by Scott Wapner
The battle with Ackman had consumed the company since December 2012, when Ackman had first laid out his stunning case and his billion-dollar short. Now—finally—for the very first time, Johnson and Herbalife’s other executives felt they could begin to understand why the war had happened in the first place.
It was a war that began with little more than a phone call.
2
THE PITCH
William Ackman was sitting in his office at 888 Seventh Avenue, on Manhattan’s West Side, when the phone rang. It was early summer 2011, and a woman named Christine S. Richard was on the line, a hint of urgency in her voice.
“Bill, I think I found the next MBIA,” she said through the receiver, knowing the acronym would instantly pique Ackman’s interest.
MBIA was the bond insurance behemoth that had arguably put Ackman on the map. He’d battled with the company from 2002 to 2009, ultimately winning a $1.4 billion windfall, but not before a sprawling struggle in which he became the subject of investigations by both New York’s attorney general, Eliot Spitzer, and the Securities and Exchange Commission.1
It was a long and drawn-out affair that had begun when Ackman, a relative newcomer on the hedge-fund scene at his fledgling firm, Gotham Partners, went short on MBIA stock, betting its shares would plummet if the then white-hot housing market weakened. In addition, he’d bought something called credit default swaps—insurance policies, in effect, that would pay off even further if the company went bankrupt, as Ackman expected. Ackman had accompanied his investment with a fifty-page missive titled “Is MBIA Triple A?” that took aim at the company’s pristine credit rating—in essence, its lifeblood.2 Ackman systematically took the company apart, accusing MBIA of misrepresenting the value of its assets and listing several accounting shenanigans and other transgressions he claimed could lead to a liquidity event—the death knell for a business where confidence in the company’s credit means everything. MBIA chief executive officer Gary C. Dunton admitted as much about the firm’s prized triple A rating, once telling the New York Times reporter Joe Nocera that it was the most critical thing MBIA had. “Our triple A rating is a fundamental driver of our business model,” he had said.3
Simply put, MBIA would be toast without it, and Ackman knew it, which is why he also did something almost unheard of at the time for a short-seller—he released his scathing report over the internet in a public “fuck you” of sorts to the company. Ackman wanted people to read it—for the market and investors to doubt the firm’s solvency—and he didn’t stop there. Ackman went to the SEC and New York State insurance regulators, hoping they’d come to the same conclusions he did, slap the company around, and cause the stock price to plummet.
The effort, though intense, was mostly for naught, as month after month, then year after year, Ackman pressed his case, and MBIA managed to fight him off.
Finally, the tide began to turn in Ackman’s favor when the SEC and Mr. Spitzer began investigating MBIA’s accounting practices in 2004.4 One year later, the company would be forced to restate its earnings for an eight-year period, though the stock held up reasonably well during this process, which tested Ackman’s resolve.
The investment finally paid off in 2007, when the onset of the financial crisis crushed stocks like MBIA under the weight of the subprime housing bust. Lehman Brothers and Bear Stearns would eventually go belly-up, and many wondered if companies like MBIA were next.
Sure enough, MBIA shares did suffer. By December 2007, shares had fallen more than 56.3 percent, including more than 25 percent in a single day, as confidence in the sector quickly began to evaporate.5 It may have been a lucky break, but Ackman had finally received his bounty. He made more than $1.4 billion on MBIA and earned a reputation as one of Wall Street’s hot shots.
Richard hoped Ackman was ready for another go-around.
It wasn’t an easy sell. The more than half-decade war with MBIA had left its battle scars, or “brain damage,” as Ackman described it. He’d told those close to him, even some of his own investors who were clamoring for the next big hit, that he’d almost certainly never do such a public short campaign again. It was just too exhausting.
“I didn’t want to do another public short,” said Ackman. “It’s a huge strain on the organization, and you get a lot of this negative press, and everyone hates you. That’s really the answer.”
