Wednesday, March 18, 2015

Herbalife, The Company You Keep

In an odd bit of timing we've been lucky enough to receive two key court filings yesterday related to Herbalife. Yesterday Judge Dale Fischer dismissed a class action securities lawsuit against Herbalife (Awad, et al, order embedded at bottom). The lawsuit hinged on three key elements to establish the alleged securities fraud claims against Herbalife:

  1. a material misstatement or omission
  2. scienter (intent or knowledge of wrongdoing)
  3. loss causation 

Judge Fischer ruled that Awad, et al failed to adequately plead loss causation and thus demurred from ruling explicitly on the merits of material misstatement or scienter. Although his ruling is based solely on loss causation and thus renders misstatement and scienter moot, Judge Fischer's memorandum offered the following additional explanation on the merits of the other two elements:
"the Court notes that Defendants’ scienter and material misrepresentation arguments are generally unpersuasive; dismissal likely would have been proper on either basis. At the parties’ March 9, 2015 hearing, Plaintiffs’ counsel acknowledged that Plaintiffs must prove that Herbalife is a pyramid scheme in order to prevail in this action."

Judge Fischer continued to say that:

"any amended pleading will likely fail absent allegations that identify particular misrepresentations concerning specific components of Herbalife’s operations. Plaintiffs’ current scienter allegations are also suspect. A significant portion of these allegations focus on marginally relevant confidential witness testimony and insider trading history, neither of which appears sufficient to establish a strong inference of scienter."
It doesn't sound to me like there is much of a chance of rescuing the case.


Declaration of Prof. William Keep
In addition to the Fischer order, TINA.org entered a motion for leave to file an amicus curae objecting to the settlement agreement in the Bostick class action case. TINA's motion was buttressed by the expert declaration of Prof. Bill Keep. Inexplicably, Professor keep claimed in his declaration (to the best of his knowledge) that the 70% retail rule which Herbalife requires distributors to follow, could somehow "apply to 0% of a distributor's purchases." For some odd reason Keep declared that the 70% requirement applies to what distributors hold for resale and supports this claim by citing a sentence in the Herbalife sales and marketing plan's Production Bonus Requalification guidelines section. That sentence reads: 
"In any given month, a Distributor must sell to retail customers, and/or sell at wholesale to downline Distributors, at least 70% of the total value of Herbalife products they hold for resale, in order to qualify for TAB Team and to earn and receive Royalty Overrides and Production Bonus for that month's business."
Prof. Keep (to the best of my knowledge) first floated what this incorrect assessment of Herbalife's 70% rule in an Atlantic article last year. Prof. Keep, however, somehow missed the Earnings Certification Form that exists in the SAME EXACT EXHIBIT he refers to in his declaration:



He also completely missed the actual rule (Rule 18-C), which is also in the SAME EXACT EXHIBIT that very clearly defines what Herbalife's 70% rule is:


All of this is not to say that this expert declaration lacks utility; it does make me wonder how much of his opinion is supported by what may have been a cursory review of the documents he based that opinion on. Also, with the filing fresh in my mind, I couldn't help but wonder if the TINA motion was the objection "filed by attorneys affiliated with, and potentially funded by, the short sellers" that Bostick Attorney Thomas Foley(counsel for Plaintiffs) predicted was coming so I contacted TINA, which quickly dispelled the idea. Laura Smith, their Legal Director, graciously provided me the following statement:

"TINA.org has not received any funding or support from any of the individuals or organizations you cited in your email* in connection with our amicus brief that opposes the terms of the proposed settlement in the Bostick v. Herbalife litigation.
With respect to the 70% rule, that rule was established in the Amway decision and requires distributors to resell at least 70% of the products they have purchased each month in order to ensure that distributors do not attempt to get bonuses solely on the basis of the products they purchase.  Herbalife's version of that rule, however, as articulated in plaintiffs' complaint in the Bostick case and in Herbalife's own materials, does not require its distributors to resell at least 70% of products they have purchased each month.  Rather, it allows them to count self-consumption to satisfy the 70%. Thus, 0% could have been resold and a distributor could still satisfy Herbalife's 70% rule."
*(I cited the Ackman family, Pershing Square, or its agents/assigns, such as, but not limited to Global Strategy Group, Evelyn Mantilla, and Chris Healey)
I also contacted Professor Keep asking if he could explain the inconsistency in his affidavit and his only response was that he would "wait for the deposition". 

WHOA!?! Who said anything about a deposition? I replied that such a response, "On the heels of the WSJ article and the Courant article...begs the question: what deposition are you referring to? Are you being deposed by the DOJ or are you going to be deposed in the Bostick litigation?" I have yet to hear back, but will update this post accordingly if Professor Keep provides me with greater detail. Maybe it was just a quip. 


The reason I find the Courant article so interesting is because it expands the information provided to us by the WSJ in that it states that a Federal grand jury had subpoenaed individuals regarding the possible manipulation of Herbalife stock. Although there are no reports that indicate Ackman is the actual target or that he is going to be indicted, the chances are pretty high that somebody will be. 

In fact, Columbia Law Professors put the odds of escaping indictment after a grand jury at 11:162,000(standing or otherwise seems to be irrelevant). You've got better odds of winning a Pick 4 straight lottery ticket (although $5000 probably won't buy much of a defense). Until further details emerge, it remains to be seen whether or not our lucky lottery winner should be buying that ticket in New York or Connecticut.

Maybe it's too simple an explanation, but it really strikes me as odd that a Federal Jury dealing with a Connecticut based target would subpoena testimony from Connecticut residents in New York(not Connecticut), unless the investigation was being run out of New York and was focused on a target in New York.


Order GRANTING Defendants’ Motion to Dismiss (Docket No. 60) by theskeptic21