Herbalife reaches settlement in suit by distributors.

Herbalife International Inc. and a group of its top-earning distributors have reached an agreement for settling a class-action lawsuit that accused the company and the distributors of essentially running a pyramid scheme.

The proposed class action settlement, which U.S. District Court Judge S. James Otero will review this week for preliminary approval, requires the defendants to pay $6 million to compensate about 8,700 former and current distributors who either bought specific promotional materials or lost money selling Herbalife's dietary supplement products.

None of the defendants are admitting guilt as part of the settlement. Nevertheless, the case is the latest successful legal action against the Los Angeles company that has been dogged for years by charges that its multilevel marketing business model is little more than a pyramid scheme.

"There is a big problem within the whole industry," said Dr. Stephen Barrett, a consumer advocate who has written about multilevel marketing. "Most people enter it with the hope they are making an investment that will lead to considerable income. The fact is the vast majority of people who join as distributors don't."

Supplements, diet aids

Attorneys for Herbalife, the distributors and the plaintiffs all declined comment on the settlement, which was filed May 21 in U.S. District Court in Los Angeles.

Herbalife, based in Century City, sells a broad array of nutritional supplements, diet aids and other products through a network of independent distributors who buy the products from the company and then resell them.

The company, which was taken private in 2002 but still files quarterly reports with the Securities and Exchange Commission because of its public debt, reported net income of $17.3 million for the first quarter ended March 31, compared with $18.6 million for the like period a year earlier. Sales were $278.1 million, up from $240.4 million a year ago.

In order for a multilevel marketing model not to be considered a pyramid scheme, the majority of the sales are ultimately supposed to be made to retail users. However, top Herbalife distributors make the most money by getting a share of sales made by lower-level distributors.

The lawsuit, filed Feb. 19, 2002 in Los Angeles federal court by two lower-level distributors, accused Herbalife and a group of high-level distributors, including those whose sales qualified them for membership in the company's top "President's Team," of violating federal and state laws designed to prevent pyramid schemes. It specifically targeted a period during the 1990s when Herbalife's domestic sales accelerated after having been stalled for years.

The lawsuit alleged the growth came as a result of a marketing scheme encouraged by the company and employed by the distributors called "The Newest Way to Wealth," which used the Internet, automated calling and other tools to attract distributors. Ultimately, they alleged, it operated as a pyramid scheme because it failed to result in enough retail sales.

The suit also alleged that top-level distributors made more money selling independent promotional materials, which were supposed to help the lower-level distributors drive sales, than on the actual sales of Herbalife products.

Settlement terms

The proposed settlement is open to current and former distributors who bought Newest Way to Wealth marketing materials between Feb. 1998 and May 2, 2003. They also must have reached the "supervisor" level, which Herbalife defines as distributors who buy at least $4,000 in products in one month or $2,500 in two consecutive months.

Former distributors will be able to seek claims from a $1 million fund to receive compensation for any marketing materials they bought. They can also seek compensation for total losses they may have suffered from a $3 million settlement fund.

Distributors still with the company will not get refunds, but Herbalife has agreed to discount its products to them by 10 percent for one year up to an aggregate maximum of $2 million.

The settlement also would require independent distributors to inform lower-level distributors that they aren't required to purchase promotional materials and to offer refunds.

There are an estimated 6,400 former and 2,300 current supervisors who will qualify for the settlement. If the total claims exceed the funds available, the settlement calls for all claims to be reduced on a pro rata basis.

Assuming the initial approval is granted this week, final approval of the settlement would take about two additional months.

The company was most famously hit with a permanent injunction by the California attorney general in the 1980s, which required Herbalife and its distributors to follow various guidelines in how it operated its multilevel marketing distribution model.

While Herbalife has declined to comment on the lawsuit, in an interview last November its new chief executive, Michael Johnson, acknowledged the company's marketing practices may have strayed in the past but said the company was committed to fixing them. Johnson was installed by' an investor group that bought the company in 2002 following the death of its charismatic founder, Mark Hughes, in May 2000.