No one understood the ordeal more than Richard herself. She had documented the whole MBIA saga while an investigative reporter at Bloomberg News, exposing some of the company’s major issues. She later wrote a book about Ackman’s crusade, Confidence Game: How a Hedge Fund Manager Called Wall Street’s Bluff. It told of a relentless investor willing to go to great lengths to win, even if it meant waiting years to do so.
The MBIA story, and all of its gyrations, had taken its toll on Richard too. After taking a leave of absence to write the book about Ackman’s quest, she left Bloomberg altogether to take a job with the Indago Group, a small and somewhat secretive boutique research shop that counted some of New York’s top hedge-fund managers as clients, including Ackman.
Richard and the firm’s founder, Diane Schulman, a former TV producer and licensed private investigator, were paid top dollar for their exclusive investment ideas and had been given the catchy, if kitschy, nickname “The Indago Girls” by their mostly male clientele. Schulman had helped the investor Steven Eisman, famous for his role in Michael Lewis’s The Big Short, do some digging for his short bet against for-profit education stocks.6 Eisman had made a killing on the investment, giving Schulman and Indago some well-deserved street cred in the ego-heavy hedge-fund world.
Schulman had given Richard a list of companies to comb through—some Chinese internet firms and the like—but they were too opaque and obscure and hard to do good research on. However, there was another name on Schulman’s list that Richard vaguely recognized from some reporting a former colleague had done years earlier—the name she’d tell Ackman that day on the phone in the summer of 2011. It was Herbalife.
Herbalife was a publicly traded nutrition company that sold health shakes, teas, and vitamin supplements. When Richard gave him the name, Ackman paused for a moment, as if he’d never heard of the company before. Even if he had heard the name, he probably didn’t know its ticker symbol or exactly what it did. That would change, and soon.
Richard briefly ran through some of the research she’d already done on the company, telling Ackman how she thought it could be a pyramid scheme.
Now Ackman seemed intrigued.
Richard had spent hundreds of hours poring over pyramid-scheme cases, finding many troubling similarities to what she’d dug up on Herbalife. She didn’t have to look too hard either. Multilevel marketing (MLM) companies have been heavily scrutinized since the early 1970s, mostly for their controversial pay structures in which people are compensated for how much product they actually sell along with how many new folks they recruit into the business. Other short-sellers have given the industry a quick scan plenty of times throughout the years, believing the twisty businesses enrich only those who get in early, while the rest of the suckers who sign up late get screwed. Some have even been called pyramid schemes by the government, were later sued, and then were permanently shut down.
In one of the first such cases, a company called Koscot Interplanetary, which sold beauty services and cosmetics, was targeted by the Federal Trade Commission (FTC) and accused of being a fraud.7 Those who signed up were encouraged to spend $2,000 for essentially nothing more than a fancy title and the right to earn commissions. They were then prompted to spend another $5,400 to buy the actual cosmetics. Members who joined would earn bonuses on new recruits who came aboard, as long as they also made similar investments.8
But on November 18, 1975, Koscot was ordered by the FTC “to cease using its open-ended, multilevel marketing plan; engaging in illegal price fixing and price discrimination and imposing selling and purchasing restrictions on its distributors; and to cease making e
xaggerated earnings claims and other misrepresentations in an effort to recruit distributors.”
Other cases soon followed, providing Richard with a treasure trove of material. Even in recent years, there have been companies with some of the same eyebrow-raising characteristics. In June 2007, the Federal Trade Commission sued the MLM company BurnLounge, which operated online digital music stores. Following an investigation, the FTC concluded BurnLounge was a pyramid scheme since the majority of its members were compensated more for recruiting new members into the business than for actually selling services.9
In July 2007, a California court barred the company from operating and froze the assets of one of its promoters, pending a trial. More than fifty thousand people were said to have been affected in the scam, with more than 90 percent of them losing money.
The FTC shuttered several more MLMs, including the Global Information Network, Trek Alliance, and a company called Five Star that marketed leases of “dream vehicles” for free, as long as they paid an annual fee and recruited others into the opportunity. After a trial, the US District Court for the Southern District of New York determined Five Star was a pyramid scheme since people didn’t make anything near the money they were promised.
