Is Bill Ackman the Next Barry Minkow? PART 2

Point 3: Third Party Invalidation

If there was ever a bigger smoking gun, it would be the one appearing from under the “Third Party Investigative Reports” menu option on Ackman’s website, ironically titled “Facts About Herbalife.” There you will find two links. One leads to a single article by über-anti-MLM critic Robert FitzPatrick, whose case against MLM has been thoroughly discredited, as was his anti-USANA report which Barry Minkow paid him to create. There’s one more link titled “Fraud Discovery Institute Reports”. Within the latter you will find four reports making a case for why Herbalife is a “doomed by design” pyramid scheme, is “cooking the books”, and is producing potentially deadly products with “dangerously high levels of lead” in them.

The Fraud Discovery Institute was Barry Minkow!

That’s right. All four of these “Third Party Investigative Reports” were penned by a twice-convicted, and currently imprisoned stock fraud felon and extortionist! They were a part of Minkow’s attempt to manipulate Herbalife’s stock (the stock he had shorted back in 2007), and which he later completely retracted! In August of 2008 Minkow declared Herbalife’s business model was, in fact, legitimate, and that its product are safe. A press release 4 jointly produced by Herbalife and Minkow declared:

“The Fraud Discovery Institute retracts its accusations against multi-level marketer Herbalife… Upon further investigation by FDI founder Barry Minkow, the Fraud Discovery Institute became convinced that Herbalife employs systematic internal controls, including the use of outside, independent laboratory testing, which ensures their products are manufactured safely and in compliance with California law. It is evident to the Fraud Discovery Institute that Herbalife produces products that are safe, and that the company strives for continuous improvement in product quality.

The Fraud Discovery Institute immediately withdraws all accusations against Herbalife, including any Proposition 65 allegation relating to any Herbalife product and any contentions against the Herbalife business model.”

In several books written by or about him, Barry Minkow tells of his close friendship with a man – who he eventually steals $2,000 from and causes to lose his job – who joins Herbalife around the mid-80s. Not only does Minkow have nothing bad to say about Herbalife within this context, in his own book “Buyer Beware” (1997) he includes a section on MLM where he states:

“Companies such as Amway, Avon, Excel, Herbalife, Mary Kay, and Tupperware have opened the doors to hundreds of copycats, some legitimate and some that hide as pyramid schemes. In this chapter I address MLM companies that are not pyramid schemes.” 5

“Multilevel marketing is often a lawful and legitimate business method that uses a network of independent distributors to sell consumer products.” 6

So Minkow likes Herbalife, believes they are a “legitimate” company and “not a pyramid scheme,” goes to prison for perpetrating one of the largest stock frauds in U.S. history, gets out, becomes a credible “fraud buster” (which he actually was in the beginning), then shorts Herbalife’s stock, trashes them viciously, makes a reported $50,000 on his puts, then suddenly retracts every negative accusation and states Herbalife is all A-okay. Then gets busted for stock fraud and extortion and is sent back to prison.

That’s the source of Bill Ackman’s “Third Party Investigative Reports”!

Miscellaneous, mistaken, and misleading mudslinging

I wish I could write another 30 pages about this, but alas, I have to make a living. Those Enchiritos don’t make themselves.

If I could, I’d also cover (in a lot more detail), Ackman’s other blunders and ludicrous logic, such as the tired, impotent accusation that MLM distributors “make more money from recruitment than from sales”. Of course they do! Just like Ray Kroc made more money from the sales of hamburgers via his McDonalds franchises than from the Big Macs he personally fried and wrapped. Just like every business owner on Earth, over the entire history of business, has made more money by getting other people to sell their products than from their own personal sales! Seriously, does this ridiculous argument still have weight with anyone? Apparently Mr. Ackman is hoping it does.

Ackman says 99.9%”7 of Herbalife reps don’t make money, and that Herbalife is supposedly hiding this fact. That is, hiding it by openly disclosing a detailed breakdown of what percentage of active reps reach each rank, the percentage of reps that are active, and the average earnings at those ranks, within their annual “Statement of Average Gross Compensation of U.S. Supervisors”. 8

Indeed, this is where Ackman is obtaining his payout data which he claims Herbalife is not disclosing – from Herbalife’s public disclosures. This is a disclosure that Herbalife is not legally required to produce, but which they have chosen to provide. From this disclosure we can conclude that about 10% of “Active” Herbalife supervisors earn a significant profit 9 , which amounts to about 3.9% of all Herbalife reps, so the actual percentage who, “don’t make money,” is more like 96.1%, not 99.9%. A picked nit, perhaps, but if Ackman is so well armed with facts to support his case, why the need for any hyperbole at all?

The main point here is that this 96% don’t make money because 96% don’t do what they are supposed to do, well enough, long enough, to make any. It’s directly analogous to those who enroll in gym memberships. Although there have been no studies to nail down the exact number, we can surely agree that at least 96% of all those who have filled out a gym membership application did not come even remotely close to meeting their fitness goals. Why? Because of bad treadmills, bad weight benches, bad trainers, bad saunas… or because they didn’t do what they were supposed to do well enough, long enough?

