Tuesday, July 26, 2016

No. 172: Herbalife, the Federal Trade Commission, and a Wake-up Call for Primerica

Herbalife International of America, Inc. and its affiliates sell nutrition supplements and other products through a "multilevel marketing organization" of the type that is sometimes referred to as a "pyramid scheme." Herbalife's multilevel marketing organization is similar in many respects to the multilevel marketing organization that Primerica, Inc. uses to sell life insurance policies and other financial products. The Federal Trade Commission (FTC) recently completed a major investigation of Herbalife's multilevel marketing organization. I think the results of the investigation are a wake-up call for Primerica.

The FTC Complaint
On July 15, 2016, in federal court in Los Angeles, the FTC filed a "Complaint for Permanent Injunction and Other Equitable Relief" against Herbalife. The complaint alleges that Herbalife has been using deceptive acts and practices in violation of Section 5(a) of the FTC Act, which prohibits "unfair or deceptive acts or practices in or affecting commerce." (See FTC v. Herbalife, U.S. District Court, Central District of California, Case No. 2:16-cv-5217.)

The complaint has four counts: "unfair practices" (relating primarily to the compensation structure), "income misrepresentations" (primarily the advertising of substantial income opportunities), "false or unsubstantiated claims of income from retail sales," and "means and instrumentalities" (false and misleading representations). Here is the five-paragraph concluding section of the complaint:
145. In sum, Defendants' compensation structure incentivizes Distributors to purchase thousands of dollars of product to receive recruiting-based rewards and to recruit new participants who will do the same.
146. This results in the over-recruitment of participants and the oversupply of Defendants' products and exacerbates participants' difficulty in selling Herbalife products for a profit.
147. Participants in a business opportunity should have some reasonable prospect of earning profits from reselling products to consumers. However, most Herbalife participants earn little or no profit, or even lose money, from retailing Herbalife products.
148. In the absence of a viable retail-based opportunity, recruiting, rather than sales, is the natural focus of successful participants in Defendants' business opportunity.
149. Thus, participants' wholesale purchases from Herbalife are primarily a payment to participate in a business opportunity that rewards recruiting at the expense of retail sales.
The Proposed Settlement
Also on July 15 the FTC filed a "Stipulation to Entry of Order for Permanent Injunction and Monetary Judgment" containing a proposed settlement that is subject to court approval. It is common practice for an agency to file a complaint and a proposed settlement simultaneously.

The proposed settlement provides for numerous and significant changes in the operations of Herbalife. It also provides for Herbalife to pay a $200 million monetary penalty to the FTC.

The case was assigned to U.S. District Judge Christina A. Snyder, who was nominated in 1997 by President Bill Clinton and confirmed by the Senate that year. The FTC is represented by three of its attorneys in Washington, DC, one in Seattle, and one in Los Angeles. Herbalife is represented by two attorneys associated with Sidley Austin LLP.

On the same day the FTC issued a statement and a press release about the case. The press release is entitled "Herbalife Will Restructure Its Multilevel Marketing Operations and Pay $200 Million for Consumer Redress to Settle FTC Charges." The press release is subtitled "Company Must Tie Distributor Rewards to Verifiable Retail Product Sales and Stop Misleading Consumers about Potential Earnings." Also on the same day Herbalife filed with the Securities and Exchange Commission an 8-K (significant event) report. Major media outlets reported the settlement online the same day and in print the next day.

The Ackman/Icahn Struggle
Bill Ackman is a prominent short seller. He has long described Herbalife as a pyramid scheme that is headed for collapse. Carl Icahn is a prominent investor who has a large holding of Herbalife shares, and several of his associates are on Herbalife's board of directors.

For years Ackman and Icahn have been engaged in a public dispute about Herbalife. When the proposed settlement was announced, Icahn declared victory and Herbalife shares rose sharply. Those reactions probably stemmed from the fact that the FTC decided to enter into a proposed settlement rather than try to shut down the company.

I think the question of whether the proposed settlement is a victory for Herbalife and Icahn is yet to be determined. The settlement provides for complex and extensive revisions in Herbalife's business model. I think it is too early to tell whether Herbalife would be able to maintain its current level of profitability if the settlement is approved and if Herbalife makes the major revisions that are required in the settlement.