As for what had been found on Herbalife, “Send me something,” Ackman told Richard, who made an appointment to visit him face-to-face the next time she was in the city.
The day of the meeting, Manhattan was sweltering, the humidity barely budging even after a midday downpour, when Richard, still soaking wet from the storm, took the elevator up to the forty-second floor, and the offices of Pershing Square, Ackman’s firm.
Richard exited the elevator bank, walked through the glass doors into the pristine, white-washed offices, and was escorted to Ackman’s conference room overlooking Central Park, the spectacular view mostly obscured by the angry weather outside.
It was there that Richard waited for her prized audience.
Finally, after several lonesome minutes, Ackman flew into the room in a whirlwind, trailed by an assistant, who handed him a tote bag overflowing with papers, along with a golf umbrella. Clearly distracted, Ackman quickly apologized and said he was unable to stay because of a pressing family matter, leaving Richard disappointed and drenched.
But before rushing for the exit, Ackman asked one of his top analysts, Shane Dinneen, and a Pershing Square attorney named Roy Katzovicz to sit in for him and hear Richard out. Seated around the conference table, Richard reached into her bag and pulled out the report, its edges wrinkled and weathered from travel, all the while trying to quiet her jangling nerves. Richard may have been an accomplished journalist who’d made a living writing about hard-to-understand subjects on Wall Street, but she felt out of her league in front of guys who were Ivy League analyzers of arcane numbers and corporate balance sheets.
Richard took a deep breath and began, focusing on Herbalife’s questionable compensation plan for its legion of distributors. She likened their constant push to recruit new clients to running on a treadmill, as members made purchase after purchase of the company’s products in a quest to move up the food chain to where the real money was made. “It’s so manipulative and disrespectful,” said Richard as she described the structure, zeroing in on claims made by some of Herbalife’s top sellers, who boasted in marketing videos of the fancy cars, boats, and mansions they’d attained through selling the company’s shakes.
While Richard spoke, Dinneen appeared to do some calculations in his head, considering many of the key questions anyone on Wall Street would ask before making an investment: How big was Herbalife? Who were its customers? Who were the largest shareholders? And so on.
The men in the room seemed interested but not overly enthusiastic. Still, they peppered Richard with questions for the next ninety or so minutes, before the meeting eventually wrapped. Dinneen seemed the most taken by what he’d heard, but wanted to do his own research before fully buying what Richard was selling. It wasn’t that he didn’t believe Richard’s work—it was just the way he operated.
Dinneen, who had fiery orange hair and a slim, athletic build, had started at Pershing straight from Harvard, where he graduated at the top of his class. He was intensely competitive, to the point where he’d go for a run in Central Park and almost toy with the other joggers—setting a pace to goad them, then blow by them in a flash, leaving them standing still.
In the office, Dinneen showed the same kind of determination. Colleagues said he came across as aloof and dispassionate, and he would often walk around stone-faced and openly try to “one-up” other analysts in Pershing’s weekly investment meetings. But there was no denying Dinneen’s brilliance and intellectual endurance.
Ackman was drawn to it. He’d taken to Dinneen in part because he’d done the bulk of the work on one of Pershing’s biggest-ever winners, an investment that would go down as one of the greatest in hedge-fund history. In 2008, Pershing Square had bought shares in General Growth Properties (GGP), a mall operator that was teetering on bankruptcy. Ackman had eyed the stock for months, but Dinneen repeatedly urged that they hold off on buying until shares dropped even more. It proved to be prescient advice. When the real-estate bubble popped in 2008, General Growth’s stock dropped below $1 a share. The company would end up filing for what was then the largest real-estate bankruptcy in US history. Ackman pounced, investing at the bottom, helping to bring the company out of Chapter 11. The trade was a home run, turning the original $60 million into a stunning $3.7 billion.10
Dinneen’s work on GGP had earned the analyst star status at Pershing Square, at least with his boss. If Herbalife was really the fraud Richard had described, Ackman wanted Dinneen to be the one to determine it.
