Herbalife Says That the 70% Rule Is a Joke Anyway

Yesterday afternoon a bunch of SEC filings from Herbalife ($HLF: no positions) hit the Sec.gov website.   For those unfamiliar with the $HLF saga, hedge fund manager David Einhorn blew the stock up by asking some simple questions on their early May earnings call, leading to speculation that he may have a short position in the stock.   For more background, see my prior posts on the subject.

Reacting to Einhorn’s questions, Herbalife responded (and subsequently filed with the SEC) that they had policies in place to insure that their business model was not a pyramid scheme, emphasis mine:

“The percentage of product of any multi-level marketing company consumed by its distributors is substantial. This is not surprising since consumers who are enthusiastic about the products become distributors in order to purchase at a discount and possibly to share and sell the products to others. In addition, in order to minimize the risk of product being accumulated by distributors, the company has policies in place such as the 70% Rule, the Ten Customer Rule and the Buy Back policy. “

Herbalife also gave Einhorn the answer that he was looking for about the breakdown of low end distributors that they were no longer disclosing in their financial statements (self consumers, small retailers, potential supervisors).

Now come the new filings:

On June 5th, the SEC sent Herbalife a letter, asking, basically, why they were no longer disclosing such info – why they deemed it to be non-material:

So Herbalife, on June 18th, responded that they didn’t view the information as valuable to investors.  You can read their reply in the filing.  Then, with respect to the 70% rule, they add:

“We also note the Staff’s reference to our policies to minimize the risk of product accumulation by distributors, such as the 70% Rule. We have implemented a number of practices intended to minimize this risk, several of which are built into our core business model. For example, we collect payments from our distributors before any product is shipped, which we believe provides financial disincentives to the accumulation of unsold product. In addition, the new sales leader qualification method discussed above encourages distributors to make smaller, more frequent purchases within a twelve-month period rather than initially placing a few larger orders. Our daily consumption DMOs discussed in detail in our periodic filings encourages our distributors to buy and sell or use smaller quantities on a more frequent basis. In addition to the aspects of our core business model noted above, we also have product return and buy-back policies that we believe further minimize the risk of product accumulation and policies which some members of the network marketing industry employ, such as the 70% Rule, that also provide additional comfort regarding product accumulation. Because we believe our core business model involves several safeguards against product accumulation, we do not view the supplemental policies, such as the 70% Rule, as information that is material to investors. “

The SEC didn’t like that answer though, and on June 27th, they sent Herbalife another letter,

And here’s where it gets interesting.  On July 5th, Herbalife responded, essentially with the Teddy KGB reply – aka – “It’s a f*cking joke anyway”

Still Up 20 Grand

 

Herbalife gives a lengthy reply which you can read for yourself, but the bottom line is that they say

“We wish to advise the Staff that the reason the “70% rule” was referenced in our Item 7.01 Form 8-K filed on May 2, 2012 related to our desire to provide a complete overview of the discussion from our earnings call rather than to indicate that we view the “70% rule” as material. “

and then (emphasis mine):

“Because we do not rely on the “70% rule” in any meaningful way and because of the more recent regulatory and other legal developments surrounding the Amway Protections, we do not regard the “70% rule” as material under Item 101(c) of SEC Regulation S-K or otherwise. “

Translation: “remember that 70% rule that we said we use to make sure that our distribution chain isn’t a Ponzi Scheme?  Well, we don’t actually really use that for any real impact or effect.”

interesting…
KD

 

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