Ackman actually states that failed Herbalife reps, as a group, “spend an enormous [amount of] time and energy, and they’ve sucked in their friends and family …”. But, that describes what the successful distributors do! If they’ve spent a lot of time and energy successfully persuading their friends and family to join, and they’ve presumably all expelled the same time and energy getting their friends and family to join – then these would be the folks who are making money. Those that fail to make money are those that fail to enroll others, or acquire any customers. Or, perhaps they enroll one or two friends, who then fail to enroll anyone, who then all quit – usually within a few days or weeks. In Minkow’s case against USANA (published in early 2007) the claim was made that the large majority of reps did not make a profit, and the large majority quit within the first year. However, in USANA’s voluntarily reported 2006 “Average Earnings Chart” they explicitly defined the lowest rank where at least some profits were virtually assured to take an average of 18 months to achieve. So of course the large majority won’t make a profit if that large majority quit within the first 12 months! And, indeed this describes the behavior of the large majority of MLM participants in any MLM company. Yet, in spite of the fact that this hole in Ackman’s They-all-work-hard-and-enroll-others-who-all-do-the-same-but-fail-to-make-money argument is Harlan Tunnel-sized, apparently no one can see it from Wall Street.

Ackman, like Minkow, has a knack for misrepresenting otherwise insignificant information in an effort to form mushroom clouds out of puffs of smoke. For example, Ackman insinuates deception on the part of Herbalife for their “Millionaire Team” rank’s title. “Despite the name, distributors only earn $97,000 per year”, he says. Mr. Ackman is the one hypocritically doing the deception here. Herbalife reports the “median” annual earnings at this rank is $97,303, which means if all annual incomes of every “Millionaire Team” member were listed in descending order, the one half way down the list would be $97,303. Therefore, there certainly can be, and likely are, annual million dollar earners among those at the very top of this list.

Another example is Ackman’s claim that “[Herbalife’s] 70% volume requirement can include sales to one’s downline. By definition, this does nothing to limit internal consumption”.11 That’s because the 70% volume requirement is designed to limit the front loading and stock piling of product, not to limit internal consumption. A fact well known by MLM participants with even a modicum of experience. Ackman goes on to say that Herbalife has enforced the 70% volume restriction fewer than ten times from 2006 to 2009.12 Continuing his obligatory glass-half-empty line of reasoning he suggests this is due to “lax enforcement”. No alternate explanation is even considered, such as: very few Herbalife distributors violate the policy.

When making his case for why Herbalife products sell so well in spite of their premium pricing Ackman tries to play ignorant by claiming it can’t be due to an exorbitant advertising budget because Herbalife reported “de minimis”13 advertising costs to the SEC. 14 But, of course, multilevel marketing companies employ word-of-mouth advertising as their primary method of promotion, and the financial incentives paid to those who talk up the products are in lieu of any conventional advertising. Herbalife’s actual cost of advertising has averaged almost $328 million in each of the first three quarters of this year, and exceeds $8 billion just since 2000! 15

The best example might be Ackman’s response to Herbalife CEO Michael Johnson’s exclamation that “The United States will be better when Bill Ackman is gone.” 16 When the comment was reiterated, completely out of context, Ackman called it “scary” and said he was “obviously concerned about [his] personal safety [and for] other people’s personal safety”. He then asks rhetorically, “When the CEO of a public company makes threatening statements, you have to ask yourself, why would he possibly say something like that?” Here’s Mr. Johnson’s comment placed back in its proper context:

“This is a legitimate company. Mr. Ackman’s proposition that the United States would be better when Herbalife was gone – The United States would be better when Bill Ackman’s gone.”

Mr. Johnson’s heated, off-the-cuff remark was simply an attempt to turn around a comment that Mr. Ackman had already made about Herbalife. He obviously was referring to Ackman being gone from commenting publicly, online and on television, about corporate valuations and stock analysis. And, possibly, he might even have meant gone from society. As in, imprisoned. But obviously he was not suggesting that Ackman be gone from the Earth!

Then there’s the “Former Distributor Testimonials” section of his “Facts About Herbalife” website where, out of what should be tens-of-millions of screwed, angry ex-distributors (if all he claims were even fractionally true) he’s managed to cherry pick a grand total of 57 complaints by failed, ex-Herbalife reps. At least, we can only assume that’s who they are since a large number of them are anonymously posted comments on anti-MLM message boards such as mlmsurvivorclub.com, mlmwatch.com, and the [sarcasm on] oh so reliable ripoffreport.com [sarcasm off]. More than half are at least seven years old, some going back almost 12 years. I have not perused them all, but the general theme seems to be their failure in Herbalife was always someone else’s fault, and that someone should have told them what all the expenses were going to be before they incurred them. I wonder, how does one discover what costs are involved in operating a business only after they’ve incurred them? And rather than go after Herbalife, shouldn’t we be trying to track down those scoundrels who held a knife to the throat of all these disgruntled ex-Herbalife reps and forced them to buy thousands of dollars of allegedly unwanted inventory, useless sales tools, and ineffective training? Or, might this have been poor, but completely voluntary business decisions made entirely by the failed rep?