The Primerica Angle
Primerica, Inc., the successor to the A. L. Williams organization (ALW), sells life insurance policies and other financial products through a multilevel marketing organization that ALW developed in the late 1970s. Primerica's multilevel marketing organization resembles that of Herbalife in many respects and differs in some respects.

I think the biggest difference between Herbalife and Primerica is that the FTC has been barred by statute for more than three decades from doing anything about insurance companies. Indeed, the FTC is barred by statute from even investigating insurance companies without a formal request from a Congressional committee. Here is the current language of the statute:
The Commission may exercise such authority [to conduct studies and prepare reports relating to the business of insurance] only upon receiving a request which is agreed to by a majority of the members of the Committee on Commerce, Science, and Transportation of the Senate or the Committee on Energy and Commerce of the House of Representatives. The authority to conduct any such study shall expire at the end of the Congress during which the request for such study was made. [15 U.S. Code, Section 46—Additional powers of Commission.]
In addition, the Consumer Financial Protection Bureau, which was established by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, is barred from doing anything about insurance companies. See my post No. 137 dated January 4, 2016.

On the other hand, another section of the Dodd-Frank Act established the Financial Stability Oversight Council (FSOC). That section does not bar the FSOC from investigating insurance companies. Indeed, it provides for the FSOC to investigate "nonbank insurance companies." The FSOC has designated three major U.S. insurance organizations—American International Group, MetLife, and Prudential Financial—as "nonbank systemically important financial institutions." MetLife filed a lawsuit against the FSOC, a federal judge rescinded the designation, and the FSOC's appeal is ongoing. See my post No. 170 dated July 15, 2016.

Thus it appears that state insurance regulators are the only source of protection for insurance consumers against potential wrongdoing through multilevel marketing organizations in the insurance business. It remains to be seen whether the recent developments involving the FTC and Herbalife will have any influence on state insurance regulators. As far as the past is concerned, with a few minor exceptions, I am not aware of state insurance regulators showing significant concern about the potential anti-consumer aspects of the multilevel marketing organization that Primerica and its predecessor have used for many years.

Available Material
I am offering a complimentary 77-page PDF consisting of the 42-page FTC complaint against Herbalife, the 31-page settlement between the FTC and Herbalife, the three-page FTC press release about the case, and the one-page FTC statement about the case. Email jmbelth@gmail.com and ask for the FTC/Herbalife July 2016 package.


Monday, July 11, 2016

No. 171: Cost-of-Insurance Increases—Additional Secret Information from AXA Equitable Life Becomes Public

In No. 143 (February 15, 2016) and No. 169 (June 28, 2016), I discussed a cost-of-insurance (COI) class action lawsuit that Brach Family Foundation filed against AXA Equitable Life Insurance Company on February 1, 2016. The complaint alleged breach of contract when AXA singled out certain policyholders for substantial COI increases. The case was assigned to U.S. District Judge Jesse M. Furman. (See Brach Family Foundation v. AXA Equitable Life, U.S. District Court, Southern District of New York, Case No. 1:16-cv-740.)

The Amended Complaint
On May 2, as described in No. 169, a Brach attorney filed an amended complaint with secret information redacted (blacked out). On May 16, as mentioned, Judge Furman ordered the Brach attorney to refile the amended complaint without the redactions. In this follow-up I discuss additional secret information from AXA that has become public.

Opposition to the Motion to Dismiss
On May 27, as indicated in No. 169, an AXA attorney filed a motion to dismiss the amended complaint, together with supporting documents. On June 23, a Brach attorney filed an opposition to the motion to dismiss consisting of a memorandum of law and a declaration by the attorney. Both documents contained redactions. As he did earlier with the amended complaint, the Brach attorney asked Judge Furman for permission to file the documents under seal. The judge allowed the documents to be filed under seal temporarily and said this (citations omitted):
If Defendant believes that the unredacted memorandum, declaration, and exhibits should remain under seal, it shall file a letter no later than June 29, 2016, explaining why the redactions are consistent with the presumption in favor of public access to judicial documents. The Court notes again that "the mere fact that information is subject to a confidentiality agreement between litigants is not a valid basis to overcome the presumption in favor of public access to judicial documents." If Defendant does not file a letter by June 29, 2016, Plaintiff shall file the unredacted memorandum, declaration, and exhibits by June 30, 2016.
On June 30, after obtaining a one-day extension, an AXA attorney submitted a letter to Judge Furman saying: "Defendant does not request continued sealing of the unredacted documents...." On July 1, in view of the AXA attorney's letter, the judge ordered Brach to file the unredacted documents in the public court file. The Brach attorney did so that day.

