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FTC v. BurnLounge
BurnLounge Appeal Decision:
Guidance on Pyramid v. Legitimate MLM and the Role of Personal Use in Pyramid Analysis
© Jeff Babener, Babener & Associates/MLMLegal.com
On June 2, 2014, in the case of FTC v. BurnLounge, the U.S. Court of Appeals for the Ninth Circuit issued a seminal decision, affirming a lower court finding that the BurnLounge MLM (multilevel marketing) program was an illegal pyramid scheme, in violation of section 5(a) of the Federal Trade Commission Act, a decision that will dramatically impact the landscape of direct selling to provide guidance on two fundamental legal issues:
(1) What activity constitutes a "pyramid scheme?"
(2) What is the role of "personal use" (by distributors) in pyramid case analysis?
Stakeholders: "We Won!!" Proxy Wars...
Victory has 100 fathers and defeat is an orphan. -John Kennedy (1961)
As with any inconclusive war, the stakeholders offered immediate statements of victory or vindication.
That is, other than BurnLounge. BurnLounge lost, and a permanent injunction was affirmed.
However, BurnLounge was a proxy war on the tests for "pyramid" and the role of "personal use" in pyramid analysis, among the interested parties, short sellers of publicly traded direct selling companies, publicly traded direct selling companies, industry spokespersons such as the DSA, the FTC, MLM critics, etc.
Each, in turn, issued press releases or statements claiming victory and validation of their respective positions.
The BurnLounge decision offered guidance for all stakeholders and a clear message for "going forward."
To Short Sellers:
Rethink your criticism of direct selling companies. Distributors’ personal use is a legitimate end destination for product sales. Criticism of personal use is not a valid criticism. So long as distributor purchases are not merely incidental to the business opportunity, such purchases in reasonable amounts for personal use, coupled with rewards for one's own purchases, as well as use by non-distributors and other distributors is as legitimate as a sale to a non-distributor customer, and is not a basis for a pyramid.
To the FTC:
Congratulations, you won this case on the facts presented. However, since the Omnitrition case (1996), you have been arguing the wrong legal standard on personal use for more than 15 years, albeit a slight diversion in a 2004 FTC Advisory Opinion that recognized legitimacy of personal use. The court pointed out: "The FTC counters that 'internal sales to other Moguls cannot be sales to ultimate users consistent with Koscot.'" The court proceeded to roundly reject this contention noting that this argument is not "supported by the case law." And so the message to the FTC is that personal use criticism will not be accepted in the future and the FTC should look back to its 2004 Advisory Opinion position.
To the Industry:
Accept your victory on recognition of personal use as a legitimate destination for product and representative of "sales to ultimate users." However, "get your act together," and adopt "best practices" methods and rules that promote product use over mere recruiting. The presence of personal use is not "a free ticket out of trouble." It will be viewed as part of a legitimate MLM, but it is only one factor for the case by case fact based analysis of the "economic reality" of an entire program in which the acid test will be that the predominant and primary motivation of distributor purchases is for personal use or resale and not merely to qualify for rewards in the program by personal purchases and recruitment of others to do the same.
Major Impact of the BurnLounge Case.
The BurnLounge decision will become a guiding legal precedent in the direct selling field and will become known for several significant legal signals, including the following:
|(1) The operative facts of the BurnLounge program made it a pyramid scheme.|
|(2) The court ended a multi-decade legal debate on "personal use," in which it recognized that "personal use" of product/service by distributors as a legitimate end destination for product/service in which distributors are accepted as "ultimate users" under a long line of cases that differentiates pyramid v. legitimate direct selling based on an analysis of whether or not program rewards are "unrelated to sales to ultimate users."|
|(3) The court established a going forward pyramid test that is fact driven, and which balances whether distributor payments and commissions are driven by recruitment, on the one hand, or sales to ultimate users on the other hand, i.e., are distributor product/service purchases incidental to the business opportunity?|
|(4) The court’s decision provides common ground that would allow the FTC and the direct selling industry to reconcile on an acceptable standard to both interests based on principles enunciated by the FTC in a 2004 Advisory Memorandum to the Direct Selling Association. The door is now open to "codifying" such a standard.|
