FTC v. BurnLounge: 10 point mini-primer and action plan on the “personal use” issue:

  1. Overreach of BurnLounge Final Order creates uncertainty on “personal use” issue…

    FTC stated policy has been to prosecute egregious pyramid schemes as opposed to mainstream direct selling. By and large, this has been the case since the famous 1979 FTC Amway unsuccessful prosecution.

  2. FTC and major court pyramid decisions, including FTC v. BurnLounge, focus on front-loading, large investments, products and services that do not stand on their own in the marketplace, payment of recruitment commissions for purchases of nonconsumer items such as sales tools, unsubstantiated earnings claims and programs where the motivation for distributor product purchases is driven by intent to “buy in” and qualify for commissions in the business opportunity … and is incidental to a real desire for product or service for resale or personal use.
  3. The existence of distributor purchases of consumer products and services, in reasonable amounts, for “personal use” is common in the direct selling industry and does not appear to be a driving “pyramid” criticism of the FTC or court decisions.
  4. Notwithstanding the absence of “personal use” criticism, a disconnect exists”; it is common place, in FTC and pyramid cases, to issue orders that provide that distributor “personal use” purchases should not be recognized as “sales to ultimate users” for purpose of determining if a program is a pyramid or legitimate.
  5. 0verreaching on the “personal use” issue creates a cloud of legal uncertainty for the direct selling industry and the livelihoods of millions of distributors.
  6. The BurnLounge Final Order continues this “disconnect” and perpetuates an unnecessary cloud of legal uncertainty on the role of “personal use” in pyramid analysis.
  7. The BurnLounge Final Order is sure to be cited in future FTC actions, state, federal and international regulatory actions, class actions and private lawsuits, proposed state, federal and international laws, regulations and rules.
  8. Prior uncertainty from previous FTC actions and other cases have prompted multiple states to recognize legitimacy of personal use, creating confusion between states and between federal and state on this issue. As early as 1986, the state of California recognized “reasonable personal use” in a stipulated order involving Herbalife. And even the FTC, in 2004, clarified, in a FTC Staff Advisory Opinion, that it did not necessarily object to personal use, and noted that it tended to overreach in court cases in order to achieve stronger flexibility in prosecutions of egregious pyramid schemes.
  9. In 2003, the industry introduced proposed federal clarification legislation, HR 1220 to recognize personal use and remove the disconnect and uncertainty; the industry, specifically the DSA, should again initiate such proposed federal legislation.
  10. In the alternative, the FTC and DSA, with permission of the BurnLounge defendants, should seek to amend the BurnLounge Final Order to recognize that “sales to the ultimate consumer” include distributor purchases in reasonable amounts for personal use.

And now, the context …

The FTC v. BurnLounge Saga

In March, 2012, after a five-year journey started in 2007, the end of the saga of FTC v. BurnLounge came to a dramatic conclusion with a stunning judgment of $17 million against the MLM digital music seller and its owners.

It is likely that neither the direct selling industry nor the music industry wept any tears, as the BurnLounge phenomenon was viewed by various observers as an outlier to the direct selling model, portrayed by the Court and FTC as the facade of an online MLM direct seller of music downloads in which the revenue of music sales to consumers was absolutely incidental to the true model in which distributors purchased varying “packages,” ranging from $29.95 to $429.95, plus monthly fees, and were rewarded for recruiting other distributors to do the same, and so on. This actual model, said the court and FTC, fit the classic definition, not of a legitimate direct selling business model, but rather that of an illegitimate pyramid headhunting recruitment scheme in which profits were made by distributors recruiting each other to pay large sums of money that they might not ordinarily pay, but for the earning opportunity.

In other words, argued the FTC and the Court, the products sold did not stand on their own in the marketplace and the Court made sure to point out that the overwhelming revenue did not come from digital music sales to the consuming public, but rather from “package purchases” by distributors.

Said the FTC in its 2012 Press Release:

At the request of the Federal Trade Commission, a U.S. district court judge has ordered the operators and top promoters of a deceptive pyramid scheme to pay a total of $17 million to refund consumers who were burned by the scam. The court order permanently halts marketing methods used by the operation known as BurnLounge, which lured more than 56,000 consumers from around the country by masquerading as a legitimate multi-level marketing program and making misleading claims about earnings to be made.

The FTC filed a complaint against BurnLounge in 2007 as part of its ongoing efforts to protect consumers from fraud and deception. BurnLounge had touted itself as a cutting-edge way to sell digital music through multi-level marketing, but music sales accounted for only a small percentage of its sales. The agency charged that BurnLounge recruited consumers from across the country by telling them that participants earned huge incomes. Investors could buy into the BurnLounge organization for prices ranging from $29.95 to $429.95, plus monthly fees. While participants were compensated for music and album sales, most compensation came from recruiting others into the plan.

And, although the direct selling industry has had its disagreements with the FTC, it is understandable that there may be few in the industry that would not be on the same wave-length as the FTC and Court on this episode. It made sense from the standpoint of an industry observer that this case fell in line with other FTC prosecutions of “egregious” pyramid schemes such as FTC v. Equinox ($5,000 inventory “front-loads”) and FTC v. Skybiz (millions of website hosting packages sold with only a tiny fraction activated for use by real customers) or the U.S. criminal prosecution of Gold Unlimited, which paid huge rewards for down payments on undelivered gold bullion contracts.

The direct selling industry will not weep for the demise of programs that courts have ruled to be “over the top.” However, it will live with the taint of such practices that, during their brief existence, masquerade as legitimate MLM companies, draining good recruitment candidates, but more importantly tainting future recruitment opportunities because of the “bad taste” left with the public.

But more important to the industry, such cases, often inadvertently, leave behind undeserved tiny nuggets of unjustified and “just plain wrong” legal precedent that wreak havoc and uncertainty for the legitimate direct selling industry for years to come. And so it happened with FTC v BurnLounge. Buried in one line in the final judgment is a legal proposition that is, in actuality, in conflict with the FTC’s stated position on legitimacy, the trial court’s own written rationale for the decision and the direct selling industry’s view on legitimacy … all related to the recognition of the legitimacy of distributor product purchases, in reasonable amounts for “personal use.”

All three, the FTC, the industry and the Burnlounge Trial Court opinion, would be in agreement that a program is a pyramid if the sale of product to distributors is driven by qualification for “rewards” rather than usage of the product or service. If the primary motivating factor for distributor purchases is qualifying in the business opportunity, a program is likely a pyramid headhunting recruitment scheme in which distributors recruit others to pay money and so on.

But one line, buried in the final judgment, sure to be cited in the future, removed all nuance and deliberate thought from this issue by ordering that “no distributor personal use product purchases” were even to be considered in evaluating legitimacy. And such language, if applied to the multi-billion dollar direct sales industry, could easily create legal challenge to many of the world’s leading direct selling companies, many in business for decades and some even publicly traded on stock exchanges.

The Final Judgment Order language appeared as follows:

19. “Prohibited Marketing Scheme” means an illegal pyramid sales scheme, … Ponzi scheme, chain marketing scheme, or other marketing plan or program in which participants pay money or valuable consideration in return for which they obtain the right to receive rewards for recruiting other participants into the program, and those rewards are unrelated to the sale of products or services to ultimate users. For purposes of this definition, “sale of products or services to ultimate users” does not include sales to other participants or recruits or to the participants’ own accounts.

This last tagline, if adopted by other courts, is a “game changer” in analysis of pyramid vs. legitimate.

Read more at: www.mlmlegal.com.

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