Herbalife (NYSE:HLF) Wins Pyramid Scheme Lawsuit

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By Jacob Maslow

Herbalife HQAS part of a two-year campaign against Herbalife (NYSE:HLF) waged by hedge fund manager William Ackman along with his Pershing Square Capital Management Company, Herbalife was hit by a shareholder lawsuit. The lawsuit alleged that the company portrayed itself as a legitimate operation when, in reality, it was operating an illegal pyramid scheme. The US District Court in Los Angeles threw out the case because the plaintiffs failed to show that the company manipulated its stock price by misrepresenting itself as a legal multilevel marketing company. This development is sure to work in favor of Herbalife’s stock. The diet supplement and weight loss company’s stock has been hammered hard due to William Ackman’s allegations. This company makes a huge amount of money, but its stock has been hammered hard. Expect it to rebound now that this legal ordeal is out of the way.

From my perspective, I think the reason why there is such a distrust of Herbalife is due to popular misconceptions regarding multilevel marketing. Multilevel marketing operates on a tiered referral system. If you look at that arrangement on a chart, it may look like it is arranged as a pyramid. However, not all sales systems that take the form of a pyramid are illegal pyramid schemes. The reason why Herbalife’s multilevel marketing system is arranged like a pyramid is because that is how social networks work. One level refers another level, which refers another level. Just because it is arranged that way, it doesn’t necessarily mean that it is an illegal pyramid scheme.

What makes a pyramid scheme illegal? Illegal pyramid schemes all share one common factor. They don’t sell a product. What they sell is the opportunity to sell an opportunity to participate in the scheme. In other words, they are simply giving people the right to collect registration fees.

Such systems don’t really push products. In fact, in many cases, no products are involved. The only real product, if you want to call it that, is the right to collect registration fees. That is an illegal pyramid scheme. Herbalife, just based on its operations and how its salespeople actually perform, is far from an illegal pyramid scheme. It is no surprise then that US District Judge Dale Fischer threw out this suit.

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