1. The Operative Facts of the BurnLounge Program made it a Pyramid Scheme.
BurnLounge offered online music packages and download opportunities to its distributors and the public. To a large extent, the design and implementation of the BurnLounge program created "low lying fruit" on the pyramid issue. It was not a close call. In the BurnLounge program, distributors were required to purchase music packages in order be eligible for compensation. In turn, they were rewarded for finding other distributors to do the same. In the end, the trial court noted and the appeals court recognized that the overwhelming sales came from music packages mandated for purchase by distributors, as opposed to downloads to the public.
In making its distributors purchase music packages, BurnLounge did not follow an industry standard approach. In the typical major direct selling company, the only cost to be a distributor is the purchase of a modestly priced non-commissionable sales kit. Many state pyramid laws recognize an exemption, from the term prohibited consideration, for the mandated purchase of a modestly priced non-commissionable sales kit. And then distributors are permitted to purchase product for resale or personal use or promote customers to buy directly from the company. BurnLounge departed from this standard practice and, in mandating the purchase of product as a gateway to MLM commissions, it established itself as a program driven by recruitment as opposed to sales to ultimate users or, as the trial court and appeals court observed, distributor purchases "were incidental to the business opportunity."
As will be discussed, the court applied a long-established standard test for pyramid schemes evolving through several key decisions including FTC decisions in Koscot, Amway and affirmed in a Ninth Circuit decision involving Omnitrition:
In Webster v. Omnitrition International, Inc., the court approved the FTC’s test for determining whether a multilevel marketing (MLM) business is a pyramid scheme: a pyramid scheme is "characterized by the payment by participants of money to the company in return for which they (1) receive the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users." Not all MLM businesses are illegal pyramid schemes. To determine whether an MLM business is a pyramid, a court must look at how the MLM business operates in practice. (Citing cases involving Omnitrition, Koscot, Amway and Gold Unlimited.)
Said the court:
|We agree with the district court that BurnLounge was an illegal pyramid scheme in violation of the FTCA 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.|
2. The Court Brings Clarity to the Issue of "Personal Use" in Pyramid Analysis.
And, because the facts of BurnLounge took it out of the "close call" category, although the BurnLounge case advances the state of the law on pyramid analysis on issues of "personal use, " "ultimate user" and " motivation for distributor purchases," it points to a future of fact driven "case by case" analysis as to whether an MLM program is a pyramid scheme v. a legitimate direct selling company.
Most importantly, the court ended a multi-decade legal debate on "personal use," in which it recognized that "personal use" of product/service by distributors as a legitimate end destination for product/service, in which distributors are accepted as "ultimate users" under a long line of cases that differentiates pyramid v. legitimate direct selling based on an analysis of whether or not program rewards are "unrelated to sales to ultimate users."
The court specifically rejected the FTC contention that purchases for personal use by distributors should not be counted as "sales to ultimate users." This ruling will change a long-held litigation and enforcement position of the FTC that has found its way into complaints, legal briefing, and injunctive court orders (including the BurnLounge lower court order).
The case history on the issue of whether or not "sales related to ultimate consumers" should or should not include "personal use" by distributors is long and twisted. It is a meandering journey with side trips, with the journey concluding with some finality in the BurnLounge appeal court decision.
Leading direct sellers are the first to recognize that many of their distributors join for the purpose of becoming discount buyers and for their own personal use of products. (They would also be the first to agree that product purchases made merely to qualify for rewards in the marketing plan is "wrong.") In fact, an early study by the Direct Selling Association as to why direct sellers join companies, revealed that the number one reason individuals join is that they like and believe in the product. MLM critics have focused on "personal use" by distributors, as a major factor in criticizing leading direct selling companies as pyramids. From their perspective, if usage of product is not dominated by non-distributor retail customers, then, a fortiori, a program is a pyramid scheme.
