When the Wolves Bite

2

THE PITCH

William Ackman was sitting in his office at 888 Seventh Avenue, on Manhattan’s West Side, when the phone rang. It was early summer 2011, and a woman named Christine S. Richard was on the line, a hint of urgency in her voice.

“Bill, I think I found the next MBIA,” she said through the receiver, knowing the acronym would instantly pique Ackman’s interest.

MBIA was the bond insurance behemoth that had arguably put Ackman on the map. He’d battled with the company from 2002 to 2009, ultimately winning a $1.4 billion windfall, but not before a sprawling struggle in which he became the subject of investigations by both New York’s attorney general, Eliot Spitzer, and the Securities and Exchange Commission.¹

It was a long and drawn-out affair that had begun when Ackman, a relative newcomer on the hedge-fund scene at his fledgling firm, Gotham Partners, went short on MBIA stock, betting its shares would plummet if the then white-hot housing market weakened. In addition, he’d bought something called credit default swaps—insurance policies, in effect, that would pay off even further if the company went bankrupt, as Ackman expected. Ackman had accompanied his investment with a fifty-page missive titled “Is MBIA Triple A?” that took aim at the company’s pristine credit rating—in essence, its lifeblood.² Ackman systematically took the company apart, accusing MBIA of misrepresenting the value of its assets and listing several accounting shenanigans and other transgressions he claimed could lead to a liquidity event—the death knell for a business where confidence in the company’s credit means everything. MBIA chief executive officer Gary C. Dunton admitted as much about the firm’s prized triple A rating, once telling the New York Times reporter Joe Nocera that it was the most critical thing MBIA had. “Our triple A rating is a fundamental driver of our business model,” he had said.³

Simply put, MBIA would be toast without it, and Ackman knew it, which is why he also did something almost unheard of at the time for a short-seller—he released his scathing report over the internet in a public “fuck you” of sorts to the company. Ackman wanted people to read it—for the market and investors to doubt the firm’s solvency—and he didn’t stop there. Ackman went to the SEC and New York State insurance regulators, hoping they’d come to the same conclusions he did, slap the company around, and cause the stock price to plummet.

The effort, though intense, was mostly for naught, as month after month, then year after year, Ackman pressed his case, and MBIA managed to fight him off.

Finally, the tide began to turn in Ackman’s favor when the SEC and Mr. Spitzer began investigating MBIA’s accounting practices in 2004.⁴ One year later, the company would be forced to restate its earnings for an eight-year period, though the stock held up reasonably well during this process, which tested Ackman’s resolve.

The investment finally paid off in 2007, when the onset of the financial crisis crushed stocks like MBIA under the weight of the subprime housing bust. Lehman Brothers and Bear Stearns would eventually go belly-up, and many wondered if companies like MBIA were next.

Sure enough, MBIA shares did suffer. By December 2007, shares had fallen more than 56.3 percent, including more than 25 percent in a single day, as confidence in the sector quickly began to evaporate.⁵ It may have been a lucky break, but Ackman had finally received his bounty. He made more than $1.4 billion on MBIA and earned a reputation as one of Wall Street’s hot shots.

Richard hoped Ackman was ready for another go-around.

It wasn’t an easy sell. The more than half-decade war with MBIA had left its battle scars, or “brain damage,” as Ackman described it. He’d told those close to him, even some of his own investors who were clamoring for the next big hit, that he’d almost certainly never do such a public short campaign again. It was just too exhausting.

“I didn’t want to do another public short,” said Ackman. “It’s a huge strain on the organization, and you get a lot of this negative press, and everyone hates you. That’s really the answer.”

No one understood the ordeal more than Richard herself. She had documented the whole MBIA saga while an investigative reporter at Bloomberg News, exposing some of the company’s major issues. She later wrote a book about Ackman’s crusade, Confidence Game: How a Hedge Fund Manager Called Wall Street’s Bluff. It told of a relentless investor willing to go to great lengths to win, even if it meant waiting years to do so.

