Short Seller Bill Ackman's Crusade Against Herbalife

Bill Ackman’s quest to expose Herbalife started 18 months ago with a call from a stock researcher who had written a book about the hedge fund manager. She suggested that the nutrition company Herbalife might make a good target for Ackman, an activist investor who has lobbied for shake-ups at Target and Canadian Pacific railway. The tip sparked a research project that pulled in many employees of Ackman’s fund, Pershing Square Capital Management, along with two law firms and forensic accountants. On Dec. 20, Ackman went public with a three-hour presentation (PDF), accusing Herbalife, which has revenue of $4.5 billion, of using inflated pricing, misleading sales information, and a complicated incentive structure to hide a pyramid scheme. Ackman’s big bet against Herbalife—he’s sold 20 million shares short—has the investment world abuzz.

Ackman’s charges center on the company’s network of 3 million distributors in at least 85 countries who sell vitamins, shake mixes, and skin gels. Those independent contractors earn revenue by hawking products directly to customers and recruiting new distributors, for which they earn a share of those sales and incentives from the company. Classic pyramid schemes attempt to make money by solely recruiting new participants, according to the U.S. Securities and Exchange Commission. The Federal Trade Commission has said a pyramid scheme exists if profits come “primarily” from recruiting. “Once you realize that this is about promoting a business opportunity—you recruit five friends who each recruit five friends who each recruit five friends—it becomes very clear that it’s a pyramid scheme,” Ackman says. “Pyramid schemes are inherently fraudulent.”