Dinneen dove in, doing a bottom-up analysis of Herbalife and reporting what he’d found to Pershing’s investment committee, which met weekly on Tuesdays. During those sessions, a half-dozen Pershing analysts would sit around the conference table and pitch their ideas while the others, including Ackman, scrutinized them.
Paul Hilal, a Pershing Square partner who’d met Ackman at Harvard, seemed especially ambivalent about the idea. He also made it no secret, to anyone who would listen, that shorting Herbalife was a risky endeavor since the laws prohibiting and defining pyramid schemes were especially murky and hard to fully understand.
Scott Ferguson, another senior partner with an Ivy League pedigree, had more “personal” concerns. Ferguson openly worried that Herbalife distributors who were making several millions of dollars a year selling the company’s products wouldn’t take kindly to some Wall Street asshole trying to shut the whole operation down. He feared they could become violent, once telling Ackman he was scared that one of them would even try to shoot him.
Ackman wasn’t one to come across as timid, but he was skeptical of the trade and how or even if it could pay off. When Richard returned a few weeks later for her long-awaited face-to-face, she found Ackman far from ready to commit to adding Herbalife to the Pershing portfolio. “What is this?” he asked about one section of the report. “What does that mean?” he’d interrupt as he flipped through Richard’s work.
It was just the way Ackman’s analytical mind—and mouth—worked. He could pick apart a pitch quickly, deciding within seconds if it had merit or not. He’d pull facts with astounding regularity from the depths of something he’d read or researched several years earlier. As most in the office had quickly learned, debating Ackman could prove futile for the unprepared. Ackman’s intellect made him enough of an adversary.
Then, there was his presence.
At 6′3″, with piercing blue eyes, a barrel chest, and the fully-grayed mane of a man twenty years his senior, Ackman was imposing, as much for his physical appearance as for his quick, unsparing wit. Richard knew that as well as anyone, having interviewed Ackman while working on Confidence Game. Now, she found Ackman anything but sold on her short idea.
Ackman noted that Herbalife had been in business for thirty years, appearing wholly un
convinced government regulators would put a dagger into the company now. “Why would anyone care?” Ackman wondered. And even if Richard’s thesis was right, Ackman questioned whether there would be a catalyst to prove it publicly, which is what was needed to bring down their stock price and make the investment a financial success.
There was also the lingering MBIA hangover—the toll that the whole affair had taken on him personally and the fact that he had no real desire to repeat such a saga.
The meeting ended with Richard pledging to keep Ackman informed of any new developments she’d found, which she periodically did until the end of the year.
Richard kept digging, taking a particular interest in Herbalife’s mushrooming nutrition clubs, a part of the business its CEO, Michael Johnson, had declared in 2009 was “the greatest source of our growth over the last three to four years.”11 By 2011, Herbalife had more than sixty-seven thousand nutrition clubs around the world. Herbalife billed the clubs as social hangouts where people could gather, try a nutritional shake or tea, and learn about the company and the business opportunity it presented.
The clubs had started in Zacatecas, Mexico, in 2006, and quickly caught on in nearby communities. When Johnson and the company’s president, Des Walsh, visited one during a routine business trip to the country, they were so taken by what they saw they came home determined to replicate their success in the United States, which they did. In fact, the clubs had grown so prolific in recent years they accounted for 35 to 40 percent of Herbalife’s global sales.
Richard had a different view and thought the clubs were shady, if not downright sinister. Just like she’d done as an investigative reporter, Richard had gone out in the field and done surveillance on nutrition clubs in Pennsylvania, Rhode Island, and New York City. She was disturbed by much of what she’d found. The establishments were almost always rickety-looking storefronts, mostly in heavily Latino neighborhoods. There were no signs or official Herbalife markings, and doors were always kept closed, with the windows fully covered by curtains. “Welcome” signs were prohibited, along with anything else that could give the appearance of a typical retail operation, including those now ubiquitous credit card logo stickers on the front door, which were also banned.