A Federal District Court Judge in the Central District of California this week threw out a lawsuit against Herbalife, Ltd. (“Herbalife”), which alleged that Herbalife had violated federal securities laws by misrepresenting various aspects of its business operations. This is the second amended complaint that has been dismissed by the Judge in this action. We have previously advised readers about the dismissal of the first amended complaint, which focused on broadly-framed alleged misrepresentations concerning Herbalife’s status as a legitimate multi-level marketing company or, as the plaintiff alleged, an illegal pyramid scheme.

Why did the Court dismiss the second amended complaint against Herbalife?

The second amended complaint alleged specific misrepresentations regarding Herbalife’s business practices and operations made in corporate filings under federal securities laws which the plaintiff, a pension and retirement fund, alleged were made with the intention to deceive investors. Specifically, the plaintiff had alleged that Herbalife materially misrepresented its ability to track retail sales to out-of-network individuals, a requirement mandated by the terms of a permanent injunction issued against Herbalife 30 years ago. However, in order to make out a cause of action based upon a material misrepresentation, the plaintiff is required to plead scienter, or the intent to deceive, which the Court ultimately concluded that plaintiff did not sufficiently do. Accordingly, the Judge dismissed the second amended complaint, although he did state that the plaintiff could file another amended complaint if filed before August 27, 2015.

Importance of Ensuring That Multi-Level Marketing Programs Remain Distinct from Pyramid Schemes

We have previously written about the important distinctions between legitimate multi-level marketing programs and illegal pyramid schemes. Herbalife itself has admitted on prior occasions that it is more susceptible to legal challenges because its business practices may occupy the gray area between a legitimate multi-level marketing company and an illegal pyramid scheme. Herbalife’s battles in court, as well as the current regulatory climate, serve to reinforce the importance for multi-level marketing ventures to engage knowledgeable counsel to review program terms and conditions and related marketing to determine whether the subject programs comply with applicable law. However, with a relatively thin line separating legitimate multi-level marketing programs from illegal pyramid schemes, it is equally important to continually monitor the performance of the programs, because compliant written policies will not protect against lawsuits and regulatory action if program sponsors operate their businesses closer to that of pyramid schemes.