Is Herbalife A Pyramid Scheme?

Herbalife, a company that sells weight loss shakes, vitamins and other similar products, is worth billions of dollars. The company has been around for more than 30 years, and it's traded on the New York Stock Exchange.

Bill Ackman thinks the whole thing is a pyramid scheme.

Ackman manages a hedge fund that has shorted more than a billion dollars worth of Herbalife stock. If the stock falls — and Ackman says he thinks it will fall all the way to zero — the fund will make money.

Ackman and his colleagues made their case in a three-hour-long speech at an investment conference last month. The PowerPoint presentation had more than 300 slides. It's all online at a website Ackman created (and is advertising on Google whenever people search for "Herbalife").

Herbalife doesn't sell its products in stores. It sells them through an army of ordinary people who have signed up to sell the products on their own. The way the business is structured, these people can make more money by signing up other people to be Herbalife distributors.

This structure, known as multilevel marketing, isn't unique to Herbalife. Amway and Avon are two other big companies that use it. And there's nothing wrong with it — as long as there are real customers out there for the product.

Ackman argues that Herbalife is all about recruiting new distributors, and not about selling weight loss shakes and vitamins to real customers.

Not surprisingly, Herbalife disagrees. The company says it has millions of customers around the world. The CEO went on CNBC and accused Ackman of "market manipulation" — a typical accusation CEOs hurl against shorts.

So, who's right here? How hard can it be to tell whether a giant company is a pyramid scheme? In this case, weirdly, it's really hard.

For a company like Herbalife, the difference between being a legitimate business and being a pyramid scheme comes down to what happens on the ground with all those people who signed up to sell products.

If it's a legitimate business, they're mostly selling the products to people who actually want to use them.

Herbalife officials say that's exactly what's going on. The company recently commissioned a survey that found that 90 percent of the people who buy Herbalife products are not distributors; they're people who just want to drink the shakes or whatever.

Des Walsh, the company's president, says Herbalife has been doing steady business for years in Iceland and other small countries where a pyramid scheme wouldn't be able to endure.

Ackman, argues that the company is constantly going into new markets, exploiting people and moving on. He says distributors often wind up stuck with thousands of dollars of Herbalife products and no customers.

Herbalife got a boost last week when another big hedge fund manager, Dan Loeb, announced that his fund recently bought Herbalife stock worth well over $300 million.

Loeb says the company is profitable and is growing. He points out that the federal government has cracked down on pyramid schemes in the past but hasn't had a problem with Herbalife. In a letter to investors, Loeb's fund wrote:

"The short thesis rests on the notion that the FTC has been asleep at the switch, missed a massive fraud for three decades and will shortly awaken (at the behest of a hedge fund short seller) to shut down the company. We find this to be preposterous."

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