Herbalife: The House of Cards Put

Activist investing meets activist government.
Economist StaffMarch 14, 2014

Uncle Sam has gone where Bill Ackman’s fellow billionaires declined to go — and given the activist investor a boost he badly needed. In December 2012 the boss of Pershing Square, a hedge fund, announced a $1 billion bet that Herbalife would go bust, based on his belief that the dietary-supplement firm runs an illegal pyramid-selling scheme. Since then Herbalife’s shares had crept higher, thanks not least to buying by tycoons such as Carl Icahn, George Soros and Dan Loeb. But on March 12  the share price tumbled when Herbalife announced it is being investigated by the Federal Trade Commission (FTC).

This will raise Ackman’s hopes of eventual vindication for his belief that Herbalife’s “multi-level marketing” system is in essence a shake-down of the people on the bottom layer (the company strongly denies this, and just about everything else Ackman has said about it). But it will also add to the concerns of critics of Ackman, who fear he is creating a new form of political power by combining two of the things the American public most hates about wealthy folk: short-selling and state-of-the-art lobbying.

His bet against Herbalife is a classic short, selling borrowed shares that will have to be repurchased later (at a lower price, Ackman hopes) to return them to their owners. As for the lobbying, on March 9 the New York Times ran a long, sniffy article which tracked down people who claimed to have suffered financial losses at Herbalife’s hands and whose stories Ackman has bundled up to present to Congress.

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Short-selling generally does not deserve its bad rap. Often it helps to prevent damaging financial bubbles by providing a reality check on an irrationally exuberant market. Arguably, reinforcing shorting with well-executed lobbying should not make it more unacceptable, merely more effective. It is not as if the shorter has all the firepower. Ackman is said to have spent over $264,000 on his Herbalife campaign, but the company’s federal-lobbying budget in 2013 was over seven times that.

Ackman has talked of a moral crusade against Herbalife and promised to give away any personal profits from the trade to charity. His critics see him simply as a greedy billionaire who is now exploiting America’s newly laissez-faire attitude to political spending in pursuit of a big financial payday. There is no reason to think he has undue influence at the FTC. Even if, despite the company’s denials, Ackman were to provide convincing proof that Herbalife sells snake oil to gullible immigrants, that might not demonstrate conclusively that it has acted illegally. The laws governing pyramid schemes and multi-layer marketing are notoriously fuzzy. Nor might any punishment be severe enough to close the business.

What if the FTC investigation were to find grounds to drive Herbalife into bankruptcy, as Ackman hopes? Would the public treat him as a hero, who took a big risk to stop the exploitation of vulnerable people? Or would they merely view his success as evidence that he had become a “House of Cards” style billionaire with too much power in Washington?

© The Economist Newspaper Limited, London (March 15, 2014)

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