Nu Skin Under Investigation In China For Pyramid-Scheme Allegations

Chinese officials are investigating allegations that Nu Skin has perpetrated “illegal multi-level marketing activities” in the country. Nu Skin is conducting its own review, having already identified policy infractions among its sales representatives during the firm’s recent period of rapid growth in China, and is putting its recruitment efforts on hold to cooperate with regulatory authorities and improve its training programs.

Nu Skin Enterprises, Inc. is suspending business promotional meetings in China and applications for new sales representatives to beef up its training and education programs, following media reports that have launched a state investigation into allegations of an illegal pyramid scheme.

The Provo, Utah-based direct-selling firm’s own initial “self-examination” has uncovered problems, Nu Skin acknowledged in a Jan. 21 letter to customers filed with the U.S. Securities and Exchange Commission.

“We were disappointed to learn that during our recent rapid growth, there were instances where some of our sales people failed to adequately follow and enforce our policies and regulations. We sincerely apologize for these unfortunate and unauthorized activities,” the company states.

It cites some of its existing policies, which prohibit inaccurate attribution of endorsements to public figures or media reports, exaggerated product claims and “improper descriptions of Nu Skin's distinct business model in China that confuse it with Nu Skin's business model in other markets.”

According to the filing, Nu Skin has initiated its own internal review with a view toward implementing corrective actions.

Questions about the firm’s business operations in China arose Jan. 15 when The People’s Daily – the official newspaper of the Communist Party of China – reported that the anti-aging skin-care and nutritional products firm “is suspected of conducting illegal multi-level marketing activities in the country.”

According to the state-run news outlet, Nu Skin has been “exaggerating its influence and creditworthiness in company brochures by passing advertisements for news reports and organizing ‘brainwashing’ gatherings.”

Nu Skin responded to the article and ensuing media blitz with a pair of releases. In a Jan. 15 statement, the firm defended its business model, claiming that the People’s Daily piece contained “inaccuracies and exaggerations” and that no attempt was made to verify information with the company.

The firm noted that it has been doing business in China for 11 years, “dedicated to operating in full compliance with applicable regulations,” and that its operations are monitored regularly by the Chinese government.

According to the release, Nu Skin holds licenses to conduct direct selling in 19 of China’s 32 provinces.

Furthermore, the firm said, “we actively educate our sales force to follow all regulations as well as company policies and procedures, and any member of our sales force not operating in accordance with local law or with our company policies is subject to discipline.”

In a next-day release, the company confirmed that Chinese officials have launched an investigation into the allegations.

Nu Skin, in turn, is undertaking “our own province-by-province business review” and taking measures to strengthen its training and education programs following “substantial growth in our China sales force” over the past year.

Meanwhile, the firm continues to communicate openly with regulators and welcomes any relevant guidance from them, according to the statement.

Nu Skin expects the probe to negatively impact its revenue in China, but remains focused on ensuring long-term, sustainable growth in the market. The firm’s stock has plummeted following the People’s Daily report and Nu Skin’s announcements, from $136.47 Jan. 14 to $70.81 at market close Jan. 16.

Herbalife Ltd., which has been similarly pressed to defend and provide visibility into its direct-selling business model, also saw a drop in its stock following news of the Nu Skin investigation, from $80.79 Jan. 14 to $71.65 at close of business Jan. 16 (Also see "Herbalife Works To Rewrite Pyramid-Scheme Narrative, Improve Transparency" - HBW Insight, 15 Jul, 2013.).

China Crackdown Forewarned

In August 2012, Citron Research – led by activist short seller Andrew Left – published a blog post titled “The Two Faces of Nu Skin,” asserting that the firm operates in China in “gross violation” of the country’s laws. In addition to Nu Skin’s MLM platform, Citron called into question the company’s “pseudo-scientific claims” and the safety of its ageLOC Galvanic Spa offerings (Also see "Nu Skin Unfazed By Allegations Of China Violations, Projects More Growth" - HBW Insight, 27 Aug, 2012.).

The financial commentary provider warned investors that Nu Skin’s activities in China were in danger of “coming to an abrupt halt,” with “devastating consequences” for a company whose revenue stream relies heavily on business in the country.

Analysts estimated in November 2013 that sales of Nu Skin products in China accounted for roughly 80% of the firm’s growth over the past year and roughly 50% of its overall sales in the third quarter of fiscal 2013.

The same month, the company issued guidance for fiscal 2014, projecting revenue growth of 22% to 25% to approximately $3.9 billion to $4 billion for the year (Also see "Nu Skin Projects 22%-25% Growth In FY 2014 On Weight Management" - HBW Insight, 25 Nov, 2013.). In its Jan. 16 release, Nu Skin said it was too early to gauge the extent to which those estimates could be affected by recent regulatory developments.

At the Canaccord Genuity’s Global Growth Conference in 2012, Nu Skin CFO Ritch Wood addressed concerns raised by Citron in a presentation emphasizing transparency into the company’s operations and the evolution of the direct-selling market in China.

While China implemented a ban on direct selling in the late 1990s, prohibitions on the practice were lifted in 2005. At that time, the Chinese government instituted regulations and a licensing system to govern direct-selling enterprises – including “compensation restrictions on how you can compensate your sales people,” according to Wood.

Nu Skin spent the next two years adapting to the new rules, the exec said.

He identified [Amway Corp.] and [Avon Products Inc.]as two direct-selling firms that operate in China “with a very similar methodology” to that employed by Nu Skin.

Since the new regulatory framework was put in place, Nu Skin’s business has taken off in China, Wood noted.

The firm is scheduled to release fiscal 2013 fourth-quarter and year-end results Feb. 6.