Herbalife, the direct-selling company under attack from short-seller Bill Ackman, allowed an affiliated business to continue operating in its network for almost a decade after Canadian authorities had labelled the operation a pyramid scheme, a Financial Times investigation indicates.
Mr. Ackman, founder of hedge fund Pershing Square, has claimed that Herbalife itself is a pyramid scheme, while the company has said it is legitimate, prompting a high-profile battle between investors on either side of the argument.
The history of Online Business Systems, which until this year specialized in recruiting salespeople for the Herbalife network, raises questions about the practices Herbalife had previously tolerated.
OBS is the successor to Global Online Systems, a company judged to be a criminal "scheme of pyramid selling" by a Canadian federal court in 2004. Both were part of an ecosystem of business built around promoting Herbalife to sell marketing materials and other services such as "sales leads" to the direct seller's recruits.
Herbalife is a direct-selling business, one with a network of over 3 million salespeople, known as distributors, responsible for its sales of diet shakes and nutritional pills. A legitimate multi-level marketing scheme is based around selling a product to end consumers, where higher sales to happy customers mean higher profits, and Herbalife says that it is such a business.
By contrast, a pyramid scheme can still have a product, but the great majority of its salespeople will not make a profit from selling it. Instead those at the top of the pyramid exploit a steady series of new recruits who invest money in their new business before eventually giving up, going bankrupt or moving on.
GOS was run by Deborah Stoltz and her sister Marilyn Thom. The 2004 judgment required the directors to change their business practices, for instance by disclosing the average compensation made by all Canadian participants in the scheme in all marketing materials.
Herbalife's disclosure of gross earnings for Canadian distributors each year only includes "active leaders," a subset representing about one in 10 overall participants.
GOS was also required to notify all of its customers of the conviction. However, before that November ruling, customers were encouraged to move to a new business, OBS, run by Nicole Dahl, the daughter of Ms. Stoltz, and her husband Shawn Dahl.
Online archives show that websites operated by GOS – such as www.4u4meletsdream.com – were rebranded as OBS. A website that encouraged GOS participants to register with OBS by September said that they would remain in the network: "Your Herbalife lineage remains the same regardless of the changes to your new marketing system."
Those recruited by OBS became part of Mr. and Mrs. Dahl's network of Herbalife salespeople, and by 2009 the couple were ranked in the company's top 50 distributors, joining its "Chairman's Club." Ms. Stoltz and Ms. Thom also continued to be prominent Herbalife distributors.
Herbalife said that its "350-strong global distributor business practices and compliance team takes pro-active and responsive measures to identify, research, and address each and every infraction of Herbalife's distributor rules and applicable regulation and law."
Earlier this year, Herbalife took steps to distance itself from OBS by restricting distributors' use of leads and marketing materials provided by the company.
Following that change, Mr. Dahl moved to a rival direct seller. Herbalife has since banned the sale of leads to or by distributors entirely. OBS, Mr. and Mrs. Dahl, Ms. Stoltz and Ms. Thom did not respond to requests for comment.