The Memorandum of Law
The redactions in the memorandum of law were in one paragraph near the end of the 31-page document. Here is that paragraph, in which I show the redactions in boldface type, with italics that are in the original, with brackets that are my insertions, and with some citations omitted:
In the alternative, if for any reason the Court were to adopt AXA's proposed construction (which it should not), pursuant to FRCP 15, leave to amend should be granted. On May 13, 2016, after Plaintiff filed its [amended complaint], AXA produced a document it submitted to the NYDFS [New York Department of Financial Services] entitled "NGE Policy and Implementation Process" which provides that "The following documents AXA's policy on assessing the need for actions with respect to Non-Guaranteed Elements (NGE) for [life insurance] policies and the implementation process for such actions." The COI rate is one such NGE. This document is therefore also part of the "procedures and standards on file" with an insurance regulator that AXA's COI increase violated, even under AXA's proposed construction of that term. AXA's procedures and standards state "[w]e will not make any NGE actions to recoup past losses" and then lists certain documents by which it is clear that "recoup past losses" means that AXA's profit objective must be fixed at issuance and cannot be changed during the lifetime of the product. See NGE Policy [on page] 2 ("we will not make any changes to NGEs for any policies based upon changes in profit objectives"). The [amended complaint] already alleges that AXA has used the [COI] increase to increase its profit objectives on some policies, see, e.g., [amended complaint] ¶¶ 50-52, 74-76, and to the extent those allegations do not already suffice for Rule 8 purposes, leave to amend should be granted so that specific reference to this AXA procedure and standard document just produced by AXA, and breach thereof, should be granted.
The Declaration
The redactions in the declaration as originally filed by the Brach attorney were in four of the six paragraphs of the four-page text of the declaration. Exhibits A and B, which are attached to the declaration, originally were redacted in their entirety.

General Observations
AXA probably decided to allow public court filing of the additional secret material discussed here in order to avoid another defeat on the issue. In other words, AXA probably concluded that Judge Furman likely would order the public court filing of the unredacted material irrespective of what AXA might have said in an effort to keep the material secret.

The latest released material is extremely interesting, especially Exhibit A to the Brach attorney's declaration. The exhibit describes in detail "AXA's policy on assessing the need for actions with respect to Non-Guaranteed Elements [NGE] for [life insurance] policies and the implementation process for such actions." Each page of the exhibit is marked "Trade Secret" and "Highly Confidential." It is significant that such a document is now in the public court file.

Available Material
I am offering a complimentary 53-page PDF consisting of the two pages of the memorandum of law containing redactions, the 31-page unredacted memorandum of law, the two pages of the text of the declaration containing redactions, the four-page unredacted text of the declaration, the 11-page unredacted Exhibit A to the declaration, and the three-page unredacted Exhibit B to the declaration. Email jmbelth@gmail.com and ask for the July 2016 Brach/AXA package.


Tuesday, July 5, 2016

No. 170: MetLife and the Financial Stability Oversight Council—The Dispute over the Company's Designation as a Nonbank Systemically Important Financial Institution

On December 18, 2014, the Financial Stability Oversight Council (FSOC) designated MetLife, Inc. a nonbank systemically important financial institution (SIFI). FSOC, a unit of the U.S. Department of the Treasury, was created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The MetLife Lawsuit
On January 13, 2015, MetLife filed a lawsuit against FSOC challenging the designation of the company as a nonbank SIFI. The case was assigned to U.S. District Judge Rosemary M. Collyer. (President George W. Bush nominated her in August 2002, the Senate confirmed her in November 2002, and she assumed senior status in May 2016.)

On March 30, 2016, Judge Collyer ruled that FSOC's nonbank SIFI designation of MetLife was "arbitrary and capricious," and she rescinded the designation. The ruling raised questions about FSOC's ability to carry out its duties under the Dodd-Frank Act. (See MetLife v. FSOC, U.S. District Court for the District of Columbia, Case No. 1:15-cv-45.)

The Appellate Case
On June 16 FSOC appealed the ruling by filing an appellate brief. MetLife's reply brief is due August 15, and FSOC's answer to the reply brief is due September 9. The makeup of the panel that will hear the appeal is not yet known. (See MetLife v. FSOC, U.S. Court of Appeals for the District of Columbia Circuit, Case No. 16-5086.)