However, MLM critics have missed a 40-year legal trend line which focuses, not on the existence of sales to nonparticipant retail customers, but rather on whether product is purchased by and used by the "ultimate user," whether or not that individual is a distributor or non-distributor. Beyond that issue, as noted above, federal and state prosecutions have been driven by factors of "inherently deceptive and egregious abuse." Of tremendous educative value to debate is the BurnLounge trial court and appeal court explanation that the operative question is whether or not distributor purchases are "merely incidental to the business opportunity." If they are incidental to the opportunity to merely qualify for rewards in the program, then the program is a pyramid program driven by recruitment rather than by sales to ultimate users.
The BurnLounge court tracks the "legal standard" history through key court decisions. Their import to the issue:
|(1) The seminal pyramid decision, In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975) (FTC decision) (inventory loading):|
|Pyramids are characterized by payments or purchases for recruitment rewards unrelated to sale of product to ultimate users.|
|(2) The second seminal decision, involved Amway, (FTC decision) In the Matter of Amway (93 F.T.C. 618) (1979):|
|An MLM program that adopts appropriate consumer safeguards that promote retail sales, anti-inventory loading and refund rights, is supportive of legitimate direct selling rather than a pyramid headhunting recruitment scheme.|
|(3) A third influential decision, Webster v. Omnitrition International, 79 F.3d 776 (1996) (class action) (inventory loading):|
|Merely adopting the Amway consumer safeguards is not sufficient to overcome the pyramid accusation if the program is characterized by abusive elements, such as inventory loading, that cause the program to be driven by recruitment rather than sale of product to ultimate users. Until the 2014 BurnLounge appeal decision, the Omnitrition case was erroneously interpreted for more than 15 years, however, to also hold that purchases for personal use by distributors could not be claimed as sales to ultimate users.|
|(4) And finally, FTC v. BurnLounge, U.S. Court of Appeals, Ninth Circuit (2014):|
|Corrects the long promoted misinterpretation of Omnitrition to hold that personal use purchases are sales to ultimate users so long as they are not "incidental to the business opportunity." And the court clarifies that the heart of the debate on pyramid v. legitimate going forward will be fact driven as to whether the MLM program is primarily driven by "recruitment" v. "sale of products to ultimate users."|
Following the pivotal Koscot pyramid case, which highlighted the abuses of "inventory loading," a good summary of the earliest thinking appears in the landmark 1979 FTC administrative law decision, In the Matter of Amway (93 F.T.C. 618), which validated Amway’s multilevel marketing program. As noted in the administrative law decision:
|Such schemes are characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell the product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users. (emphasis added). In general such recruitment is facilitated by promising all participants the same 'lucrative' rights to recruit.|
|Participants in the Koscot marketing plan paid an initial amount up to $5,000 to the company for inventory and the right to recruit others. The distributors who recruited others received $2,650 of the recruit's $5,000 payment. 86 F.T.C. at 1179. The only way a Koscot distributor could get the payment back was to recruit more distributors. 86 F.T.C. at 1131. Koscot and its distributors were primarily in the business of selling distributorships. 86 F.T.C. at 1140.|
|Participants in the GerRoMar, Inc. marketing plan bought nonreturnable inventory for up to $1,950. 84 F.T.C. at 10810. Recruiters received compensation based on the fact of recruiting regardless of whether products were sold to the consumers. 84 F.T.C. at 148.|
|The pyramid marketing program in Holiday Magic, Inc., 84 F.T.C. 748 (1974) required distributors to buy in at various levels for up to $4,500. At the highest level, distributors received $2,500 of the $4,500 for recruiting another distributor at the same level. 84 F.T.C. at 1032. The inventory purchased in this manner was nonreturnable and the company paid little attention to consumers. 84 F.T.C. at 1035.|
The FTC Amway decision went on to cite salutary consumer protection features of Amway, which, have since been adopted by leading direct selling companies and cited in almost every court decision as the "Amway safeguards": (1) an inventory buyback policy for terminating distributors; (2) a 70% rule which is an anti-inventory loading rule that prohibits reordering unless 70% of previously ordered product has been sold or used; a mandated customer rule that emphasized moving product to the ultimate user.
