Ninth Circuit Agrees With FTC That Online Marketing Program Was An Unlawful 'Pyramid Scheme'

The legal status of many membership programs promoted via social media and spam has been called into question by a recent decision of the U.S. Court of Appeals for the Ninth Circuit, which affirmed a judgment that one such program was an illegal pyramid scheme. The Ninth Circuit's statement of the law provides useful guidelines but few bright-line tests, and promoters of business models that rely upon the recruitment of new members by current members would be well advised to evaluate their programs in light of the new guidance. In 2012, we wrote about a district court decision in a case brought by the Federal Trade Commission finding that a membership-based online music marketing program was an illegal "pyramid scheme." With the affirmance of that decision, we return to the case to review the Court of Appeals' restatement of the characteristics of an illegal pyramid scheme in the online context, and to underscore that the very characteristics of online marketing programs that make them attractive (and sometimes lucrative) to promoters also create unique legal risks.

1. BACKGROUND

   From 2005 to 2007, a company called BurnLounge sold music and music-related merchandise through its website. In addition, it promoted a business opportunity in which customers could themselves become resellers of the same music and music-related merchandise, and participate financially in the recruiting of new members. Customers could do business with BurnLounge in three ways:

   They could simply buy music and merchandise. They could buy a membership package to become an "Independent Retailer," in connection with which they would be supplied with a template to set up their own retail web pages to sell music and merchandise. Independent retailers earned money from their direct sales and also earned credits, redeemable only for music and merchandise, for selling membership packages to new customers. They could buy a membership package and pay more money to become a "Mogul." Moguls earned money from their direct sales and, unlike Independent Retailers, could obtain cash for selling membership programs to new customers. BurnLounge thus operated as a "multi-level marketing" ("MLM") scheme: its business model involved a parent organization and the recruitment of distributors who in turn earned compensation by recruiting additional distributors. Over the course of its two-year life, BurnLounge signed up more than 60,000 members and took in revenues of more than $28 million...