Herbalife Nutrition Sheds $123 Million to Resolve FCPA Problems in China

Herbalife Nutrition Sheds $123
Million to Resolve FCPA
Problems in China
By Lori Tripoli, Anti-Corruption Report

Nutrition and weight management company Herbalife Nutrition Ltd.
has settled FCPA charges with the SEC and the DOJ. In the August 28,
2020, settlement, the company agreed to pay more than $123 million
in total to resolve problems at subsidiaries in China. The company is
paying more than $67 million to resolve SEC charges that the
company violated the books and records and internal accounting
controls provisions of the FCPA. On the same day the SEC publicized
its deal, the DOJ announced that Herbalife had entered into a
deferred prosecution agreement pursuant to which the company will
pay a $55.7-million fine to resolve a charge of one count of conspiracy
to violate the books and records provision of the FCPA. Last year, the
DOJ indicted two former executives of the Chinese subsidiary of
Herbalife, and one also faces SEC charges of FCPA violations.
“Herbalife approved the extensive and systematic corrupt payments
to Chinese government officials over a 10-year period to promote and
expand Herbalife’s business in China,” said Acting U.S. Attorney
Audrey Strauss of the Southern District of New York at the time the
DPA was announced. The company’s “inadequate internal accounting
controls allowed an environment of corruption to exist in its Chinese
subsidiaries for more than a decade,” said Sanjah Wadhwa, Senior
Associate Director of the SEC’s New York Regional Office in a press
release.
The settlement is “indicative of the government’s continuing focus on
combatting bribery abroad and is only one of many recent noteworthy
enforcement resolutions targeting the operations of multinationals in
China,” observed Geoffrey Atkins, a partner at Ropes & Gray in Hong
Kong, suggesting that other multinationals doing business in China
take note.
See “DOJ Charges Former Executives of Herbalife Subsidiary in China
with FCPA Violations” (Jan. 8, 2020).

Evaluating the Result

Despite these enforcement actions, Herbalife seems to be having a
good year. “Health is the new top global consumer priority,” Herbalife
Chairman and CEO John Agwunobi noted in a second quarter earnings
call in August where he announced “record-breaking quarterly net
sales” of $1.3 billion. China is one of the organization’s top countries
where “volume points grew 18 percent compared to the second
quarter of 2019,” Agwunobi said.

Small Fines Compared to Profits From Direct
Selling
If Herbalife’s “gains from direct sales pursuant to any improperly
obtained direct-sale licenses exceeded $46,452,577 (the amount the
DOJ calculated as the pecuniary gain) or $58,669,993 (the pre-interest
gain amount the SEC demanded as disgorgement) Herbalife arguably
received a good deal” in this settlement, observed Warren Allen, a
partner at WTAII. Details in the settlement papers as well as
“allegations in earlier filings against a managing director and former
head of external affairs for an Herbalife subsidiary in China suggest
the government had strong evidence that bribes were paid to obtain
and retain business in China,” he continued. “Given the apparently
strong position on liability, I would guess that much of the settlement
negotiation involved efforts to agree on gain amounts for purposes of
establishing the fine range and disgorgement requirements,” Allen
added.
Companies engaged in direct selling (selling an organization’s
products via independent sales representatives) in China must obtain
a license from national authorities as well as local authorities in each
province in which direct sales will take place. Between 2007 and 2016,
Herbalife China obtained licenses to engage in direct sales in 28
provinces, according to the DPA.
“Although the allegations do provide a bit of detail about particular
efforts to obtain licenses to operate in a few particular provinces, the
government might have argued all revenue obtained pursuant to
direct sales licenses is tainted where the licenses were obtained based
on improper payments,” Allen explained. “The company, in turn, likely
argued that improper payments only tainted revenue streams for
particular licenses during particular periods,” he continued. “The
available government filings do not spell out with granularity the
exact bases for the DOJ and SEC’s gain and disgorgement calculations,
so the revenue generated from potentially tainted direct sales might
have been higher given that Herbalife China generated $860 million in
annual net sales in 2016 alone,” he noted.

No Guilty Pleas
Other elements of Herbalife’s settlement may also be viewed
favorably. “Unlike in the Avon resolution, which is a good case for
comparison, the Chinese subsidiary here did not have to plead guilty,”
said James Koukios, a partner at Morrison & Foerster, referring to
settlements entered into by Avon Products Inc. with the DOJ and the
SEC. The DOJ’s willingness to forego a guilty plea by Herbalife’s
Chinese subsidiary “might be because, unlike in Avon, DOJ criminally
charged the two executives who were most directly responsible for
the alleged FCPA violations,” he explained. Moreover, even though the
DOJ charged the former executives of the Chinese subsidiary of
Herbalife “with violating the FCPA’s anti-bribery and internal controls
provisions and alleged that the company made corrupt payments, it
ultimately brought only a books-and-records charge against the
parent company,” Koukios noted.
That decision by the DOJ just to pursue a books-and-records charge
“against the parent company is largely consistent with the Avon
resolution and the nature of the alleged misconduct (gifts, travel and
entertainment abuses rather than grand corruption), but it is still
notable given the anti-bribery charges brought against the Chinese
executives,” Koukios said.
See our two-part interview with Avon COO Richard Davies on the
company’s monitorship: “Making a Positive Experience” (Jan. 22, 2020)
and “The Start-Up Mentality” (Feb. 19, 2020).