Amway has traditionally recognized personal use of product for commission purposes and the FTC Amway decision specifically recognized what it meant by sales to the "ultimate user":
|...This multilevel wholesaling network ends with those distributors who have not sponsored any new distributors, and who make purchases from their sponsors solely for their own use or for resale to consumers… (emphasis added)|
|… Specifically, the Amway Plan is not a plan where participants purchase the right to earn profits by recruiting other participants, who themselves are interested in recruitment fees rather than the sale of products.|
Jump forward 40 years to the most recent comprehensive federal court opinion on an FTC prosecution, FTC v. BurnLounge, U.S. District Court, Central District California, Case CV 07- 3654-GW(FMOx) (2012) (as affirmed by the Ninth Circuit in 2014) and the target and pyramid acid test analysis of the U.S. District Judge is not "personal use" by distributors; but, rather whether the motivation for "first purchases" was really as a "buy in" gateway to the opportunity.
In fact, the thrust of the opinion was not based on criticism of the sort of "personal use" by distributors so common in many leading direct selling companies. Instead, the thrust of the opinion was that the motivation for distributor purchases of "packages" was incidental to creating a market for company product or services; i.e. the true purpose for purchases was to buy into qualification for commissions in the opportunity ... a classic allegation in pyramid schemes.
In fact, the court’s own observations even seemed to ratify distributor personal use, for the right reasons, as a favorable factor in legal analysis, but noting that products, purchased as sales tools, as in the BurnLounge program, do not fit properly in the analysis:
|The bundled products had at least some minor value in and of themselves, and a consumer who had primarily in mind that value when he/she purchased them could not have been harmed by the scheme. The Court therefore finds the fact that the products had some value is relevant to the calculation of consumer harm, but only insofar as those products were purchased for their value as ultimate user products, and not for the conjoined business opportunity. To individuals who considered the bundled products as merely incidental to the business opportunity, the Court finds the products were of no relevant value. (emphasis added.)|
|BurnLounge argues that the sale of the Basic Package (i.e. the sale of an individual BurnPage and its required software) is the sale of a product to an ultimate user.37 See Whole Living, Inc., 344 F. Supp. 2d at 745-46 ("A structure that allows commission on downline purchases by other distributors does not, by itself, render a multi-level marketing scheme an illegal pyramid."). While it is true that the BurnPage could be considered a ‘product’ and a Retailer to be the ‘user’ of that product, this argument ignores the nature of the use itself. That is as a tool for sales and (more importantly) for recruitment, as demonstrated by a review of the BurnLounge promotional materials, the presentations of its spokespersons, and the statistics as to the participants who bought into the enterprise. (emphasis added.)|
In between Amway and BurnLounge, years of misinterpretation of the Omnitrition decision created havoc for the industry on the issue of personal use. A private class action had charged a company, Omnitrition, as a pyramid. Actually, Omnitrition prevailed at the trial court and summary judgment was entered for Omnitrition. The case was appealed to the U.S. Court of Appeals for the Ninth Circuit. The court ruled that material issues of fact remained to be reviewed and, therefore, the summary judgment, in favor of Omnitrition, should be reversed and the case remanded for further proceedings. Webster v. Omnitrition International, 79 F.3d 776 (1996). Shortly thereafter, the case settled and, therefore, no final trial or adjudication occurred.
In actuality, direct selling industry observers argued that it was not necessary for the appellate court to address the substantive issue of what is and what is not a pyramid. But it did, in what industry observers referenced as dicta, language not necessary to the decision; as the issue before the court was whether or not there was a material issue of fact as to whether or not Omnitrition actually implemented anti-pyramiding rules beyond the mere adoption of the written Amway safeguards rules.
For the next decade, the Omnitrition dicta created confusion as to whether distributors, who were also ultimate users, could be a legitimate destination for purposes of pyramid analysis. And that confusion, until the BurnLounge appeals decision, has been seized upon by MLM critics that leading direct selling companies (particularly those that sell personal consumables products such as nutrition) were pyramid schemes.
