In the Matter of the Complaint Against

COLLEGEDALE DIVERSIFIED ENTERPRISES, INC.
P. O. Box 1143
at Collegedale, TN 37315

P.S. Docket No. 14/29;
12/10/82

APPEARANCES FOR COMPLAINANT:
Thomas A. Ziebarth, Esq.
Consumer Protection Division
Law Department
United States Postal Service
Washington, DC 20260

APPEARANCE FOR RESPONDENT:
James D. Purple, Esq.
428 McCallie Avenue
Chattanooga, TN 37402-2009

Findings of Fact

Conclusions of Law

Appeal (1983)

INITIAL DECISION

This proceeding was initiated on August 5, 1982, when the Consumer Protection Division, Law Department, U. S. Postal Service ("Complainant"), filed a Complaint which alleges that Respondent is engaged in conducting (1) a scheme or device for obtaining money or property through the mails by means of false representations and (2) a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. § 3005. Specifically, the Complaint alleges in Count I, paragraph 3 that Respondent falsely represents that:

(a) Each distributor participating in Respondent's program is likely to be able to sponsor ten new distributors; and

(b) Each distributor participating in Respondent's program is likely to earn substantial sums of money--as much as $44,000.

Count II of the Complaint alleges that Respondent knowingly seeks remittances of money through the mails by means of false representations made by Respondent's distributors at its express direction. Count III alleges that Respondent's "multi-level marketing distributorship program" contains the elements of prize, chance, and consideration, and therefore constitutes a lottery or scheme for the distribution of money by chance through the mails. In its timely filed Answer, Respondent denied any violation of § 3005.

A hearing was held by the undersigned on September 22, 1982, in Knoxville, Tennessee. Both parties were represented by Counsel and afforded full opportunity to be heard, adduce relevant evidence and examine and cross-examine witnesses. Both parties filed proposed findings of fact and conclusions of law on November 2, 1982, which have been duly considered. To the extent indicated below, proposed findings and conclusions have been adopted; otherwise they have been rejected as irrelevant or contrary to the evidence. Based on the entire record herein, including my observation of the witnesses and their demeanor, the exhibits and other relevant evidence adduced at the hearing, I make the following findings of fact and conclusions of law:

Findings of Fact

1. Respondent is Collegedale Diversified Enterprises, Inc., P. O. Box 1143, Collegedale, TN 37315. Respondent obtains money through the mails at that address in connection with its multi- level marketing plan for the sale of fire extinguishers and burglar alarms (Tr. 17, 76; Exh. A; Exh. 1).

2. Respondent operates a mail-order business selling inexpensive fire extinguishers and burglar alarms. Respondent markets its products by allowing each purchaser to become a distributor for the company. A purchaser-distributor is provided with brochures which he shows to prospective purchasers. The brochure describes how a purchaser-distributor will receive commissions not only from sales made directly by him, but also from sales made by his distributors and subsequent distributors in his chain through five levels. In this regard, Respondent's brochure describes the manner in which one becomes a distributor and earns commissions (Exh. 1):

   Here's how the program works. When you order your product(s) you can enroll as a distributor by signing the agreement at the top of the order form. Upon receipt of your order, you'll be assigned a distributor number which you'll be sent along with your product and 10 copies of the brochure you are now reading for each product you order. Simply print your distributor number on each form and pass them out to your friends. (Additional brochures may be ordered at $.10 each or $.05 each in quantities of 100 or more and you may distribute as many as you wish.)

   You will receive $.50 commission on each 20 oz. fire extinguisher, $.75 on each 40 oz. fire extinguisher and $1.25 on each Automatic Alarm ordered by these people and $.50, $.75 or $1.25 commission on each order by the people they enroll and so on, through a total of 5 levels. When you order, you're enrolled under the person whose distributor number appears on this form and he will earn $.50, $.75 or $1.25 commission as will the person who sponsored him, and so on, through 5 levels up. This means we pay a total of $2.50, $3.75 or $6.25 commission on each product.