Here’s a telling side note to Ackman’s collection of deliberately one-sided testimonials. When asked during the CNBC interview, “Did you participate, or anyone on your team participate, as a distributor?” as part of his investigative process, Ackman responds, “No”. His spurious excuse was, “We wanted to, but we’d have to sign a distributor agreement. If you sign a distributor agreement you agree to a confidentiality stipulation. We obviously could not agree to that. So we did not.” So why not have one of his team members sign up, get on the products, review the support material, go through the training, and simply monitor their experience, and then freely comment on it? And let’s get this straight–a business based entirely on the word-of-mouth promotion of its products and opportunity has a clause in their distributor agreement that disallows their distributors to talk about any of it? And if there was such a strong prohibition in place preventing ex-Herbalife distributors from even commenting on Herbalife, let alone disparage them, then wouldn’t the authors of all 57 testimonials Ackman presents be in gross violation of that policy?

Ackman was asked during the Bloomberg interview the obvious question as to why, if all he says is true, and after having amassed, according to Ackman, “the 2.5 million distributors that exist today and maybe 10, 15 million over the passage of time”, there are so few complaints with legal authorities and only about 0.5% (one-half of one percent) of product is ever returned to Herbalife? If, indeed, 99.9% of these folks are victims of a scam that has cost them all “a few thousand dollars each”, Herbalife should be getting deluged with millions of dollars in product returns monthly, and complaints to state and federal regulators should be in the thousands per year. Ackman’s response? “You can’t return the product”, and these marks are all just “too ashamed” or embarrassed, and generally are part of a demographic that “doesn’t trust the government.” Seriously. That’s his explanation. He claims the products can’t be returned because of all the restrictive hoops Herbalife makes you go through. During the CNBC interview he explains, “The people that have any kind of meaningful amount of product are sales leaders.” So, that alleged fraction of one-percent that are sales leaders who have all this product they are not returning explains, at least in part, why 99.5% of all Herbalife product is never returned? Ackman also explains that Herbalife reps must assert that 70% of all product previously purchased has been sold or consumed before they are paid their commissions, and Herbalife won’t allow them to return what they claimed they’ve sold or consumed. Since, he continues, they all just rubber stamp this declaration each pay period, when it comes time to return their inventory for a refund Herbalife now has this clever little gotcha’. That is, they’ll refuse to pay a refund for all that product you claimed you had already sold or consumed. So let’s consider this. If an Herbalife distributor is found to have grossly violated the Policies & Procedures they agreed to, and has committed fraud against the company by declaring they’ve sold product they really hadn’t sold, Herbalife should just overlook it and say, “Ahh, don’t worry about it. Here’s a full refund for all that product you lied to us about having sold.” At least, it seems that’s what Mr. Ackman would have them do.

This 70% Rule employed by Herbalife is a safeguard against excessive inventory loading, which Ackman has asserted Herbalife does not adequately enforce. And now he has cleverly exploited it to place Herbalife in a damned if they enforce it and damned if they don’t position.

As for this “too ashamed”, or “can’t afford an attorney” explanation for not complaining, wouldn’t those poorest victims, who can least afford to lose “several thousand dollars” be the most motivated to try and get it back? Yet, a tiny fraction of one percent of them even complain to the Better Business Bureau – which rates Herbalife an A+.19 Based on a 2010 MarketWave analysis of BBB complaints against the top 100 MLM companies Herbalife placed seventh in total number of complaints, but their complaints-to-distributor ratio was among the lowest. The BBB currently reports 34 closed complaints within the last year20 with about half involving a refund request, all of which concluding with Herbalife agreeing to refund, or having “fully refunded”, the amount in question.21

Conclusion

So now we are left with only two options…

Did Mr. Ackman know all of this, and is he just employing the old “If you can’t dazzle ‘em with brilliance baffle ‘em with BS” strategy in an effort to fool enough people enough of the time to make a few hundred million dollars in “blood money”?

Or is he genuinely unaware of Herbalife’s current growth in the United States, Amway’s comparative growth, the utter lack of even the slightest shred of evidence that market saturation has ever affected a single MLM company, as well as Barry Minkow’s background and his most recent position on Herbalife, etc. etc, etc.? Which, if true, would mean he’s a grossly incompetent researcher.

I see no evidence that would suggest Mr. Ackman has ever been, previous to his Herbalife position, a grossly incompetent researcher.

“We simply want the truth to come out”, says Mr. Ackman.

So do I, Bill.