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Herbalife, meet the SEC. SEC, meet Herbalife

Herbalife Meeting

SUSAN GOLDMAN

A worker cleans the logo on the Herbalife sign. The company has been engaged in a back-and-forth dialogue with the SEC since last spring.

The relationship between companies and regulators is often an intricate tango. That's been evident over the past 12 months with Herbalife and the Securities and Exchange Commission (SEC).

Herbalife, the nutritional supplements manufacturer headquartered in Downtown Los Angeles, is smack in the middle of a huge Wall Street battle right now. Hedge funder Bill Ackman says the company is a pyramid scheme and has bet more than $1 billion that its stock will fall — to zero. On the other side, hedge funder Dan Loeb and corporate raider Carl Icahn have bought up more than 20 percent of Herbalife's shares.

On Thursday, Herbalife announced that Icahn will be able to expand his stake and name two people to the company's board, which could be a precursor to taking Herbalife private for the second time in its history.

That would put an end to Ackman's bet and also draw ongoing discussions with the SEC to a close (Herbalife would no longer be a public company).

Herbalife's dialogue with the SEC has been ongoing and two-sided since last spring, when hedge fund manager (yes, another one) David Einhorn asked three questions of the company on an earnings call that caused the stock to immediately drop by 20 percent. Herbalife responded to Einhorn's questions, but it then heard from the SEC regarding an amended filing made as a follow-up to Einhorn's inquiry. 

That SEC inquiry was later resolved. But it highlighted an internal problem that Herbalife has recently acknowledged publicly: that outsiders don't understand how it groups the people who use and sell its products. They're now referred to universally as "distributors." But they aren't all invovled in the Herbalife business model to the same degree, and CEO Michael Johnson said in a presentation on January 10 that the company is looking into changing that.

But in 2012 filings. Herbalife excluded some quarterly financial data on them.

Einhorn pounced.

Herbalife clarified:

Herbalife believes the majority of its distributors are discount buyers, who become distributors in order to purchase their favorite Herbalife products at a minimum discount of 25 percent (either directly from the company or from their upline distributor/supervisor). In addition, some of these distributors will also share with, or retail the products to other friends, family, and customers.

And:

We segment the distributors who have not attained the supervisor level into three general categories based on their product order patterns: discount buyers, small retailers and potential supervisors. We define discount buyers as customers who have signed up as distributors to receive a discount on their purchase; small retailers as product users and sales people who generate modest sales to friends and family; and distributors who are actively developing a business with the intention of qualifying to become a supervisor. We did not include the percentages...in our more recent filings because we do not view the information as valuable to the business or to investors.

At this point, it was clear to Herbalife that its nomenclature could confuse outsiders: What's the deal with all these "distributors" who don't seem to be fully involved in the business? The answer from the company was that they just want to buy Herbalife products at a discount and should really be considered retail customers.

That distinction demonstrates that Herbalife has customers, not just suckers who need to be be signed up to the pyramid scheme to keep the money coming in.

Back to the SEC. After the Einhorn event, Herbalife knew that additional short-selling interest in the stock would invite further SEC scrutiny. So when Ackman made his massive presentation in December, Herbalife got proactive and contacted the SEC. 

The Wall Street Journal had reported that this was a new SEC investigation, but it had actually occurred at Herbalife's behest. As such, there are no letters from the SEC nor filings from Herbalife in the SEC's database, but rather what sounds like an ongoing exchange of information betweem regulator and company. 

Herbalife declined to confirm the details of this sequence of events, but published reports, company presentations, and public documents indicate that it has moved into what might be called a cooperative mode with the SEC and that the cooperation is ongoing.

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