Herbalife Agrees to Distribute Cash, Product Refunds in Pyramid Scheme Lawsuit

LOS ANGELES—Herbalife Ltd., the global marketer of protein shakes and nutritional supplements, has agreed to settle a putative class-action lawsuit originally filed in California by a former distributor who claimed the company was a pyramid scheme.

The 34-year-old company arranged to set aside USD $15 million in cash for affected distributors and other expenses, $2.5 million for product refunds and abide by more than one dozen corporate policies that are intended to address claims in the lawsuit, according to court records filed last week. Last year, a federal judge refused to dismiss the lawsuit, and the parties have been working on settlement talks for months.

The settlement was reached about 18 months after the lawsuit was filed, but before U.S. District Judge Beverly Reid O’Connell had certified a class of distributors.

Under the agreement, the proposed settlement class would cover around 1.3 million former and current distributors. Herbalife, whose net sales last year totaled $4.8 billion, distributes its products through roughly 3.9 million “members"—previously known as distributors—in 91 countries.

The agreement does not contain an admission of liability or wrongdoing, according to Herbalife. Lawyers for the plaintiffs said they are unaware of any similar lawsuits pending in state or federal courts against Herbalife.

"We are fully confident that we would have prevailed," said Mark Friedman, general counsel of Herbalife, in a statement last week announcing the settlement. “Settling this matter, however, is in the company's best interest as it allows us to put it behind us and focus on the future growth of the company."

A hearing in which the parties will request preliminary approval of the settlement is scheduled to take place on Dec. 1. The court cannot grant final approval of the settlement unless it finds the agreement is “fair, reasonable and adequate," according to a memorandum in support of the parties’ joint motion for preliminary approval of the settlement.

Original Lawsuit

A 68-page complaint filed last year by former distributor Dana Bostick described a culture in which Herbalife and its representatives made promises of building wealth and enjoying a lavish lifestyle. According to the lawsuit, most distributors struggle to sell inventory and ultimately fail, with roughly 88 percent of Herbalife distributors in 2012 earning nothing and just 0.039 percent bringing home more than $250,000.

Herbalife contended Bostick couldn't have been fooled because he agreed that he read a statement that revealed distributors' modest earnings (average of $2,900 in the year Bostick became a distributor; or a medium compensation level of $741).

Four other former Herbalife distributors who claimed to have lost money in the business later joined Bostick in an amended lawsuit. All the named plaintiffs but one were deposed.

Settlement Terms

Under the settlement, Herbalife agreed to set aside a total of $15 million for distributors who meet certain requirements, attorneys’ fees and costs, and the expense of the settlement fund. Herbalife distributors who achieved the status of GET Team or above are not eligible for cash awards. As much as $2.5 million will be separately available to pay distributors who file claims for the return of unused and unopened products.

Finally, Herbalife agreed to implement or continue to maintain for three years 13 corporate policies, which are partially intended to address contentions that the multi-level marketing company is more focused on recruitment of distributors or “members" than actual retail sales. The policies include a requirement that Herbalife disclose a Statement of Average Gross Compensation to prospective members and specify figures on members who solely consumed the nutritional products or earned no money.

FTC, Attorneys General Investigations  

The settlement excludes certain claims that may arise from investigations that state and federal authorities have launched into Herbalife. Lawyers for the plaintiffs cited investigations by the FTC and attorneys general in New York and Illinois.

Herbalife has said little about the government investigations into its business practices. In a Securities and Exchange Commission filing Monday, the company said it is unaware of any criminal probes by government authorities.

“We are very very confident that as the FTC comes to their investigation finality, and they get all the facts on the table, they’re going to go, ‘this is a pretty good company,’" Herbalife CEO Michael Johnson recently told Los Angeles Magazine.

Billionaire Bill Ackman of the hedge fund Pershing Square Capital Management accused Herbalife of exploiting distributors and running a pyramid scheme, and he has predicted the company’s collapse. Herbalife has vigorously denied the allegations and questioned the motives of Ackman, who bet $1 billion that the company’s stock would plunge. In reliance on surveys, Herbalife said roughly three-quarters of its members join the company to purchase products for their own consumption rather than to pursue a business opportunity, according to court records.

State and federal regulators are not the only entities who have been investigating Herbalife’s business practices. During the course of the class-action litigation, Herbalife produced roughly 18,500 documents or 148,000 pages, according to court records. The company also produced 4 gigabytes of database materials, including the equivalent of roughly 2.4 million pages of text files.

Lawyers for the proposed class investigated a number of Herbalife nutrition clubs, interviewed current and former distributors, oversaw sampling of Herbalife’s products, and inspected the company’s quality control (QC), research and development (R&D) and corporate facilities. A number of Herbalife executives also were interviewed, including chief financial officer John DeSimone, the court records noted.

Excluding the most recent three-month period that ended Sept. 30, Herbalife has consistently beat Wall Street’s expectations over the last several quarters. Herbalife on Monday reported operating earnings of $1.45 per share, falling short of analysts' estimates of $1.51 per share, according to CNBC. Revenues of $1.26 billion missed estimates of $1.32 billion, the report said, citing Thomson Reuters data.