3. Prior to January 1982, Respondent's brochure offered only one type of fire extinguisher, for which a commission of $.40 was paid for each order (Tr. 63; Exh. A). The brochure described how a purchaser could make $44,444 in commissions simply by sponsoring ten new distributors. It was explained that a purchaser would make $4 at level one ($.40 x 10 distributors). Then, if his ten new distributors each enrolled an additional ten, the brochure noted that there would be 100 new orders at level two and that his commission would be $40. The brochure then described how a purchaser would make $400 and $4,000 at levels three and four, respectively. Finally, the brochure indicated that if every one of those distributors had enrolled ten new distributors, then the original purchaser would be paid $40,000 in commissions for 100,000 new orders at level 5. The brochure then stated " t hat is a total of $44,444 and your hardest work would be giving our brochure to the original ten you enrolled" (Exh. A).

4. The brochure that has been in use since January of 1982 eliminates the dollar amounts that a purchaser-distributor would make if every distributor in his chain was able to make a certain number of sales. Instead, the new brochure (Exh. 1) begins with the following bold-faced message: "IF YOU DON'T READ THIS YOU COULD BE A REAL LOSER." It then states that Respondent "OFFERS YOU A RARE OPPORTUNITY." It states that Respondent's multi-level distributor- ship "could make you rich... and could provide you with income for the rest of your life." Thereafter, the reader is told:

   Your earnings grow rapidly. Get your pencil and calculator ready. Choose the number of people you feel you could interest in ordering at least one of our products. Multiply this number by the commission $.50, $.75 or $1.25 for each and the total will be your earnings on level 1.

   Thereafter, the brochure takes the reader step by step in a similar manner through each of the remaining four levels so that he will get an idea of how much money he will make.

   The new brochure then states:

   ...The program is simple, easily understood and it really works... No real selling is involved. You just give the brochure to friends and the product and marketing program practically sell themselves.

   ...We, quite honestly have a product and program where everyone wins, and that's the way we like it. Order now and find out how well this program works for you.

   We're expecting a long and profitable relationship together.

5. The final page of the brochure consists of an order form and the following distributor enrollment agreement which must be signed by each prospective distributor:

   I understand that as a nonexclusive distributor for Collegedale Diversified I am not an employee, agent, or representative of Collegedale Diversified Enterprises or any other distributor within the Collegedale network. I further understand that each distributor will be operating as an independent contractor fully responsible for paying his own expenses and that Collegedale Diversified Enterprises will not be responsible for any claims made on behalf of the product or distribution program other than those set forth in writing in company literature.

6. After setting forth the prices of the products offered, the order form instructs the prospective purchaser-distributor to remit the price of the product and add a certain amount for postage and handling. Although each product comes with ten sales brochures, additional brochures can be purchased for $.10 each, or $.05 each for 100 or more brochures (Exh. 1).

7. At least a portion of the money paid to Respondent by a purchaser constitutes consideration for participation in Respondent's pyramid scheme. In this regard, Respondent's brochure makes it clear that a participant who remits, for example, $6.95 when ordering a 20 oz. fire extinguisher, receives not only the product, but a distributor number and ten copies of the brochure to enable participation in the marketing program (see first quoted paragraph in Finding of Fact No. 2, supra).

8. Respondent's president occasionally "allowed" a person to become a distributor without buying a product (Tr. 75). This was clearly an exception to his normal method of doing business, and the brochure did not even mention this possibility. A distributor was expected to buy a product and use it as a sample. However, even nonpurchasing distributors furnished valuable consideration to Respondent as a prerequisite to receiving commissions; they had to execute a distributor's contract, buy brochures, and secure additional buyer-distributors.

9. Respondent keeps a record of all distributors in each of the five levels under each purchaser-distributor. A distributor may obtain a computer printout of the names of the distributors in his chain for a $.50 charge (Exh. 1).

10. Since the degree of success of an individual distributor depends largely upon the number of distributors in his chain, his chance of success necessarily diminishes as the market becomes saturated with new distributors (Tr. 17).

11. Since Respondent began its business in May of 1981, it has acquired about 10,000 distributors (Tr. 66-68). During the time that the company has been in business, Respondent has paid out a total of about $10,000 in commissions to its distributors (Tr. 80-81). The most successful distributor has earned about $1,000, two others have earned about $500 each, and ten others have earned about $250 each (Tr. 80-81). These 13 individuals account for about $4,500 of the total commissions paid. The remaining $5,500 was disbursed by the company to the remaining 9,987 distributors earned an average of only $.55 in total commissions from Respondent.

