During a more than three-hour presentation yesterday, billionaire investor Bill Ackman choked up while describing his family’s immigrant beginnings, called Herbalife (HLF) Ltd. Chief Executive Officer Michael Johnson “a predator” and labeled that company “a criminal enterprise.”
Herbalife stock rose 25 percent.
The increasingly public spectacle of Ackman eviscerating a company on stage, television and online after betting $1 billion that it will fail is raising questions about his credibility on Herbalife and whether there are limits to how short sellers make their case.
“It seems odd to many that you could publicly trash a company and affect its stock price negatively and that somehow there would be no consequences for that,” said Mark Fickes, a former SEC attorney who is now a lawyer at Cannata Ching & O’Toole LLP. “The fact he has the resources to disseminate the information this way, it doesn’t make it wrong.”
Ackman has denounced Herbalife as a pyramid scheme since December 2012, spending $50 million of Pershing Square Capital Mangement LP’s money for a probe that included undercover investigators. He has since predicted that Herbalife’s distributors would leave in droves and that auditors wouldn’t sign off on the company’s financial statements. So far he is wrong about both.
Ackman’s presentations alleging fraud included one on Herbalife’s China unit and another featuring a documentary and panel discussion with former distributors claiming to have been scammed. The shares rose after both presentations. He has repeatedly, including yesterday, promised new evidence that would prove his allegations. The shares have gained 60 percent since Ackman first revealed his short.
While Ackman is playing hardball with Herbalife, his actions aren’t illegal and accusations of market manipulation would be overblown, said John Coffee, a securities law professor at Columbia University in New York.
“Although his characterizations are harsh and possibly overstated, investors are fully aware of his self-interest,” Coffee said in an e-mail. “The First Amendment gives him a lot of breathing room, and the real cost to him is that he may lose a great deal of money if he cannot get Herbalife’s stock price to crater.”
A lawsuit against Ackman is a possibility, Herbalife Chief Financial Officer John Desimone said yesterday — after Ackman’s event — in a Bloomberg Television interview with Stephanie Ruhle.
“That’s on the table, that’s an option. I think our case gets stronger every day. It’s frustrating,” Desimone said. “The rules of transparency that we operate under is not the same set of rules that Bill Ackman operates under.”
Asked whether he was goading Herbalife to sue Pershing Square, potentially giving him grounds to scrutinize its non-public records, Ackman replied, “Bring it on.”
To make a stock manipulation case, the SEC has to prove that the misconduct was deliberate. Intentionally spreading false or misleading information about a company is a violation of both civil and criminal law, according to the regulator’s website.
Short sellers like Ackman can openly criticize a company as long as they believe what they’re saying, said Adam Pritchard, a former SEC senior counsel who now teaches law at the University of Michigan.
“The major constraint here is whatever he says has got to be either true or he has to have a good reason for believing it’s true,” Pritchard said. “If he believes one thing and is saying another, that’s a problem. If he has a good faith belief, then he’s in the clear.”
Investors benefit from accurate reports about stocks, regardless of whether they’re positive or negative, said Barbara Roper, director of investor protection at the Consumer Federation of America.
“What we care about is the information be accurate and reliable,” she said. “If what he’s saying is accurate, do we fault him because he’s making a big deal of it? It all depends on the quality of information and analysis.”
The SEC has a history of probing vocal short sellers. Ackman himself faced scrutiny by the regulator and then-New York Attorney General Eliot Spitzer over his 2002 bet against bond-insurer MBIA Inc. The investigations, which came after Ackman published a research report criticizing MBIA, were later dropped. Ackman profited after the company reported record mortgage losses during the 2008 financial crisis.
The agency has opened and dropped other high-profile investigations related to public criticism of companies. David Einhorn, co-founder of Greenlight Capital LLC, faced an investigation after questioning in 2002 Allied Capital Corp.’s accounting. The agency also probed in 2006 whether Gradient Analytics Inc. conspired with a hedge fund customer to issue research aimed at pushing down Overstock.com’s shares. The SEC closed both investigations without taking action.
This is only the latest controversy raised by Ackman’s investing style. He helped invent a new deal trick this year when Pershing Square quietly amassed almost 10 percent of Allergan Inc. (AGN) to back a takeover bid by Valeant Pharmaceuticals International Inc., structuring the trade with options to avoid triggering disclosure requirements from the U.S. Federal Trade Commission.
At J.C. Penney Co., Pershing Square exited its stake as the retailer’s largest investor in August, after a failed remake effort. Over the course of Ackman’s three-year activist investment, Penney shares lost 58 percent. Weeks after he quit the board and sold his stake, the troubled retailer issued stock that further diluted remaining shareholders.
Ackman’s allegations yesterday centered on nutrition clubs, which Herbalife says are key to getting people to use its products daily. Ackman said the clubs are a front for an illegal recruiting scheme, designed to push large purchases of unsellable weight loss powder. The sales enrich Herbalife and top distributors while defauding mostly poor Latinos, he said.
Outlining the findings of a Pershing Square-funded investigation, Ackman claimed the company uses the promise of club ownership to target the poor through mandatory training programs and restocking. The model forces would-be distributors to consume the products at their own cost, Ackman alleged.
By Ackman’s calculation, nutrition clubs lose $12,000 on average. Ackman said unpaid trainees pay more than $3,000 for meaningless certifications to run a club of their own. Herbalife said Ackman was wrong and uninformed.
Looking to get ahead of Ackman yesterday morning, Herbalife released the results of a company-funded economic analysis showing that it’s not a pyramid scheme.
In an interview, researcher Walter H. A. Vandaele, an economist at Navigant Economics LLC, said 97 percent of Herbalife’s products are purchased for end-use consumption. That validates Herbalife’s status as a multilevel marketing firm, rather than a pyramid scheme, he said.
Herbalife gave Vandaele, who worked for the FTC from late 1981 to early 1986, access to sales and order records for about 800,000 independent distributors that passed through Herbalife from January 2012 until mid-2013. Only personal identifying information was withheld, he said in the interview.
Asked what Ackman is missing in his research, Vandaele said, “I don’t think he is doing a fully scientific study.”