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The SEC's Back and Forth With Herbalife

Some interesting reading popped up on the SEC’s website in recent days: A series of exchanges between the regulator and Herbalife.

John Block | Botanica | Getty Images

These kinds of exchanges, often routine and painfully mundane in nature, are tagged on the SEC’s website.

However it seems to me that in the case of Herbalife, some of the back-and-forth regarding the company’s 10-K appears to be anything but routine.

You can read them in their entirety here, here, here, here and here.

Adding to the intrigue: It appears regulators are pursuing some of the same line of questioning posed several months ago in an earnings conference call by hedge fund manager David Einhorn, whose name is not mentioned (though Herbalife, in one of its responses, refers to “the person asking the question.”)

More to the point, the agency wanted to know why Herbalife had stopped disclosing certain details of sales to distributors—and why the company doesn't give disclosure on something known as the “70 percent rule,” which gets to the controversial issue of how much of Herbalife's sales are to end customers. Critics believe that is a critical part of the Herbalife story.

Under the “70 percent rule,” distributors must prove that 70 percent of their purchases from Herbalife every month have been sold “or consumed.” In multi-level marketing circles, the rule is considered a critical component of proof that a company is not a pyramid scheme. Herbalife has always maintained it isn't such a scheme, as noted on its website.

The company maintained in a response to the commission that, because of other practices aimed at getting distributors to move their Herbalife stock, the 70 percent rule was superfluous.

The SEC wasn't satisfied, firing back “your response does not clarify why the 70 percent rule should not be considered a part of your core business model.”

The company reiterated in yet another response that it simply doesn’t believe the rule is relevant.

And that was pretty much it, with the SEC sending a formal “we have completed your review” letter.

Herbalife told me today that the “documents speak for themselves and the matter has been closed. There is no SEC investigation.”

My take: It’s unknown whether regulators will dig deeper. Could be this will pass. But this much is clear: With the SEC asking the same questions as Einhorn, and even a few more, investors probably should be, too.

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