Judge grants preliminary approval of settlement in Herbalife pyramid scheme lawsuit

Herbalife Ltd. is a step closer to disposing of a proposed class-action lawsuit that accused the multilevel marketer of exploiting distributors and operating a pyramid scheme.

A federal court in California has preliminarily approved a settlement of the lawsuit. Under the agreement, the proposed settlement class would cover around 1.3 million former and current distributors.

Herbalife 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.

Based on a preliminary evaluation, a federal judge found the settlement agreement was “fair, reasonable, and adequate." A final approval hearing has been set for May 11, 2015 before U.S. District Court Judge Beverly Reid O’Connell.

Philip Dracht, a lawyer in Salt Lake representing the plaintiffs, had no comment Wednesday on the settlement beyond the filings in the case.  

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 marketer of weight-loss shakes and nutritional supplements is the subject of government investigations into its business practices after a billionaire hedge-fund mogul accused the company of running a massive pyramid scheme, an accusation Herbalife vigorously denies.

A final settlement of the lawsuit would limit Herbalife’s exposure amid challenging times for the company. In addition to combatting pyramid scheme accusations, Herbalife has posted financial results that have underwhelmed Wall Street for two consecutive quarters. In a research note last month downgrading Herbalife’s stock to a “neutral" from a “buy," and lowering Herbalife’s price target to $55 from $75, stock analyst Michael Swartz of SunTrust Robinson Humphrey cited concerns that Herbalife’s U.S. business declined for the second straight quarter.

Compared to the same period in the prior year, Herbalife’s most recent quarterly profit plunged 92 percent to $11.2 million.

The lawsuit’s “potential cost, as well as the distraction, disruption and burden of prolonged litigation on the company and its management team" were factors that led Herbalife to reach the settlement, the company noted in an Oct. 31 statement.

"We are fully confident that we would have prevailed," said Mark Friedman, general counsel of Herbalife, in the statement. “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."

Scott Van Winkle, a stock analyst for Canaccord Genuity, which maintained a “buy" recommendation on Herbalife’s stock last month, said the settlement of the lawsuit “has been viewed favorably," citing “the relatively benign nature of the terms" in a Nov. 4 research note.

Kevin Thompson, a multilevel marketing (MLM) lawyer, noted in a blog that the cash piece of the Herbalife settlement ($15 million) was substantially smaller than he anticipated. He referenced a 2012 settlement in which Quixtar Inc. (the name previously used by Amway) agreed to provide $55 million in economic relief to a settlement class.

As is typical in settlement agreements, the Herbalife pact does not contain an admission of liability or wrongdoing. Lawyers for the plaintiffs said they are unaware of any similar lawsuits pending in state or federal courts against Herbalife.

For purposes of the settlement, O’Connell certified a class of individuals who were or still are Herbalife U.S. distributors or members from April 2009 through Dec. 2, 2014.

The class excludes the named defendants, their employees, family members, and any distributor or member who is or was a member of Herbalife’s President’s Team, Founder’s Circle, Chairman’s Club, Millionaire Team or GET Team.

Other members who are excluded from the class include individuals who agreed to be subject to arbitration provisions under an arbitration agreement that is contained in a member application agreement Herbalife revised during or after September 2013.

Class members who object to the settlement must file and serve objections no later than 49 days before the final approval hearing. At least one organization that has been critical of Herbalife intends to do so.

“We plan to object to the settlement because it won’t begin to pay for the true damages that Herbalife has caused this class," Brent Wilkes, executive director of the League of United Latin American Citizens, told the New York Post last month.

For about 18 months, Herbalife has been contending with the 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% of Herbalife distributors in 2012 earning nothing and just 0.039% 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.

The settlement excludes certain claims that arose from state and federal investigations. Lawyers for the plaintiffs cited investigations by FTC and the 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, the company said it is unaware of any criminal probes by government authorities.

Pershing Square Capital Management, the hedge fund management company whose leader Bill Ackman has repeatedly accused Herbalife of malfeasance and bet a fortune against the company, did not respond Wednesday to a request for comment on the lawsuit.