In reality, critics of MLM and leading MLM companies seemed to have missed the point of the Omnitrition court. In its analysis, the court applied principles of Koscot and Amway, which demanded "no rewards unless sales related to ultimate users." The message of the appellate court to the trial court was that Omnitrition could not be said to be promoting "retail sales" nor sales to the "ultimate consumer" if it allowed a climate of pervasive inventory loading, i.e., purchases of large stocks of inventory and payment of commissions on such sales hardly insured that product was moving on to the ultimate user.
In particular, the court was critical that distributors were urged to advance to the "supervisor" level to make meaningful commissions through initial purchases and ongoing purchases of thousands of dollars of product. In the words of the court, "people buy exorbitant amounts of products that normally would not be sold in an average market." The court’s message was that "adopting a 10 retail customer" rule from Amway, would be ineffective, even with personal use, to rid oneself of thousands of dollars of mandated inventory purchases. In other words, this case was not really about "retail sales," nor "personal use," it was about inventory loading that defeated the goal of sales to the ultimate user, even in the face of some retailing mandate. Any other reading, as by MLM critics and short sellers, would be to miss the entire factual context of the case.
In the absence of the actual context of the Omnitrition facts, industry critics and short sellers have cited the Omnitrition dicta as standing for a precedent that personal use or internal consumption should not be credited in the pyramid/legitimacy analysis. However, given a long line of precedent and follow-up cases, state legislation and FTC statements, and finally the BurnLounge Appeal decision, the personal use pyramid accusation is not warranted.
Notwithstanding its position in pyramid litigation, including the BurnLounge case, the FTC has taken a different position outside the courtroom that is fairly consistent with the position of the direct selling industry and the BurnLounge Ninth Circuit Appeal decision. In 2004, the FTC, in an FTC Staff Advisory Opinion and Pyramid Schemes Analysis, responded to an inquiry from the Direct Selling Association, intending to clarify that the FTC did not view "personal use" as the primary determinant of illegality, but rather whether purchases of goods and services were "merely incidental" to "buying in" to the opportunity. In fact, its major cases have focused on this point.
In its 2004 "clarification letter," the FTC noted:
|Much has been made of the personal, or internal, consumption issue in recent years. In fact, the amount of internal consumption in any multi-level compensation business does not determine whether or not the FTC will consider the plan a pyramid scheme, The critical question for the FTC is whether the revenues that primarily support the commissions paid to all participants are generated from purchases of goods and services that are not simply incidental to the purchase of the right to participate in a money-making venture.|
|It is important to distinguish an illegal pyramid scheme from a legitimate buyers club. A buyers club confers the right to purchase goods and services at a discount. If a buyers club is organized as a multi-level reward system, the purchase of goods and services by one's downline could defray the cost of one's own purchases (i.e., the greater the downline purchases, the greater the volume discounts that the club receives from its suppliers, the greater the discount that can be apportioned to participants through the multi-level system). The purchase of goods and services within such a system can, therefore, be distinguished from a pyramid scheme on two grounds. First, purchases by the club's members can actually reduce costs for everyone (the goal of the club in the first place). Second, the purchase of goods and services is not merely incidental to the right to participate in a money-making venture, but rather the very reason participants join the program. Therefore, the plan does not simply transfer money from winners to losers, leaving the majority of participants with financial losses.|
In summary, with the BurnLounge Appeals decision, the state of the law on personal use has now been clarified to reject misinterpretation of Omnitrition and to validate the position of the Direct Selling Industry and the "out of court" position enunciated in the 2004 FTC Advisory Opinion.
3. BurnLounge Establishes a "Fact Driven" Balancing Standard: Recruitment v. Sales.
The BurnLounge Ninth Circuit Appeals Court established a going forward pyramid test that is fact driven, and which balances whether distributor payments and commissions are driven by recruitment, on the one hand, or sales to ultimate users on the other hand, i.e.
|Are distributor product/service purchases incidental to the business opportunity?|
|Or rephrased: Is the focus in promoting the program, rather than selling products to ultimate users?|
If one reads the trial court decision, listens to the oral argument before the Ninth Circuit or reads the Ninth Circuit opinion, the words "primarily" or "predominant" are frequently used to discuss the motivation of distributor purchasing, in order to determine if they should be included in the category of ultimate users.
