It’s an illegal pyramid scheme. That’s the conclusion reached by a federal appellate court in upholding a trial judge’s ruling in an FTC action challenging a multi-level marketing business operated by BurnLounge, Inc. If you have clients in the business opportunity arena, the opinion is a must-read.
BurnLounge sold opportunities to run an online digital music store. But the FTC alleged in its complaint that the defendants were running a pyramid scheme. One defendant settled, but the remaining parties went to trial.
After a nine-day trial, the District Court agreed that BurnLounge was operating a pyramid scheme and found that more than 56,000 consumers had failed to recoup their investment. The District Court ordered BurnLounge and its CEO to pay a total of $16.2 million in consumer redress. Two other individual defendants were ordered to turn over their unjust enrichment from the scheme. The order barred the defendants from engaging in illegal pyramid sales schemes, Ponzi schemes, chain marketing schemes, and similar operations. Also prohibited: misrepresentations about any multi-level marketing or business venture, including claims about sales, income, profitability, or legality.
BurnLounge and two affiliated individuals appealed. The U.S. Court of Appeals for the Ninth Circuit upheld the trial court’s ruling, concluding “We agree with the district court that BurnLounge was an illegal pyramid scheme in violation of the [FTC Act] because BurnLounge’s focus was recruitment, and because the rewards it paid in the form of cash bonuses were tied to recruitment rather than the sale of merchandise.”
The Ninth Circuit held that the FTC presented ample evidence to support the finding that BurnLounge was an illegal pyramid scheme. In particular, the FTC’s evidence showed that: 1) “Moguls” – members who could earn income – were required to recruit new members to become eligible for all three types of cash bonuses paid by BurnLounge; and 2) Moguls were motivated by the opportunity to earn cash rewards, as shown by data illustrating the sharp difference in package purchasing patterns of Moguls vs. non-Moguls, and by the fact that BurnLounge’s sales plummeted after a preliminary order stopped the Mogul program.
The Ninth Circuit had some interesting things to say about the legal determination of what’s a pyramid scheme. The Court concluded that the test for establishing a pyramid scheme doesn’t require that the rewards for recruiting others be “completely” unrelated to the sale of products. Evaluating how BurnLounge operated, the Court observed, “Recruiting was built into the compensation structure in that recruiting led to eligibility for cash rewards, and more recruiting led to higher rewards.” The Court further stated that based on the evidence presented at trial, “Rewards for recruiting were ‘unrelated’ to sales to ultimate users because BurnLounge incentivized recruiting participants, not product sales.”
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