GO
Loading...

Herbalife safety issue draws scrutiny

Herbalife Formula 1 Nutritional Shake Mix
Source: Herbalife
Herbalife Formula 1 Nutritional Shake Mix

When Herbalife, the nutritional supplement company, first ramped up production of its best-selling drink mix at a plant in California, anxious executives were forced to scramble in early 2011 as they faced a potentially serious product safety threat.

The company detected fine shards of metal in its Formula 1 nutrition shake as it was coming off the production line. Over five weeks, the company fixed that problem and a second bout of metal contamination, it says, and there is no evidence that any contaminated product was shipped from the factory. Herbalife insists that none ever reached consumers, who often mix the powder with milk in a blender.

Still, after the factory was back up and running, questions lingered about compliance with overall regulations and industry standards at the plant.

"I get a very sick feeling in my stomach," Gary Swanson, the senior vice president for global quality, said in a private conversation in February 2011, a week after production resumed, according to documents reviewed by The New York Times.

Referring to the rules of the dietary supplement industry for good manufacturing practices, which is enforced by the Food and Drug Administration, he added: "Quite honestly, if this place has a G.M.P. audit by the F.D.A. in the next month, they're" in trouble, he said, using a vulgarity. "I don't know how else to put it."

The events surrounding those problems — and how Herbalife responded to them — are now drawing scrutiny. The reason has to do in part with an intense, and intensifying, battle that is unfolding on Wall Street.

More from the NY Times:
Ackman's other investing misses
Ackman and Penney directors part ways
US subpoenas Goldman in inquiry of aluminum warehouses

Herbalife has been at the heart of a brawl between billionaire investors. William A. Ackman, manager of the hedge fund Pershing Square Capital Management, has made a $1 billion bet that the stock will drop, calling the business a pyramid scheme, an assertion that Herbalife has vigorously denied. Mr. Ackman has suffered about $400 million in losses as other big investors, including Carl C. Icahn and George Soros's fund, have been piling into the stock, fueling its ascent.

Mr. Ackman, as part of his campaign against Herbalife, has been holding meetings with the New York State attorney general's office and the Securities and Exchange Commission in hopes of persuading them to pursue an action against the company.

Now the attorney general has subpoenaed a former employee of Herbalife to produce internal documents about the potential safety problem, according to a person briefed on the matter who spoke on the condition of anonymity because the inquiry has not been publicly disclosed.

The documents include internal e-mails, slide presentations and operations reports, according to the person briefed on the matter. The former employee, who was granted anonymity out of fear of retribution from the company, obtained the documents before leaving Herbalife in 2011, according to another person briefed on the matter.

(Read more: Ackman goes to SEC in latest chapter of Herbalife saga)

The former employee, who is seeking whistle-blower status from the S.E.C., approached the F.D.A. first late last year before turning to Mr. Ackman, who offered to pay his legal fees.

Amid the various competing interests, the documents offer a rare window into a company's actions as it faced a potential threat to a top-selling product.

When worries were first were raised about the metal contamination, Herbalife sought to fix the problem, the documents say. But much of the product made on the line that was suspect was not destroyed, the documents illustrate, which is the preferred practice recommended by some product safety experts. Instead, the company quarantined the product and sought to salvage the powder by running it through additional inspections to make sure it did not contain any metal shards. The company said that only the product that passed the inspection was released for sale.

"If you have reason to believe the product is contaminated, the correct thing to do is destroy the product," said Bill Marler, a food safety lawyer who has brought a number of prominent food-related lawsuits. "I've been involved in a lot of manufacturing cases, but this doesn't make any sense to me."

However, "there's not a requirement to destroy" potentially contaminated product, said Christopher S. D'Angelo, chairman of the product liability group at the law firm of Montgomery McCracken Walker & Rhoads. "If the product meets specs and standards, there's no reason why it can't be sold."

A spokeswoman for the F.D.A. said that, in general, a company would not need to contact the agency if the company was confident it had quarantined its contaminated products. The F.D.A. declined to comment on Herbalife specifically.

At the core of Herbalife's success is the notion that its products are safe and healthy. In its 2012 annual report, the company said its products led to "life-changing results."

The metal contamination issue, concerning the cookies and cream flavor of Formula 1 made at the plant in Lake Forest, Calif., came into focus in early 2011.

(Read more: Herbalife stock spikes as Soros said to be betting big)

"We have a serious problem with metal contamination that we discovered over the weekend," Joseph Plunkett, the company's senior vice president for worldwide manufacturing and engineering, said in a private meeting on Jan. 10 that included Richard P. Goudis, the company's chief operating officer, according to the documents reviewed by The Times.

A stainless steel screen in the production line was apparently defective, throwing off small wires that were used to hold the mesh onto its frame, Mr. Plunkett said. Though a magnet was supposed to catch any shards of metal in the product, the stainless steel of the screens was "not magnetic," Mr. Plunkett said on Jan. 10.

"Production was stopped temporarily and an investigation was conducted," according to a statement provided by Herbalife summarizing the events.

In addition to replacing the screen, the company quarantined much of the contaminated powder. The powder that had already been packaged—a "small" amount—was disposed of, according to a person briefed on the matter. But even with the inspection plan in place, doubts lingered. "Maybe, in hindsight, we would have shut it down a little sooner," one senior executive said in the Jan. 10 conversation.

Herbalife also moved to obtain X-ray equipment to inspect the potentially contaminated bottles, the documents show. In a Jan. 18 conversation, Mr. Plunkett said the inspection with the X-ray machine would start the following week and would likely take three weeks to complete. The company ultimately decided against using an X-ray machine because of concerns that the cookie crumbs in the formula would be difficult to distinguish from metal shards.

Before long, production on that line was restarted.

"We are getting up near 100 bottles a minute," Mr. Plunkett said on Jan. 24, to which Mr. Goudis said, "Wow," according to the documents.

But another concern soon arose: the monorail system for the "super sacks" that contained the raw ingredients had been shedding, with pieces of metal falling into the product, according to a person briefed on the matter.

The solution involved putting a pan beneath the equipment to catch the falling shards, this person said.

Production was halted on Jan. 25 to address this second issue, according to an internal operations report. As part of the investigation, the EAS Consulting Group, a consulting and auditing firm for the dietary supplements industry, was retained to advise on the cleanup, Herbalife said in the statement.

The inspection process involved opening sealed bottles and running them through a metal detector to "confirm the absence of metal contamination," Herbalife said. The bottles and the bulk powder that made it through the process were cleared for release.

The production line was restarted on Feb. 16.

Herbalife said in a statement that the factory "operates at the highest quality and sanitary standards and its operating procedures are designed to comply with or exceed the appropriate current good manufacturing practices for foods and dietary supplements."

By The New York Times

Contact Hedge Funds

  • CNBC NEWSLETTERS

    Get the best of CNBC in your inbox

    To learn more about how we use your information,
    please read our Privacy Policy.
    › Learn More

NetNet