|The central inquiry will always be:|
|What do they pay, and why do they pay it?|
|And the ultimate standard of inquiry going forward in pyramid cases will be:|
|What is the predominant or primary motive of distributors in making purchases?|
|Is the primary motivation:|
|(a) For purposes of resale or personal use?|
|(b) Or, as a gateway purchase to qualify for rewards in the MLM opportunity and compensation plan?|
|What is clear after the BurnLounge case is that "personal use" purchases become somewhat "neutral," i.e., such purchases, which are not incidental to the opportunity, are not to be excluded in the analysis of sales to ultimate users. And, on the other hand, the mere presence of some personal use purchases or even some sales to retail customers, will not, in itself, be determinative of legitimacy. With that in mind, many other factors will need examination.|
How will this work in future cases? It is fairly simple. Get out a piece of paper and make two columns for the "good facts” and the "bad facts." In a simplistic sense, the winner of pyramid v. legitimate or recruitment v. sales, will be the dominant list. Well, actually, it is not all that simple, because a court will likely choose to ascribe more weight to designated items on each list.
Clearly, the "bad" list will include, but is not limited to, such factors as:
|Front-end loading or inventory loading,|
|Large upfront fees,|
|Mandated purchases to qualify for commissions or rank advancement,|
|Bogus product or service,|
|No buyback policy,|
|No mandate for retail sales by distributors,|
|No restrictions on "over" ordering,|
|Unsubstantiated earnings representations,|
|No evidence of product consumption by ultimate users, either by outside customers or distributors,|
|Payment of commissions for training or sales tools as opposed to being based on product sales to ultimate users,|
|Evidence of unsold product in the marketplace characterized by "garage loading,"|
|Actual headhunting or recruitment fees,|
|Mandatory purchases of peripheral or accessory products or services,|
|And the list will continue with any abusive practice that does not focus rewards primarily driven by sales to ultimate users.|
And the "good list"... again, some, but certainly not all the important factors:
|High quality goods and services,|
|Demonstration of a "real world" marketplace for the product or service,|
|Goods and services that are fairly priced,|
|No upfront mandated investment or payment other than a modestly priced|
|No inventory requirements,|
|Demonstration that product/service is used by consumers, whether they be retail customers or distributors,|
|Sales commissions and rank advancement strictly based on sales of product or service to ultimate users,|
|Emphasis on sales and use to ultimate users, including retail customers and personal use by distributors,|
|Amway Safeguard: Buyback policy for terminating distributors,|
|Amway Safeguard: Anti-inventory loading rule, such as 70% rule, prohibiting purchases unless distributors have sold or used a specified amount of previously purchased product,|
|Amway Safeguard: Mandate of some specified level of retail sales to outside customers as a condition for qualifying for commissions and rank advancement,|
|Avoidance of Earnings Representations/Potentials/Hypotheticals/Testimonials unless a transparent average earnings disclosure is provided to potential distributors,|
|Above all, emphasis on rewards on sales of product/service to ultimate users (retail customers or distributor personal use in reasonable amounts) rather than rewards arising from recruitment of other distributors,|
|Requirement that any personal use purchases by distributors be in reasonable amounts,|
|Requirement that any product purchases for resale be in commercially reasonable amounts and subject to buy back policy for terminating distributors,|
|Quality training to distributors that emphasizes both product sales as well as recruit development,|
In the end, any court will be required to conduct this balancing test. And it will seek assistance not only from the parties and the evidence, but, as noted in the BurnLounge Ninth Circuit decision, from qualified direct selling experts. Those experts will assist in fact finding, but they not will be the fact finder nor the author of the legal standard … this role is for the trial court.
