Pigs Get Fattened

William Ackman’s campaign against vitamin supplement company Herbalife came to a halt recently, following a years-long campaign to use a government apparatus meant for protecting consumers to bankrupt a stock he had bet against. While Ackman ended up losing money in the end, his actions serve as a reminder of how the most well-intentioned agencies are often perverted by the cronyistic impulses of regulators and private citizens.

Ackman’s crusade against Herbalife began in May of 2012. A hedge fund manager, Ackman decided to “short” the stock of Herbalife around this time. Shorting a stock involves borrowing a stock, selling it to a third party, then buying it back later when the prices fall to return the shares to the original lender.

Ackman took his short position on Herbalife because he believed that the company was structured like a Ponzi scheme. Herbalife incentivizes a network of independent distributors to recruit new distributors by offering a commission on recruits’ sales, and Ackman alleged that actual retail sales were minimal. As a private citizen, Ackman was perfectly free to bet on the company collapsing under the weight of regulatory scrutiny.

Unfortunately, Ackman was not content to simply sit back and watch. Instead of letting the regulatory process take its course, Ackman attempted to put his thumb on the scale. His hedge fund management business first released a research report that attempted to prove Herbalife was not a legitimate business mere months after taking a short position on the company. Ackman eventually spent $50 million over the course of a couple years on a public relations campaign designed to turn public sentiment against Herbalife.

Questionable as the ethics of attempting to manipulate public opinion to sway regulators may be, his campaign failed to have the intended result. Ackman then turned to a different tactic, using his connections in Congress to try and convince legislators to shut down Herbalife. According to the New York Times, Ackman personally lobbied members of Congress and regulators to push for action against the nutritional supplement company. Meanwhile, Ackman lost billions on his short position as Herbalife stubbornly refused to go belly up.

None of this is to say that Herbalife was entirely innocent. Ackman was not without cause to believe that Herbalife’s business model was questionable, as the Federal Trade Commission (FTC) eventually reached a settlement with Herbalife that fined the company $200 million and required a third party to monitor its business practices. Even so, consumer protection provisions are generally not intended to be used by a hedge fund manager using his government connections to attempt to cover up a bad bet.

Ackman has since cut his losses and covered his short position on Herbalife. Meanwhile, Herbalife has seen its stock go back up due to its successful compliance with FTC restrictions put in place as part of the settlement. Since Ackman could have made money at several points over the time that he shorted Herbalife’s stock, some have seen this as an appropriate opportunity to quote a Wall Street saying: “Bulls make money, bears make money, pigs get slaughtered.”

This may be too optimistic. Ackman’s crusade against Herbalife ended in failure, but his lobbying managed to generate a chorus of high-profile condemnations of Herbalife. Senator Ed Markey, for example, petitioned the FTC to look into Herbalife’s business practices following a meeting between his staff and Ackman. Herbalife’s stock dropped 14 percent the day that Markey contacted the FTC. Ackman may have lost money, but his case exposes the power that wealthy and well-connected individuals can have over regulatory processes.

Regulators should be guided by the interest of consumers, not the financial interest of hedge fund managers. Wall Street may believe that pigs get slaughtered, but crony capitalism can enable the pigs to get fattened instead.

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