The MBIA story, and all of its gyrations, had taken its toll on Richard too. After taking a leave of absence to write the book about Ackman’s quest, she left Bloomberg altogether to take a job with the Indago Group, a small and somewhat secretive boutique research shop that counted some of New York’s top hedge-fund managers as clients, including Ackman.

Richard and the firm’s founder, Diane Schulman, a former TV producer and licensed private investigator, were paid top dollar for their exclusive investment ideas and had been given the catchy, if kitschy, nickname “The Indago Girls” by their mostly male clientele. Schulman had helped the investor Steven Eisman, famous for his role in Michael Lewis’s The Big Short, do some digging for his short bet against for-profit education stocks.⁶ Eisman had made a killing on the investment, giving Schulman and Indago some well-deserved street cred in the ego-heavy hedge-fund world.

Schulman had given Richard a list of companies to comb through—some Chinese internet firms and the like—but they were too opaque and obscure and hard to do good research on. However, there was another name on Schulman’s list that Richard vaguely recognized from some reporting a former colleague had done years earlier—the name she’d tell Ackman that day on the phone in the summer of 2011. It was Herbalife.

Herbalife was a publicly traded nutrition company that sold health shakes, teas, and vitamin supplements. When Richard gave him the name, Ackman paused for a moment, as if he’d never heard of the company before. Even if he had heard the name, he probably didn’t know its ticker symbol or exactly what it did. That would change, and soon.

Richard briefly ran through some of the research she’d already done on the company, telling Ackman how she thought it could be a pyramid scheme.

Now Ackman seemed intrigued.

Richard had spent hundreds of hours poring over pyramid-scheme cases, finding many troubling similarities to what she’d dug up on Herbalife. She didn’t have to look too hard either. Multilevel marketing (MLM) companies have been heavily scrutinized since the early 1970s, mostly for their controversial pay structures in which people are compensated for how much product they actually sell along with how many new folks they recruit into the business. Other short-sellers have given the industry a quick scan plenty of times throughout the years, believing the twisty businesses enrich only those who get in early, while the rest of the suckers who sign up late get screwed. Some have even been called pyramid schemes by the government, were later sued, and then were permanently shut down.

In one of the first such cases, a company called Koscot Interplanetary, which sold beauty services and cosmetics, was targeted by the Federal Trade Commission (FTC) and accused of being a fraud.⁷ Those who signed up were encouraged to spend $2,000 for essentially nothing more than a fancy title and the right to earn commissions. They were then prompted to spend another $5,400 to buy the actual cosmetics. Members who joined would earn bonuses on new recruits who came aboard, as long as they also made similar investments.⁸

But on November 18, 1975, Koscot was ordered by the FTC “to cease using its open-ended, multilevel marketing plan; engaging in illegal price fixing and price discrimination and imposing selling and purchasing restrictions on its distributors; and to cease making exaggerated earnings claims and other misrepresentations in an effort to recruit distributors.”

Other cases soon followed, providing Richard with a treasure trove of material. Even in recent years, there have been companies with some of the same eyebrow-raising characteristics. In June 2007, the Federal Trade Commission sued the MLM company BurnLounge, which operated online digital music stores. Following an investigation, the FTC concluded BurnLounge was a pyramid scheme since the majority of its members were compensated more for recruiting new members into the business than for actually selling services.⁹

In July 2007, a California court barred the company from operating and froze the assets of one of its promoters, pending a trial. More than fifty thousand people were said to have been affected in the scam, with more than 90 percent of them losing money.

The FTC shuttered several more MLMs, including the Global Information Network, Trek Alliance, and a company called Five Star that marketed leases of “dream vehicles” for free, as long as they paid an annual fee and recruited others into the opportunity. After a trial, the US District Court for the Southern District of New York determined Five Star was a pyramid scheme since people didn’t make anything near the money they were promised.

As for what had been found on Herbalife, “Send me something,” Ackman told Richard, who made an appointment to visit him face-to-face the next time she was in the city.

The day of the meeting, Manhattan was sweltering, the humidity barely budging even after a midday downpour, when Richard, still soaking wet from the storm, took the elevator up to the forty-second floor, and the offices of Pershing Square, Ackman’s firm.