August 5, 2016

FTC Settles with Herbalife Over Business Model and Misleading Earnings Claims

Seller Beware: Consumer Protection Insights for Industry

Herbalife's 2+ year FTC investigation came to an end last month when it settled with the FTC for $200 million, which will be distributed to former Herbalife program participants. The Stipulated Order entered on July 25 also requires Herbalife to restructure its business model to compensate its distributors based on verifiable retail sales, and prohibits Herbalife from paying compensation solely for enrolling or recruiting new distributors. If less than 80% of Herbalife's sales are to actual end-users, it must reduce compensation.

The Herbalife settlement is consistent with how the FTC has treated multilevel marketing programs in the past. Under the FTC's test, a multilevel marketing program runs afoul of the FTC Act if participants pay money in return for "(1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users." Here, the FTC alleged that Herbalife did not offer "a viable retail-based business opportunity" and that the compensation structure "incentive[d] not retail sales, but the recruiting of additional participants." If your company uses multilevel marketing, you'll want to read the complaint and order carefully to see how your company's program stacks up.

While this part of the complaint and settlement grabbed the headlines, another part has implications beyond multilevel marketing programs. The FTC also alleged that Herbalife misrepresented that its distributors can earn substantial income. As detailed in the complaint, Herbalife conveyed specific income expectations through testimonials, anecdotes, and other means. And according to the FTC, it also implicitly represented that participants can earn significant incomes through lifestyle imagery portraying "expensive houses, luxury automobiles, and exotic vacations."

The FTC alleged that these earnings claims were misleading because the "overwhelming majority of Herbalife Distributors make little or no money, and a substantial percentage lose money." According to the FTC, "the only way to achieve wealth from the Herbalife business opportunity is to recruit other Distributors," but recruitment rewards are "highly concentrated" with most distributors receiving little or no money from recruitment. The complaint alleges that among the top 13% of distributors, more than half received recruitment rewards payments of less than $300 in 2014, while the top 0.03% of distributors averaged over $600,000. The FTC rejected as ineffective Herbalife's disclosures of what participants could expect to earn. According to the complaint, the disclosure, which was made in a separate document, "does not provide clarity or realistic expectations, but instead obfuscates through a dense maze of verbiage and numbers."

The settlement bars misleading and unsubstantiated income representations. It also prohibits Herbalife from representing or implying that participation in the program "is likely to result in a lavish lifestyle," including through images of mansions, exotic automobiles, yachts, or similar luxury items. This demonstrates again the FTC's willingness to look beyond words to the surrounding imagery, and to hold companies responsible for implicit messages in their marketing and promotional materials that create unrealistic or unsubstantiated consumer expectations. This enforcement action is also a reminder that companies will be well-served by providing clear, simple, and prominent disclosures of the typical results consumers can expect in ads and endorsements touting above-average outcomes.

© Arnold & Porter Kaye Scholer LLP 2016 All Rights Reserved. This blog post is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

Subscribe Link

Email Disclaimer