Herbalife: New Data Suggests SEC is Still Investigating, But Lack of Updates Leave Investors in the Dark


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Herbalife Ltd - HLF    

Is the SEC still investigating Herbalife?  New data re-affirms risk of SEC investigative activity.  An SEC investigation was indirectly disclosed in early 2013 (meaning the company did not, and has not since, directly stated it was under investigation by the SEC in its filings). At the time, investors were provided with the scantest of detail regarding some document/information requests. The company's provided no update on SEC activity since.  If only to stick it to their detractors, one would think the company would state clearly were the SEC not investigating or if an investigation was over.  That obviously has not happened.

We present our findings, the company's relevant disclosures, and our analysis of the same.  We close with a cautionary note regarding what you should be aware of when a company announces an investigation has ended with no enforcement action recommended or taken.

Facts of Interest or Concern:

In a letter dated 22-Dec-2014, we received information from the SEC suggesting this company was involved in unspecified SEC investigative activity.  We received a similar response in May-2014.  Aside from sweeping references to inquiries and such, HLF has not provided any meaningful update on SEC activity since first disclosing its existence in the 10-K filed 19-Feb-2013.

Initial Disclosure: From the 10-K filed on 19-Feb-2013 [emphasis added]--

Following December 2012 market events and a subsequent meeting we requested with the staff of the SEC’s Division of Enforcement, the staff requested information regarding the Company’s business and financial operations. Consistent with its policies, the Company is and will fully corporate with these inquiries.

Quick Take Unless you have a compelling reason (like reporting a crime), who do you know that calls the cops out of the blue to request a meeting with them?  Really, think about it for a second.  You are asking for trouble. 

This is what we call a stealth disclosure of an SEC probe. It also cannot be analyzed as the company fails to say what the SEC is investigating or why.  Companies using these tactics typically do so when they judge an SEC exposure sufficiently material to require disclosure, but they don't want the bad press or potential negative market reaction that can accompany it.  Regardless of motive, failure to give prominence to an SEC probe is misleading. 

We think the SEC notified the company it had opened an inquiry first and the company then requested a meeting with the SEC to discuss the matter. That happens all the time. But companies requesting meetings with SEC enforcement staff absent an inquiry?  Not so much.

Most recent disclosure, from the Herbalife 10-Q filed 03-Nov-2014 [emphasis added]--

From time to time, the Company is subject to inquiries from and investigations by various governmental and other regulatory authorities with respect to the legality of the Company’s network marketing program. Given the nature of recent allegations made by certain short sellers and related market events, the Company has received and believes it may receive additional state and federal governmental and similar inquiries (such as the previously disclosed inquiries from the FTC and SEC). To the Company’s knowledge, there are no ongoing criminal investigations of the Company or its business model by any governmental authority. To the extent any governmental or regulatory inquiry or investigation is or becomes material it will be disclosed individually. Consistent with its policies, the Company has cooperated and will fully cooperate with any government or regulatory inquiries or investigations.

Our Take:  We've long railed against the construct that it's acceptable for a company to only disclose something if it "is or becomes material".  That's because management gets to decide, they have all the facts, they may be conflicted, and investors would almost certainly use standards different than theirs. 

So is Herbalife still being investigated by the SEC?  Two FOIA responses received from the SEC since May-2014 certainly suggest the answer is yes.  As always, a pending appeal response from the SEC will tell us with certainty (Reminder: about 2/3 of investigations are confirmed as on-going on appeal). 

Surely something's changed with that SEC probe Herbalife first "sort-of" disclosed in early 2013.  Phone calls exchanged, meetings held, documents produced, testimony given, etc. If only to stick it to their detractors, one would think the company would state clearly were the SEC not investigating or if an investigation was over.  That obviously has not happened. 

Regardless of motive, we find the clever word games early on regarding SEC activity, followed by the lack of update speaks to contempt for investors. We recommend avoiding such companies.

Final word:  Barring anything extreme, we expect any SEC investigation of Herbalife will end, as most investigations eventually do, with "no enforcement action" recommended or taken by the Commission.  Too often investors are quick to conclude that means the company was exonerated. They are also too quick to ignore changes in operations, accounting, and/or procedures potentially brought about by a protracted SEC probe that can have lasting negative impact on a company going-forward (e.g., what happens when a company is no longer able to use a bribe as a tool of commerce where it widely used them in the past?). 

The SEC is clear that the notices it sends at the end of an investigation, "must in no way be construed as indicating that the party has been exonerated or that no action may ultimately result from the staff’s investigation" 

This was excerpted from the final paragraph of Securities Act Release No. 5310 which is routinely sent to companies at the end of SEC investigations. Keep that in mind here, and with all companies you follow.

Given the controversial nature of Herbalife we offer this additional disclosure:  Unless it impacts our analysis, we are indifferent to what any company we research makes, sells, or does.  We are equally indifferent to who loves the company, who hates it, or why they feel that way.  Always, we follow the facts where they lead us. Always, if we say a company has an undisclosed SEC probe we can back it up with a document in black & white on government letterhead provided to us in response to a Freedom of Information Act request we made on that same company.  Always, we receive these records directly from the government using our own fully-documented efforts.  We prohibit trading in shares of any companies on which we are conducting active research.  No one connected with Probes Reporter has securities positions of any kind in Herbalife.  No one paid us to research this company, produce this report, or influence the timing of the same. 

To learn more on our process and what our findings mean, click here.

Notes: The SEC did not disclose the details on investigations referenced above. The SEC reminds us that its assertion of the law enforcement exemption should not be construed as an indication by the Commission or its staff that any violations of law have occurred with respect to any person, entity, or security.  New SEC investigative activity could theoretically begin or end after the date covered by this latest information which would not be reflected here.