Herbalife continues to be at the center of controversy as the pyramid scheme debate rages on. Activist investor and short-seller Bill Ackman has brought forth countless former Herbalife distributors who allege that the company essentially ripped them off. Of course Herbalife denies those allegations, and the battle rages on.

Herbalife Ltd. HLF

Herbalife misleads about compensation?

So exactly what, if anything, is misleading about the company’s compensation plan? As it turns out, the entire thing sounds very confusing. In a post on Seeking Alpha, Christine Richard of Orion Research highlighted some statements made by Herbalife management that could be taken as misleading. Before we dive in, it should be noted that Richard’s Seeking Alpha profile page states that she has written a book about Bill Ackman and that his firm Pershing Square Capital Management is a client of her firm Orion Research. She has also been credited by The Wall Street Journal with giving Ackman the idea to short Herbalife.

For example, she states that a 550-gram container of Formula One ordered by a senior consultant who gets a 35% discount in Panama has a total pretax cost of $24.48. According to an invoice Richard posted, Herbalife seems to suggest a retail price of $26.43 for that container.

In other words, the distributor would earn only $1.95, which is 7% of the retail price. That’s a far cry from the percentage give in a statement Herbalife made in its annual report in 2012. It reads: “Royalty overrides and bonuses together with the distributor allowances represent the potential earnings to distributors of up to approximately 73% of retail sales.”

How Herbalife recruits make money

A slide from an Herbalife presentation reportedly shows that distributors can earn the most income through retail profits. Later in that presentation, it’s shown that retail profits are the result of getting different discounts on Herbalife products, which are supposedly between 25% and 50%. Of course the higher a distributor climbs in the Herbalife tree, the greater the percentage of the discount he or she earns.

However, Richard notes that the bottom of one of the slides states: “Retail and wholesale profits are calculated on earn base.” In her own words, she defines “earn base” as “a number Herbalife uses to shrink distributor income.”

Does Herbalife really shrink distributor income?

She reports that Herbalife has been imposing what it calls a “packaging and handling” charge since the 1990s. That charge is now 7% of Herbalife’s suggested retail price. The company then adds on shipping charges. According to Richard, Herbalife’s financial statements show that these charges bring the company quite a lot of revenue—as much as $396.7 million in 2010.

She states that most of the money from these charges actually wasn’t needed to pay for the packaging or shipping. In fact, the charges piqued the interest of the Securities and Exchange Commission in 2011. Regulators sent a letter to Herbalife CEO Michael Johnson to ask about it, and he responded by saying that in 2010, shipping and handling costs were $58 million.

She notes that this means a staggering 85% of what Herbalife charged for shipping and handling to get its products to distributors wasn’t even being used to pay for shipping and handling. The company just raked in some tidy profits through these charges.

Where did the money go?

According to Richard, the top distributors at Herbalife started seeing a 5% “production bonus” not long after the initial “packaging and handling” charge of 5% was added (before it was raised to 7%). Just a very few Herbalife distributors qualify for the production bonus, which she states “is calculated on purchases going down a potentially infinite number of levels.”

In 2013, Herbalife dumped the packaging and handling charge as scrutiny of its business practices heated up. The multi-level marketing company said in a letter sent to its distributors that the charge “has long been a difficult topic for Distributors to explain and Customers to understand.”

Richard alleges that the 5% money transfer from the bottom of the company at the lowest level distributors up to the highest level distributors is still going on even though that charge has been eliminated. She said the company just made it “a bit less obvious.”

She points to a document on Herbalife’s website called the “Simplified Pricing Structure.” The Shipping line got the new name “Shipping and Handling” and about a 1% increase. Apparently the company upped retail prices by approximately 5% at the same time.

Simplify?

Of course this change affected the entire model because Herbalife figures distributor commissions and discounts off the suggested retail prices. This means increasing prices would result in larger discounts and higher commissions, resulting in having less money to pay for the production bonus.

However, Herbalife seems to go through a very complicated series of mathematical equations to come out ahead. Really the best thing to do is read Richard’s article in through for the complete explanation of what the company seems to be doing. It’s quite confusing—as she notes—but that may be by design.

As of this writing, shares of Herbalife were up by 0.99% to $31.55 per share.