claims, Herbalife has taken its campaign to Washington, where it rallied members of Congress to scrutinize Mr. Ackman. The company also recently donated $40,000 to a nonprofit group, Citizens for Responsibility and Ethics in Washington, or CREW, that has called on lawmakers to investigate Mr. Ackman. “We have a responsibility to our customers, employees, members and shareholders to defend ourselves vigorously in the face of Bill Ackman’s disingenuous campaign and attempts at stock manipulation,” said Alan L. Hoffman, a spokesman for Herbalife. Mr. Ackman has denied Herbalife’s claims, arguing that he had a reasonable basis to criticize the company. He has pledged to donate personal profits to charity, though his investors would still benefit if his bet succeeded.

“Herbalife has taken a page out of the playbook of Enron, MBIA and other companies who have attacked short-sellers when serious questions of wrongdoing have been raised,” Mr. Ackman said in a statement. (Short-sellers bet that a company’s stock will lose value, as opposed to those who are “long” a stock, betting that its value will rise.) Mr. Ackman’s argument that the company is a pyramid scheme centers on how Herbalife makes its money. He contends that Herbalife, which sells its products through networks of independent resellers, makes more money by recruiting new distributors than it does from actual sales, a red flag for a pyramid scheme. It is a wager that Mr. Ackman has pledged to “take to the end of the earth” and one that will ultimately depend on whether the government punishes Herbalife. To draw the government’s attention, Mr. Ackman has employed a handful of law firms and the Global Strategy Group, a public affairs firm that organized rallies and conducted opposition research on Herbalife. He also hired lobbyists to attract the attention of lawmakers, including Senator Edward J. Markey, Democrat of Massachusetts, when Mr. Markey was a member of the House. In January 2014, months after his staff had met with Mr. Ackman, Mr. Markey wrote letters to the F.T.C., the S.E.C. and Herbalife. Soon after, the F.T.C. said it had opened an investigation into Herbalife. Emboldened, Mr. Ackman turned up the heat, stating last June: “I think the government is going to start arresting people.” He also accused Herbalife distributors of committing “mail fraud, wire fraud, all kinds of crimes.” Those events were a turning point for Herbalife. The company expanded its corps of lawyers at Gibson Dunn and Sidley Austin. It also hired Mr. Hoffman, a former federal prosecutor who had served as deputy chief of staff to Vice President Joseph R. Biden Jr. At the White House, Mr. Hoffman worked alongside Terrell McSweeny, who is currently an F.T.C. commissioner. Herbalife hired Pamela Jones Harbour, a former F.T.C. commissioner, as head of compliance. The company is adding seasoned lobbyists to its ranks, too, including Randall Popelka, a former official in the George W. Bush administration, and Eric Rosen, a lobbyist for Heather Podesta, a Democratic insider. It also retained outside public relations experts, including Hilary B. Rosen, a Democratic strategist. The new team adopted a different strategy: Take on Mr. Ackman as though he were a political opponent.

Weeks after Mr. Markey’s letter, for example, a lawyer for Herbalife sent a letter of its own to the S.E.C. The lawyer, Barry R. Goldsmith, a partner at Gibson Dunn and a former senior S.E.C. enforcement official, argued that Pershing Square knew of Mr. Markey’s letter in advance because the hedge fund had posted an earlier version of the letter online. Mr. Goldsmith implied that Pershing Square may have altered its bet against Herbalife before the letter’s public release, saying that Herbalife discovered a series of trades that were “consistent with Mr. Ackman’s ongoing efforts to manipulate Herbalife’s stock.” Whoever placed the trades most likely reaped millions of dollars in paper gains after Mr. Markey’s letter pummeled Herbalife’s stock. “We had no prior knowledge the letters were coming out, and didn’t trade on advance information,” Mr. Ackman said in a email statement, adding that Pershing Square learned of the letter from a reporter. Gibson Dunn presented similar evidence a few months later when it attended the first of five meetings with the F.B.I., the S.E.C. and federal prosecutors in Manhattan, documents show. In other meetings, Herbalife zeroed in on letter-writing campaigns by community activists that attacked Herbalife. As The Times reported last year, some people who signed the letters did not recall doing so, and some groups that composed the letters received payments from consultants employed by Pershing Square.

“This is market manipulation,” an Herbalife lawyer said, according to a person who attended one of the meetings, held on the fifth floor of the United States attorney’s office. Market manipulation is illegal because it deceives investors by artificially affecting the price of a stock, often by spreading false information. It is a difficult case to make, however, because prosecutors must prove that there was no legitimate investment purpose. False statements are not inherently illegal and are generally protected under the First Amendment. The government would need to demonstrate that Pershing Square intentionally lied, or was at least reckless in making materially misleading statements. Despite its protestations, Herbalife has chosen not to sue Mr. Ackman, which other companies have done with other hedge funds. Mr. Hoffman said Herbalife would prefer the government to take action. Over time, the government’s interest in Herbalife’s claims has waxed and waned. At least once, the government turned down a request for a meeting, people briefed on the matter said. And yet, at a meeting last month, so many people attended that it had to be relocated to the more spacious Manhattan offices of the S.E.C., one of the people said. Over the last year, Herbalife also rolled out a multimillion-dollar ad campaign and commissioned opposition research from Sard Verbinnen, a public relations firm. On Monday, Herbalife made public, a website that includes videos highlighting Mr. Ackman’s investment mistakes, in response to Mr. Ackman’s own website, And just as Mr. Ackman has relied on his network of grass-roots organizations to lobby lawmakers, Herbalife has found its own allies in Washington. CREW, which has long campaigned against short-sellers using political connections for financial gain, contacted Herbalife last year about Mr. Ackman’s effort. Melanie Sloan, the founding executive director of CREW, then spent months researching Mr. Ackman. Eventually, the group wrote a letter to several members of Congress urging them to investigate “the ways short-sellers are manipulating the government regulatory process.” CREW created a website called Capitol Gamed, with a headline labeling Mr. Ackman “one of Wall Street’s worst.” By then, Ms. Sloan had left CREW for her own consulting firm, whose clients include Herbalife. And shortly before CREW sent the letter to lawmakers, Ms. Sloan urged Herbalife to donate $40,000 to CREW. Herbalife agreed. Ms. Sloan made the donation, her colleagues said, and billed Herbalife.

Noah Bookbinder, who became executive director of CREW in March, said the group was in the process of refunding the donation but would continue operating the website. He disputed the idea that Herbalife might have influenced CREW, saying the group “has never taken a position on the underlying merits of any of the allegations with regard to Herbalife.”