There are lots of other things in our world with a hint of pyramid scheme to them, some obvious scams, some not. Ponzi schemes like the one perpetrated by Bernard Madoff rely on cash from new investors to pay off the early ones. Then again, Social Security sort of works that way too. And really, anybody who invests in stocks and bonds — including Ackman — is to some extent relying on future investors to bail them out.
What makes Social Security and the business of investing in something other than sure-to-collapse scams is underlying economic growth. As economist Paul Samuelson famously wrote in 1967, “A growing nation is the greatest Ponzi game ever contrived.” Transparency helps, too. Slowing growth and rising life expectancy in the U.S. mean Social Security won’t be as a great a game for current workers as it has been for their elders. But this is disclosed in great detail every year in the Social Security trustees’ report.
When it comes to so-called multilevel marketing companies such as Herbalife — other big names in the field include Avon, Amway, Nu Skin, Primerica, Pampered Chef and Tupperware — what distinguishes legitimate businesses from illegal pyramid schemes is similarly a combination of underlying demand and transparency. At least, that seems to be what has distinguished them since 1979, when the Federal Trade Commission determined that Amway was not an illegal pyramid scheme. This dividing line isn’t explicitly defined. When New York Times columnist Joe Nocera tried to get a definition out of the FTC earlier this year, the response was, “we won’t be able to offer you any on (or off) record assistance.” A former FTC economist told Bloomberg’s Matt Stroud in February that the lack of a clear rule makes it hard for the agency to crack down quickly on even the most obvious scams.
Now back to Herbalife. Its flagship Formula 1 meal replacement shake powder has sales that are “more than double those of its three leading competitors — Ensure, Kellogg’s and SlimFast — combined,” Fortune’s Roger Parloff writes in an epic and hugely educational new examination of Ackman’s battles with the company. Parloff cites extensive Herbalife-funded research showing that the vast majority of its products are being consumed rather than moldering in distributors’ garages, then adds:
Investors were understandably skeptical of any company-ordered surveys. So several funds did their own. One longtime major investor told me he commissioned a blinded, high-datapoint, randomized survey asking a wide variety of questions. The results basically lined up with Herbalife’s, he said. “Say what you will,” he comments, “you may think the stock’s overpriced, you don’t think it’s a good business opportunity, or whatever. It’s impossible to argue there isn’t a product.”