07.18.16
Herbalife, Ltd. has agreed to restructure its U.S. business operations and pay $200 million to compensate consumers to settle Federal Trade Commission charges that the company deceived consumers into believing they could earn substantial money selling diet, nutritional supplement and personal care products.
The terms of the settlement, which concludes FTC’s investigation, do not change Herbalife's business model as a direct selling company, but the company will now reward distributors for whey they sell instead of how many people they recruit.
In its complaint against Herbalife, the FTC also charged that the multi-level marketing company’s compensation structure was unfair because it rewards distributors for recruiting others to join and purchase products in order to advance in the marketing program, rather than in response to actual retail demand for the product, causing substantial economic injury to many of its distributors.
“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,” FTC Chairwoman Edith Ramirez said. “Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices.”
According to the FTC’s complaint, Herbalife claimed that people who participate can expect to quit their jobs, earn thousands of dollars a month, make a career-level income, or even get rich. The FTC complaint claimed that the overwhelming majority of distributors who pursue the business opportunity earn little or no money.
For example, as stated in the complaint, the average amount that more than half the distributors known as “sales leaders” received as reward payments from Herbalife was under $300 for 2014. According to a survey Herbalife itself conducted, which is described in the complaint, Nutrition Club owners spent an average of about $8,500 to open a club, and 57% of club owners reported making no profit or losing money.
The distributors who do make a lot of money, according to the complaint, are compensated for recruiting new distributors, regardless of whether those recruits can sell the products they are encouraged to buy from Herbalife.
Finding themselves unable to make money, the FTC’s complaint alleges, Herbalife distributors abandon Herbalife in large numbers. The majority of them stop ordering products within their first year, and nearly half of the entire Herbalife distributor base quits in any given year.
The settlement requires Herbalife to revamp its compensation system so that it rewards retail sales to customers and eliminates the incentives in its current system that reward distributors primarily for recruiting. It mandates a new compensation structure in which success depends on whether participants sell Herbalife products, not on whether they buy products.
The order imposes a $200 million judgment against Herbalife to provide consumer redress, including money for consumers who purchased large quantities of Herbalife products (such as many Nutrition Club owners, among others) and lost money.
Herbalife and the Illinois Attorney General also reached a settlement, and the company agreed to pay $3 million as part of this separate agreement. With the conclusion of the Illinois investigation, Herbalife said it is not aware of any active investigations by any other state attorney general.
"The settlements are an acknowledgment that our business model is sound and underscore our confidence in our ability to move forward successfully, otherwise we would not have agreed to the terms," stated Michael O. Johnson, chairman and CEO, Herbalife.
While the company said it believes many of the allegations made by the FTC are factually incorrect, Herbalife believes settlement was in its best interest because “the financial cost and distraction of protracted litigation would have been significant,” and after more than two years of cooperating with the FTC's investigation, the company wanted to move forward.
Under the order, Herbalife will pay for an Independent Compliance Auditor (ICA) who will monitor the company’s adherence to the order provisions requiring restructuring of the compensation plan. The ICA will be in place for seven years and will report to the FTC, which will have authority to replace the ICA if necessary.
The settlement also prohibits Herbalife from misrepresenting distributors’ potential or likely earnings. The order specifically prohibits Herbalife from claiming that members can “quit their job” or otherwise enjoy a lavish lifestyle.
The terms of the settlement apply only to the company's sales in the U.S., which comprise approximately 20% of total net sales. Herbalife said many of the terms agreed to were either already being contemplated or are extensions of practices already in place and will be implemented over the next 10 months. The two primary components of the agreement are:
Those who currently have a membership with Herbalife, and those coming into the business, will be categorized as either a preferred member (those who become a preferred member to purchase products at a discount) or distributor (those who choose to build a business and sell products through direct sales). This will allow Herbalife to better track both groups and provide a personalized experience for these individuals.
Distributors will be compensated based upon retail sales and will provide receipts for their transactions. Their compensation will also be based on purchase for personal consumption within allowable limits. Herbalife's independent distributors are currently required to keep sales transaction receipts. With advancements in mobile technology, tracking retail sales is now even easier, and the company has already developed proprietary technological solutions including a mobile application in the U.S. to make the process as efficient and easy as possible.
Other terms agreed to include enhancing training provided to distributors; requiring a business plan and a one-year waiting period before opening a nutrition club; extending the amount of time a distributor may return an initial membership pack; paying for all shipping costs associated with any returned products; prohibiting auto-shipment of products; auditing by an independent third party; and extending the protections on income claims including greater specificity around lifestyle claims.
Importantly, as was the case with the FTC's Amway decision in 1979 (In the Matter of Amway Corporation Inc., et. al.), the company anticipates these agreed upon procedures will now provide direction for the entire direct selling and multi-level marketing industry. Therefore, the company believes that while some of the additional terms do not have significant impact, these provisions will improve policies throughout the industry.
For example, Herbalife implemented stricter consumer protection rules relating to auto-ship several years ago and the practice now represents less than 1% of all company sales. Similarly, only 0.02% of all Herbalife products in the U.S. are returned to the company, so paying shipping costs associated with returned orders is expected to have minimal impact.
"I have always believed in Herbalife's strong fundamentals and am pleased the Board has decided to increase my ownership limit from 25% to 34.99% of the Company's outstanding shares. A significant part of my investment success is directly tied to our in-depth investment research and understanding of often complex and unique issues facing companies," said Carl Icahn. "I have the greatest confidence in Herbalife's CEO, Michael Johnson, and the entire management team, who have skillfully led the Company through adversity, including holding firm against a high-profile PR campaign against the Company by Bill Ackman where it was alleged more than once that the company would be shut down. Obviously, we are still here."