4. A Real Opportunity for Reconciliation Between the FTC and Direct Selling Industry.
On the issue of "personal use" and other tests for legitimacy, the direct selling industry has been fairly constant. As noted by this author in a recent article on personal use at www.worldofdirectselling.com:
|Q: "What is your opinion on compensating a direct seller and his/her upline for that direct seller’s purchases made for personal consumption?"|
|A: In the last 10 years, distributor personal use, as a legitimate end destination (sales to the ultimate user) for product/service has been increasingly recognized by courts, legislatures and regulators: In 2013 and 2014, two EU tribunals; now counting, more than a dozen U.S. states have amended MLM statutes; in 2004, an FTC advisory opinion applauded efficiencies of MLM "buying clubs"; even the most recent U.S. Ninth Circuit Court of Appeals decision, BurnLounge (June 2, 2014) recognized personal use purchases as ultimate user purchases, and, as legitimate, so long as they were not merely incidental to the business opportunity. The emerging legal standard, legitimate v. pyramid, is not the existence of personal use, but rather, whether the predominant motivation for distributor expenditure is to qualify for reward in the MLM program as opposed to purchase for personal use or resale. Or as the BurnLounge Appeals Court noted, is the focus on promoting the program rather than sale of product to the ultimate user?|
Coming into the BurnLounge case, the direct selling industry and the FTC were on different paths, or as Robert Frost might say, "two roads diverged in a yellow wood." However, given the BurnLounge Appeal Decision and the opportunity for the FTC to return to its more consistent 2004 Advisory Opinion, it may be time for reconciliation. To rephrase Robert Frost, "two roads have converged in a yellow wood."
The Direct Selling Association has indicated an intent to seek federal legislation on the pyramid subject, and the time may be appropriate for a joint effort with the FTC. For a starting draft discussion, it is submitted that the following model pyramid language, incorporating the BurnLounge Ninth Circuit discussion on personal use, might serve as a synthesis of trending state legislation, FTC staff advisory and reasoning set forth in various federal and state court opinions:
Pyramid Scheme means a program in which participants pay money or valuable consideration that is primarily motivated to 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. A prohibited pyramid payment, or consideration, does not include payment for non-commissionable not for profit or at cost sales and marketing materials support. For purposes of this definition, sale of products or services to ultimate users include sales to participants, in reasonable amounts, for actual personal or family use in which purchases are not merely incidental to the business opportunity.
Another approach, and one with somewhat less ambiguity, but not necessarily following in the federal case evolution, is language adopted in more than a dozen state statutes, which recognizes personal use, so long as it is coupled with consumer safeguards to avoid inventory loading and to provide for a reasonable inventory repurchase policy. In 2014, the state of Tennessee adopted such a pyramid test:
|(8) "Pyramid promotional scheme":|
|(A) Means any plan or operation by which a participant gives consideration for the opportunity to receive compensation that is derived primarily from the introduction of other persons into the plan or operation rather than from the sale and consumption of goods, services, or intangible property by a participant or other persons introduced into the plan or operation; and|
|(B) Includes a plan or operation under which:|
|...(ii) A participant, on giving any consideration, obtains any goods, services, or intangible property in addition to the right to receive compensation.|
|(C) Nothing in this part may be construed to prohibit a plan or operation, or to define a plan or operation as a pyramid promotional scheme, based on the fact that participants in the plan or operation give consideration in return for the right to receive compensation based upon purchases of goods, services, or intangible property by participants for personal use, consumption, or resale so long as the plan or operation does not promote or induce inventory loading and the plan or operation implements an appropriate inventory repurchase program.|
|(House Bill 2356 approved by the Governor, April 25, 2014 and effective July 1, 2014)|
And perhaps a synthesis of the above two approaches would be appropriate for a long term policy.
The adoption of such "reconciliation" language would provide a great service to the direct selling industry and its distributors and customers to avoid the continuing rehash of whether or not such businesses are legitimate or pyramid schemes. And such model legislation would also drown the cacophony of direct selling critics who wreak havoc and turbulence on financial markets with respect to publicly traded direct selling companies.
Links to Resources posted at www.mlmlegal.com.
|FTC v BurnLounge Ninth Circuit Appeal Decision.|
|FTC v BurnLounge Trial Court Decision, for the mlmlegal.com analysis.|
|Herbalife: What Short Sellers Missed on the Way to the Press Conference, for a history of pyramid prosecutions and the personal use issue.|
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