12. Respondent's marketing program constitutes a lottery or scheme for the distribution of money by chance.

Conclusions of Law

1. The first issue for consideration is whether Respondent violated 39 U.S.C. § 3005, which provides for a mail stop order when it is found that . . .any person is engaged in conducting. . . a lottery, gift enterprise, or scheme for the distribution of money or of real or personal property, by lottery =, chance, or drawing of any kind. . . .

   The necessary elements of a "lottery" are the furnishing of a consideration, the offering of a prize, and the distribution of the prize by chance. Brooklyn Daily Eagle v. Voorhies, 181 F. 579, 581 (1910); Tenpen Sales Corporation, P.O.D. Docket No. 2/35 (May 10, 1961).

2. The instant case is factually similar to Tenpen Sales Corporation, supra. That case involved a scheme in which a typical purchaser, "A", buys a pen from one of the company's distributors for $1 to be used as a sample. "A" then becomes a distributor by purchasing five more pens from the company for $1 each which he sells for the same price to five new purchasers. His purchasers then each become distributors who follow the same procedure, i.e., each finds five more buyer-distributors. This procedure is repeated through seven levels. "A" receives 5% commission, or $.25 (5% x $5.00), for each sale made by any distributor in his chain within seven levels. According to the brochure, if every distributor in "A's" chain followed the instructions and arranged for the sale of five pens, a total of 97,655 orders would be placed and "A" would earn $24,413.75. The Judicial Officer held that the three elements of a lottery were present in Tenpen since "A" had paid a few dollars as consideration for the chance to receive thousands of dollars in commissions for sales over which he had no control.

3. Subsequent to the Judicial Officer's decision in Tenpen Sales Corporation, supra, the Tenth Circuit held that a similar marketing scheme constituted a lottery. Zebelman v. United States, 339 F.2d 484 (10th Cir. 1964). In that case, each person who purchased an automobile from the company also became a distributor. He would receive $100 for every new participant that he found who bought a car and became a distributor. Each time these new participants found an additional buyer, the original buyer-distributor received $50. The scheme was considered to be a lottery. The Court held that the receipt of the $50 payments was a matter of chance since the original buyer could not control whether the buyers he found would be able to find additional buyers.

   In view of the above cases, it is clear that the amount of commissions that a buyer-distributor will receive in Respondent's scheme is dependent upon chance. Like a chain letter, a distributor's success depends upon the efforts of future distributors over whom he has little or no control. Respondent seeks to distinguish Zebelman from the instant case by arguing that Respondent's computer removes the element of chance. I disagree. The fact that a participant is able to obtain a computer printout that will identify all distributors in his chain does not enable him to control whether sales will be made by those distributors. Those sales still remain a matter of chance.

4. Respondent also argues that the scheme does not contain the requisite element of consideration. Again, I must disagree. Respondent's brochure makes it clear that a participant must order a product, and after remitting money to Respondent, receives not only the product, but a distributor number and ten copies of the brochure to enable participation in the marketing scheme. Thus it is reasonable to conclude that a portion of the price is paid for participation in the pyramid scheme. When determining the existence of a lottery, the element of consideration is still considered to be present even though the purchaser receives merchandise or other property in addition to his chance to win a prize. Horner v. United States, 147 U. S. 449 (1893); Tenpen Sales Corporation, supra. The same conclusion has been reached where the purchaser receives, in addition to the merchandise or other property, a "free" chance in a drawing. F.C.C. v. American Broadcasting Co., 347 U.S. 284, 290 n. 8 (1953). Moreover, in addition to the above remittance, a person who desires to take advantage of the scheme also must furnish valuable consideration to Respondent by executing a distributor's agreement and securing additional buyer-distributors for Respondent's products.

5. In view of the foregoing, I must conclude and hold that Respondent's scheme contains the elements of a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. § 3005. Having reached this conclusion, it is unnecessary for me to decide the false representation issues raised by Counts I and II of the Complaint.

6. The attached order should be issued against Respondent.

Complaint Against Collegedale Enterprises Appeal (1983)

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