BOSTON (Reuters) - Herbalife must defend itself in court against charges brought by a former distributor claiming that the nutrition and supplements company is running an alleged pyramid scheme, a U.S. federal judge has ruled.
Judge Beverly Reid O'Connell on Friday denied Herbalife's motion to dismiss the case brought in April by Dana Bostick, a California housing inspector who tried to earn extra income by selling Herbalife products. The ruling was made public on Tuesday.
"Plaintiff has adequately alleged, for purposes of a motion to dismiss, that distributors pay money for the right to sell Herbalife products," the judge wrote. She added that the plaintiff also adequately alleged that "supervisors pay money to receive recruitment rewards which are unrelated to the sale of products to ultimate users."
"This is a significant victory for our distributors as the court laid out a clear analysis of case law which will help in the prosecution of our case," said Philip Dracht, one of Bostick's lawyers.
Bostick is also seeking class action status, claiming that hundreds of thousands of other distributors have failed to make much money by trying to sell the products.
"While the court concluded that Bostick had adequately alleged a claim against Herbalife, it expressed no view of the merits of that claim," a Herbalife spokeswoman said.
She said the company has policies in place to discourage inventory loading and that "Herbalife will establish these facts for the court and seek dismissal of the complaint at the appropriate time."
The Bostick case is the first brought against the company since its business model caught the attention of Wall Street investors.
Billionaire investor Carl Icahn bet earlier this year that the share price will climb, while billionaire investor William Ackman unveiled a $1 billion short bet last year, believing that the share price will eventually drop.
The judge wrote that pyramid schemes are inherently fraudulent because they must eventually collapse. "Like chain letters, pyramid schemes may make money for those at the top of the chain or pyramid, but must end up disappointing those at the bottom who can find no recruits," the ruling said.
Bostick's lawyer, Philip Dracht, said Bostick spent thousands of dollars to purchase Herbalife products but failed to earn much money by selling them. "The retail profits are not there because of all this discounting," Dracht said.
He added that Bostick was urged by other Herbalife distributors to spend more money to buy leads that would help him earn more money but that he could not afford it.
The company's share price slipped 0.79 percent on Tuesday but remains up 94.9 percent for the year to date.
The case in United States District Court Central District of California is Dana Bostick v. Herbalife International of America Inc. et al CV 13-02488-BRO.
(Reporting by Svea Herbst-Bayliss; Editing by Dan Grebler)