Board Members Disregard Red Flags

The inappropriate behavior by various people at Herbalife and
Herbalife China seems to have been known within the company.
“Many of the issues described in the DPA and the SEC Order were
flagged to senior executives and directors through the company’s
internal audit procedures,” Atkins observed. For instance, “the SEC
Order describes an internal audit report which indicated that the
external affairs department submitted expenses covering meals for
more than 30,000 Chinese government officials and totaling
approximately $3.7 million USD over a 6-month period,” he noted.
The SEC Order describes a 2016 inquiry made by a member of
Herbalife’s board of directors about the high spending. Another board
member replied, “Please note I have questioned this every year I have
been on the board, and the company has defended its position that
these are reasonable within FCPA guidelines.” Herbalife’s senior vice
president for internal audit replied that internal audit reports on high
spending were within “tolerance.” “The director’s reaction to the

internal audit report is one of the most interesting aspects of the SEC
resolution,” said Koukios. Although “the director appears to have
appropriately identified an FCPA risk and appropriately followed up
with the audit committee and the head of internal audit,” the director
“may have been overly reliant on the internal audit head’s
characterization of the results as run-of-the-mill and expected,” he
continued. “A director facing such a situation may wish to follow up
with experienced counsel or accounting firms to put such concerns in
context, and may wish to raise the concern with the larger board,”
Koukios suggested.
Of course, board members’ obligations extend far beyond just the
FCPA. “Public companies’ audit committee members in particular have
enhanced obligations under the Sarbanes-Oxley Act to make sure
their companies have a system in place to address complaints and to
oversee auditors’ activities,” Allen cautioned. Indeed, 15 U.S. Code § 78j
–1 specifies that audit committees are supposed to have the authority
to engage independent counsel and other advisers, as they determine
necessary to carry out their duties, he noted. As practical matter,
Allen explained, “audit committees usually coordinate with
management and other stakeholders when exercising their powers to
get outside guidance.”
Still, hindsight is 20/20. “The indictments of the two former Herbalife
China executives last fall detailed many measures taken by them at
that level to hide the scheme and prevent detection by the company,”
Wade Weems, a lawyer in the Shanghai office of Kobre & Kim, noted.
Interestingly, the FCPA just “requires that a system of internal
controls provide only ‘reasonable’ assurances that transactions are
accurate and accountable,” he said. “There is no requirement for
certainty or guarantees.”
See “Board Responsibility for Ethics and Compliance” (Jun. 15, 2016).

The Wisdom of Behaving Badly and Then
Cooperating

Although Herbalife did not voluntarily disclose to the U.S.
government, the company did cooperate. Ultimately, that cooperation
resulted in “a reduced penalty from both the DOJ (25 percent) and the
SEC – cooperation is cited as a mitigating factor in both the SEC and
DOJ announcements,” Weems noted. Without that cooperation, the
government’s FCPA investigation – first disclosed by Herbalife in 2017
– could have “taken even longer, could have been more contentious
and possibly more costly to the company in terms of both legal fees

and a larger penalty (without the benefit of cooperation credit),”
Weems said.
Cooperating can help narrow the investigation in some measure.
Cooperation helps “focus the government’s investigation on a specific
set of allegations rather than a scenario where the government
conducts a sprawling investigation on their own that can uncover new
allegations, involve other business units of the company, and
continuously expand in scope and duration,” Weems said.
“Generally, in the absence of bulletproof jurisdictional or other
defenses, companies may be better off cooperating with government
investigations into misconduct,” Allen suggested. When multiple
enforcement agencies are investigating an organization, “cooperation
can, in some cases, also help companies avoid the burden of
responding to duplicative requests and providing repetitious
disclosures,” he noted.
“If a company has real exposure, cooperating with the government
and implementing a robust compliance program might be the best
option for the company to minimize liability,” suggested Eric Nitz, a
partner at MoloLamken.
See also “Miner Discusses International Cooperation and Compliance
Expectations” (Jul. 10, 2019).

Will the Herbalife Experience Have a
Deterrent Effect?

Even though Herbalife sales seem to be rosy, a DPA “is like the Sword
of Damocles,” Allen said. The provisions in the deal “have teeth and
should affect the company’s conduct for the next three years,” he
pointed out. “To avoid the potentially severe consequences of a
breach, and to meet its reporting and compliance program
enhancement requirements, the company will likely spend significant
sums on attorneys, auditors and other professionals on top of the
amounts it already spent cooperating with the government’s
investigation since at least January 2017,” Allen noted.
Any deterrent effect may be muted, though. “The deterrence is
somewhat lessened here where the underlying payments to foreign
officials were meant to secure required direct selling licenses at the
national and provincial levels within China,” Weems said. “The
payments were not meant to directly secure procurement or
contracts or obtain business,” he noted.
“Though most certainly wrongful, these payments were meant to
overcome a market barrier imposed by a foreign government –

obtaining a required direct selling license prior to doing business at
                             the national or provincial levels,” Weems observed. “Where there are
                             trade barriers at the heart of the case, and the criminal conduct was
                             aimed at overcoming those in order to gain market access, it is my
                             view that enforcement actions like this will have limitations in terms
                             of deterrent effect,” he said.
                             In some measure, the problem at issue in this case is a systemic one.
                             “Another part of deterrence should be to work to reduce these kinds
                             of bureaucratic obstacles on a global scale as they are just as much a
                             part of the problem and create the incentive and the environment for
                             this kind of corrupt conduct to take root,” Weems suggested.
                             See “Revisiting the China Initiative: Will the Focus on FCPA
                             Prosecutions of Chinese Companies Produce Results?” (Jul. 10, 2019).

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