Pershing Square Capital Management, L.P. (“Pershing Square”) today
released the following statement in response to the recent ruling by the
Ninth Circuit Court of Appeals concerning its decision in FTC v.
BurnLounge, Inc.:
On June 2, 2014, the United States Court of Appeals for the Ninth
Circuit unanimously affirmed the district court’s permanent injunction
against continued operation of BurnLounge, Inc., an illegal pyramid
scheme operating in violation of Section 5 of the FTC Act.
Herbalife Ltd. (NYSE: HLF) immediately spun this decision as
‘supportive’ of its business model – in the face of the Federal Trade
Commission’s victory in shutting down a deceptive pyramid scheme, whose
illegal elements closely parallel Herbalife’s own practices.
Investors are encouraged to read the appeals court’s ruling for
themselves to see just how ‘supportive’ it is of Herbalife. http://cdn.ca9.uscourts.gov/datastore/opinions/2014/06/02/12-55926.pdf
In its decision, the Ninth Circuit reaffirmed the principles of its 1996
decision in Webster v. Omnitrition International, Inc., which
condemned as a pyramid scheme a company that was founded by a former
Herbalife distributor and that mirrored Herbalife’s marketing plan
almost exactly. The court instructed that“[t]o determine whether a MLM
business is a pyramid, a court must look at how the MLM business
operates in practice.”
BurnLounge’s so-called Mogul program (analogous to Herbalife’s
Supervisor/Sales Leader program) was found to be illegal because
“BurnLounge’s focus was recruitment” and because the bonuses that
BurnLounge paid to its participants “were tied to recruitment rather
than the sale of merchandise.”
Citing Omnitrition, the court wrote: “[t]he mere structure of the
scheme suggests that Omnitrition’s focus was in promoting the program rather
than selling the products.” In BurnLounge, “[s]elling packages
[of products] was a way of recruiting new Moguls—in fact, it was the
only form of recruitment—because purchasing a package was necessary to
become a Mogul and earn cash rewards.”
In the same fashion, Herbalife’s distributors are pressured to reach
Supervisor/Sales Leader quickly (at a cost of approximately $3,000),
qualifying them to receive royalties and other commissions, and then to
pressure their own recruits to reach the Supervisor/Sales Leader level,
too. As the Ninth Circuit observed, “in Koscot, participants
joined the scheme by buying inventory, and participants earned rewards
by recruiting others to join the scheme, i.e., by getting recruits to
buy inventory.” In other words, a pyramid scheme cannot obscure its
illegality by using a sale of inventory as cover for paying recruitment
rewards.
The Ninth Circuit looked to the purchasing behavior of participants to
determine that “Moguls were meant to be, and were, primarily motivated
by the opportunity to earn cash rewards for recruitment.” As Pershing
Square has shown repeatedly, including in its December 20, 2012
presentation, Herbalife distributors are also given strong incentives to
focus their efforts on recruiting new distributors into the scheme
rather than selling products to genuine retail customers outside the
distribution network.
The Ninth Circuit rejected BurnLounge’s contention that the FTC was
required to show that BurnLounge’s rewards were “completely unrelated to
the sales of bona fide products,” holding instead that BurnLounge was a
pyramid scheme because “the rewards BurnLounge paid were primarily
for recruitment, not for the sale of products” (emphasis added). The
Court explained that “BurnLounge participants joined the scheme by
buying packages,” and “[p]articipants earned rewards by recruiting
others to join the scheme, i.e., by recruiting new participants to buy
packages.” Thus, “the participants sold something . . . , but the
rewards the participants received in return were largely for
recruitment, not for product sales.” Similarly, Herbalife distributors
are strongly encouraged by senior distributors to (1) purchase large
volumes of Herbalife products in order to qualify as a Supervisor, (2)
recruit new distributors into the scheme, and (3) push those new
distributors to do the same.
The Ninth Circuit also rejected BurnLounge’s argument that the company
was not a pyramid scheme because participants, when they bought
BurnLounge packages, were “ultimate users” of the products contained in
those packages. The Court recognized that “some sales occurred” and
noted the district court’s finding that the packages had “some value,”
but the Court rejected any categorical rule that sales to participants
constitute sales to ultimate users.
To the contrary, the Court held that BurnLounge was a pyramid scheme
because the purchase of BurnLounge packages by participants did not
reflect “consumer demand for the merchandise in the packages,” but,
rather, “[t]he merchandise in the packages was simply incidental” to the
purchase of the “right to participate in the money-making venture.”
Similarly, as Pershing Square has shown repeatedly, there is little
genuine retail demand for Herbalife products, and Herbalife distributors
order those products for the primary purpose of qualifying for and
maximizing the recruiting rewards they receive from Herbalife. In the
Herbalife scheme, as in BurnLounge, the opportunity to earn recruiting
rewards is “the major draw.”
The notion that the Ninth Circuit’s decision is a vindication of
Herbalife is absurd. The case certainly does not support Herbalife’s
position that sales of products to distributors who tried – but failed –
to succeed in their pursuit of the Herbalife business should be regarded
as true retail sales.
About Pershing Square Capital Management, L.P.
Pershing Square Capital Management, L.P., based in New York City, is a
SEC-registered investment advisor to private investment funds. Pershing
Square manages funds that are in the business of trading — buying and
selling — securities and other financial instruments. Funds managed by
Pershing Square have established short and other bearish economic
positions against securities of Herbalife Ltd. Pershing Square may
change its views about, or its investment positions in, Herbalife at any
time, for any reason or no reason. Pershing Square may buy, sell, cover
or otherwise change the form or substance of its Herbalife investment.
Pershing Square disclaims any obligation to notify the market of any
such changes. Please see the full Disclaimer appearing on websitewww.factsaboutherbalife.com.
Copyright Business Wire 2014