The terms of the settlement, which concludes FTC’s investigation, do not change Herbalife's business model as a direct selling company, but the company will now reward distributors for whey they sell instead of how many people they recruit.
In its complaint against Herbalife, the FTC also charged that the multi-level marketing company’s compensation structure was unfair because it rewards distributors for recruiting others to join and purchase products in order to advance in the marketing program, rather than in response to actual retail demand for the product, causing substantial economic injury to many of its distributors.
“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,” FTC Chairwoman Edith Ramirez said. “Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices.”
According to the FTC’s complaint, Herbalife claimed that people who participate can expect to quit their jobs, earn thousands of dollars a month, make a career-level income, or even get rich. The FTC complaint claimed that the overwhelming majority of distributors who pursue the business opportunity earn little or no money.
For example, as stated in the complaint, the average amount that more than half the distributors known as “sales leaders” received as reward payments from Herbalife was under $300 for 2014. According to a survey Herbalife itself conducted, which is described in the complaint, Nutrition Club owners spent an average of about $8,500 to open a club, and 57% of club owners reported making no profit or losing money.
The distributors who do make a lot of money, according to the complaint, are compensated for recruiting new distributors, regardless of whether those recruits can sell the products they are encouraged to buy from Herbalife.
Finding themselves unable to make money, the FTC’s complaint alleges, Herbalife distributors abandon Herbalife in large numbers. The majority of them stop ordering products within their first year, and nearly half of the entire Herbalife distributor base quits in any given year.
The settlement requires Herbalife to revamp its compensation system so that it rewards retail sales to customers and eliminates the incentives in its current system that reward distributors primarily for recruiting. It mandates a new compensation structure in which success depends on whether participants sell Herbalife products, not on whether they buy products.
The order imposes a $200 million judgment against Herbalife to provide consumer redress, including money for consumers who purchased large quantities of Herbalife products (such as many Nutrition Club owners, among others) and lost money.
Herbalife and the Illinois Attorney General also reached a settlement, and the company agreed to pay $3 million as part of this separate agreement. With the conclusion of the Illinois investigation, Herbalife said it is not aware of any active investigations by any other state attorney general.
"The settlements are an acknowledgment that our business model is sound and underscore our confidence in our ability to move forward successfully, otherwise we would not have agreed to the terms," stated Michael O. Johnson, chairman and CEO, Herbalife.
While the company said it believes many of the allegations made by the FTC are factually incorrect, Herbalife believes settlement was in its best interest because “the financial cost and distraction of protracted litigation would have been significant,” and after more than two years of cooperating with the FTC's investigation, the company wanted to move forward.
Under the order, Herbalife will pay for an Independent Compliance Auditor (ICA) who will monitor the company’s adherence to the order provisions requiring restructuring of the compensation plan. The ICA will be in place for seven years and will report to the FTC, which will have authority to replace the ICA if necessary.
The settlement also prohibits Herbalife from misrepresenting distributors’ potential or likely earnings. The order specifically prohibits Herbalife from claiming that members can “quit their job” or otherwise enjoy a lavish lifestyle.
The terms of the settlement apply only to the company's sales in the U.S., which comprise approximately 20% of total net sales. Herbalife said many of the terms agreed to were either already being contemplated or are extensions of practices already in place and will be implemented over the next 10 months. The two primary components of the agreement are:
Those who currently have a membership with Herbalife, and those coming into the business, will be categorized as either a preferred member (those who become a preferred member to purchase products at a discount) or distributor (those who choose to build a business and sell products through direct sales). This will allow Herbalife to better track both groups and provide a personalized experience for these individuals.
Distributors will be compensated based upon retail sales and will provide receipts for their transactions. Their compensation will also be based on purchase for personal consumption within allowable limits. Herbalife's independent distributors are currently required to keep sales transaction receipts. With advancements in mobile technology, tracking retail sales is now even easier, and the company has already developed proprietary technological solutions including a mobile application in the U.S. to make the process as efficient and easy as possible.
Other terms agreed to include enhancing training provided to distributors; requiring a business plan and a one-year waiting period before opening a nutrition club; extending the amount of time a distributor may return an initial membership pack; paying for all shipping costs associated with any returned products; prohibiting auto-shipment of products; auditing by an independent third party; and extending the protections on income claims including greater specificity around lifestyle claims.
Importantly, as was the case with the FTC's Amway decision in 1979 (In the Matter of Amway Corporation Inc., et. al.), the company anticipates these agreed upon procedures will now provide direction for the entire direct selling and multi-level marketing industry. Therefore, the company believes that while some of the additional terms do not have significant impact, these provisions will improve policies throughout the industry.
For example, Herbalife implemented stricter consumer protection rules relating to auto-ship several years ago and the practice now represents less than 1% of all company sales. Similarly, only 0.02% of all Herbalife products in the U.S. are returned to the company, so paying shipping costs associated with returned orders is expected to have minimal impact.
"I have always believed in Herbalife's strong fundamentals and am pleased the Board has decided to increase my ownership limit from 25% to 34.99% of the Company's outstanding shares. A significant part of my investment success is directly tied to our in-depth investment research and understanding of often complex and unique issues facing companies," said Carl Icahn. "I have the greatest confidence in Herbalife's CEO, Michael Johnson, and the entire management team, who have skillfully led the Company through adversity, including holding firm against a high-profile PR campaign against the Company by Bill Ackman where it was alleged more than once that the company would be shut down. Obviously, we are still here."
