PROVO, Utah—Several former Chinese distributors of Nu Skin Enterprises, Inc. claim the marketer of skin care and nutritional supplements authorized sales representatives to earn compensation on their “downline" network in violation of the country’s regulations, according to a consolidated putative class-action complaint that was filed last month in Utah federal court against Nu Skin.
Nu Skin misled shareholders, orchestrating a “massive expansion in China knowing that Nu Skin’s form of multi-level compensation violated many of China’s regulations on direct selling and prohibitions on pyramid schemes," the lead plaintiff State-Boston Retirement System, a government pension plan, alleged in the 124-page lawsuit filed on June 30.
Plaintiffs in the consolidated complaint have requested certification of a class of shareholders who purchased Nu Skin securities including options between May 4, 2011 and January 17, 2014. The end of the class period roughly coincides with a precipitous decline in Nu Skin’s stock price (NUS: NYSE), following revelations that the Chinese government was investigating its business practices.
Plaintiffs have alleged violations of Section 10(b) of The Exchange Act and Rule 10(b)(5), and Section 20(a) of The Exchange Act.
“We continue to believe the allegations are without merit and intend to defend ourselves vigorously," Nu Skin spokesperson Kara Schneck said. “Nu Skin resumed normal business operations in China on May 1, 2014. China is an important marketplace for Nu Skin and we are committed to operating in full compliance with China’s direct selling regulations to promote long-term success."
The Chinese probes were particularly alarming to Nu Skin because China is its fastest-growing market. Mainland China last year comprised 32 percent of Nu Skin's annual revenues, soaring to USD $1 billion in 2013 from $256.8 million in the previous year, according to its March 18, 2014 filing with the Securities and Exchange Commission.
In an SEC filing on Jan. 21, 2014, Nu Skin shared a copy of a letter it provided to its customers in China, announcing it would provide additional training to reinforce its existing policies, and expressing its disappointment to learn “there were instances where some of our sales people failed to adequately follow and enforce our policies and regulations."
Nu Skin temporarily suspended its business promotional meetings and accepting applications for new sales representatives.
Between Jan. 15 and Jan. 21, 2014, Nu Skin’s stock price (NUS:NYSE) plunged more than 43 percent, according to the consolidated lawsuit.
Following reviews by China’s Administration of Industry and Commerce in Beijing and Shanghai, Nu Skin revealed on March 24, 2014 that the government fined it USD $524,000 for selling products that were not registered for the direct selling channel. The company said it was fined another $16,000 for making product claims that lacked adequate documentary support, while six employees were fined a total of $241,000 for unauthorized promotional activities.
"We continue to believe in the potential of China's large and growing market," Dan Chard, Nu Skin's president of global sales and operations, said in a statement at the time of the announcement. "We remain committed to working cooperatively with the Chinese government to ensure the healthy, long-term growth of our business."
On May 1, Nu Skin resumed corporate-hosted business meetings and began accepting applications for new sales representatives.
The steps Nu Skin took earlier this year in China to address concerns previously raised “caused a significant disruption in business growth in Mainland China, our fastest-growing market," the company stated in an SEC filing. Nu Skin said it expects “that it may take some time to determine how the business will respond."
China still fueled growth in the first quarter. In the three months that ended on March 31, Nu Skin’s revenues in Mainland China rose to $212.2 million from $119.7 million in the year-earlier period.
As a global marketer of skin care and nutritional supplements with operations in 53 markets, Nu Skin operates a multi-level marketing (MLM) model that enables distributors to build a sales network and earn compensation based on product sales in their downline network.
Mainland China expressly forbids MLM sales, according to the lawsuit. Following riots that erupted in China, the government outlawed MLM businesses and pyramid schemes in 1998; seven years later, the Chinese government lifted the ban on direct-selling businesses, the lawsuit said.
Nu Skin offers a distinct compensation plan in China, paying a salary to sales employees and commissions to those same employees, contractual sales promoters, direct sellers and independent marketers, according to an SEC filing.
But the consolidated complaint cites unnamed former distributors who claimed Nu Skin paid commissions to distributors based on sales by individuals whom the distributors had recruited.
According to the lawsuit, one former distributor from the Guangzhou province claimed leaders who were upstream could earn 5 percent of their downlines’ revenues as a commission and obtain “base pay" when a sales representative attained a certain level of sales, while a former distributor from Nanjing allegedly “confirmed there were seven or eight sales people under him and his income depended on his team’s performance." Another former distributor from Shanghai said sales representatives could obtain a portion “of their sales team’s revenues if those in their downlines met minimum sales quotas," the complaint alleged.
The lawsuit also has named as defendants Nu Skin CEO M. Truman Hunt and chief financial officer Ritch Wood. The individual defendants sold stock yielding proceeds of roughly $40 million when they had knowledge that their false statements concerning growth in China were artificially bloating Nu Skin’s stock price, the lawsuit alleged.
In the wake of the Chinese scandal, six lawsuits were initially filed against Nu Skin, but two have been voluntarily dismissed. On May 1, 2014, a federal court granted a request to consolidate the lawsuits and appoint as lead counsel Labaton Sucharow, a securities law firm in New York and Delaware. In 2013, Labaton Sucharow landed on Law360’s Most Feared Plaintiffs Firm list, with Law360 noting the firm had recovered more than $1 billion for clients in securities fraud litigation the previous year.
The consolidated case is In Re: Nu Skin Enterprises, Inc., Securities Litigation, U.S. District Court for the District of Utah, Central Division, No. 2:14-cv-00033-DB.