Bill Ackman warned the board of directors of Herbalife Ltd. (NYSE:HLF) that they could face tremendous personal liability once it’s proven that the company is a pyramid scheme, in his letter back in October 24, 2013.

Bill Ackman Platform Specialty

In his letter, Ackman informed that members of the board of Herbalife Ltd. (NYSE:HLF) that his firm, Pershing Square Capital Management, brought its allegations against the company that it is a pyramid scheme to the attention of proper authorities. He emphasized to the board that he is confident that authorities will act and take requisite action to eliminate such a scheme for the interest of the public.

Potential monetary damages

Ackman wrote, “As directors of a fraudulent public company, you will be held liable, at a minimum for monetary damages, unless you have met the high standards that apply to a director’s performance.”

The activist investors reminded the board of directors of Herbalife Ltd. (NYSE:HLF) that the company and their insurance, exculpation and indemnification protection will be worthless once regulators declare that it is an illegal pyramid scheme.

“Your D&O Coverage will be likely of no value if the board knowingly allows fraudulent activity to continue. In this case, the board will not be entitled to insurance coverage and the exculpatory provisions of the company’s organizational documents will not be available for violations of the duty of good faith or the duty of loyalty,” according to Ackman.

Herbalife problems not hidden or complicated

Ackman emphasized that the problems of Herbalife Ltd. (NYSE:HLF) are not hidden, secret, complicated, or difficult to understand, and his firm brought the issues not only to the attention of the public and regulators but also to the accountants and the board of the company. According to him, the board’s continuing failure to explore the issues will likely meet an appropriate level of skepticism by a court and a jury.

Ackman advised the board of directors of Herbalife Ltd. (NYSE:HLF) not to depend or feel comfortable with the opinions of the advisors hand-picked and retained by the company’s management.

Potential liabilities

The activist investor pointed out that the board of directors of Herbalife Ltd. (NYSE:HLF) could be found grossly negligent if it fails to establish and monitor the company’s information and reporting systems to ensure the business is being conducted properly and legally.

Ackman added that the board of directors could be liable if its effective registration statement contains untrue statements of material fact or omits a material fact required to make the statements therein not misleading under the U.S. federal and securities laws even if Herbalife Ltd. (NYSE:HLF) is registered offshore in the Cayman Islands.

Furthermore, Ackman said the board of directors of the company may also incur liabilities under certain federal and state fraud consumer protection statutes.

Ackman suggested steps to minimize BoD liabilities

He encouraged them to “seriously consider” their duties and risk of personal monetary liability for breach. He also advised them to take certain steps to minimize their liability and for the best interest of Herbalife Ltd. (NYSE:HLF), its shareholders and the public.

Some of the steps suggested by Ackman include establishing a special committee to investigate in good faith the allegations of Pershing Square Capital Management, prevent any fraudulent actions by Herbalife Ltd. (NYSE:HLF) and improve the board’s oversight procedures and processes, diligently review the accuracy and completeness of all material documents, and make a request to the Federal Trade Commission to conduct a thorough investigation to find out whether the company is a pyramid scheme or not.

FTC launched investigation

The FTC launched an investigation against Herbalife Ltd. (NYSE:HLF) on March 12. A report from New York Post indicated that the management of the company approached Carl Icahn to add more representatives to its board after learning that it is under scrutiny by regulators. Icahn has not decided yet whether he will appoint additional board members. One thing is for sure, he will no longer buy more shares of Herbalife as part of a deal. Observers believed that the FTC inquiry might take more than a year.