The Amicus Briefs
In the district court, several amicus briefs were filed on behalf of the parties. Among those filing amicus briefs on behalf of MetLife were the National Association of Insurance Commissioners (NAIC), the American Council of Life Insurers, and the U.S. Chamber of Commerce. Among those filing amicus briefs on behalf of FSOC were a group of professors of economics, a group of professors of administrative law, and a group of professors who specialize in insurance and financial regulation.

In the appellate court, among those filing amicus briefs on behalf of FSOC were Ben S. Bernanke and Paul A. Volcker, a group of professors of administrative law, and a group of professors who specialize in insurance and financial regulation. I am not aware of any amicus briefs filed in the appellate court on behalf of MetLife.

The NAIC Amicus Brief
On September 28, 2015, the NAIC filed its amicus brief in the district court on behalf of MetLife. Here are the NAIC's three arguments:
A. FSOC failed to adequately consider the full range of regulatory tools available to state regulators at the individual entity and group level.
B. FSOC failed to assess the risk of asset liquidation against existing regulatory authority to actively prevent a "run on the bank" scenario, including early warning through risk-based capital requirements and stays on surrender activity.
C. FSOC failed to assess the risk of MetLife's ultimate failure against the deliberate, incremental process that applies to troubled companies supervised by state insurance commissioners.
In its conclusion, the NAIC said that "FSOC acted in an arbitrary and capricious manner." The NAIC also said that FSOC "misunderstood, misconstrued, and dismissed the state regulatory system."

The Bernanke/Volcker Amicus Brief
Bernanke is Distinguished Fellow in Residence with the Economic Studies Program at the Brookings Institution. Prior to his government service, Bernanke held academic positions at Princeton University, Stanford Graduate School of Business, Massachusetts Institute of Technology, and New York University. He served as a member of the Federal Reserve Board of Governors from 2002 to 2005, Chairman of the Council of Economic Advisors in 2005, and Chairman of the Federal Reserve Board of Governors from 2006 to 2014. He is a renowned expert on the Great Depression. He played a key role in dealing with the 2007-2009 financial crisis, and described the experience in The Courage to Act, A Memoir of a Crisis and Its Aftermath (2015).

Volcker is Chairman of Volcker Alliance, Inc., a nonprofit charitable corporation launched in 2012. Its mission is to address the challenge of effective execution of public policies and to rebuild public trust in government. He served as Undersecretary of the Treasury from 1969 to 1974, President of the Federal Reserve Bank of New York from 1975 to 1979, Chairman of the Federal Reserve Board of Governors from 1979 to 1987, and Chairman of the President's Economic Recovery Advisory Board from 2009 to 2011.

On June 23, 2016, Bernanke and Volcker filed their amicus brief in the appellate court on behalf of FSOC. They laid out the situation succinctly in this paragraph:
The District Court's decision rests on three grounds. First, the court held that FSOC was required to assess the likelihood of MetLife's distress before determining whether its distress could threaten financial stability. Second, the court held that FSOC was obligated to project estimated losses of counterparties and other market participants in the event of MetLife's distress. Third, the court held that FSOC was required to conduct a cost-benefit analysis, taking into account the costs of enhanced prudential standards on MetLife. Strikingly, not a single one of these purported requirements is enshrined in the Dodd-Frank Act, or anywhere else in statute; each is inconsistent with FSOC's interpretations of its own rules and guidance; and each defies the compelling logic behind the designation process contemplated by Congress when it established FSOC.
Bernanke and Volcker then discuss each of those three points in some detail. Here is their conclusion:
Amici respectfully submit the foregoing analysis and argument for the consideration of the Court. To accept the limitation on its authority inherent in the District Court rescission decision would in practice undermine both the letter of the relevant authorizing documents and the intent of the designation process embodied in the law.
General Observations
If the appellate court affirms the district court ruling, it would be frightening to contemplate the future of our financial system. I think it is imperative that the appellate court reverse the district court ruling.

Available Material
I am offering a complimentary 46-page PDF consisting of the 19-page Bernanke/Volcker amicus brief filed in the appellate court on behalf of FSOC, and the 27-page NAIC amicus brief filed in the district court on behalf of MetLife. Email jmbelth@gmail.com and ask for the July 2016 package relating to the MetLife/FSOC case.