The Positive Implications Of FTC v. BurnLounge For Direct Sellers

In FTC v. BurnLounge—after providing a crash course on pyramid schemes and how to properly distinguish a pyramid from a legit multi-level marketing (MLM) operation—the Ninth Circuit upheld the district court's finding that BurnLounge's business constituted an illegal pyramid scheme in violation of Section 5(a) of the Federal Trade Commission Act. In doing so, however, the court was careful to make clear that internal sales (i.e. sales of products to recruits) are properly classified as sales to "ultimate users" and, thus, do not by themselves constitute a pyramid scheme. This aspect of the court's decision is a big victory for direct sellers, who rely on and are motivated by sales to downstream recruits but whose primary motivation is for the sales of products versus merely signing up new recruits.

BurnLounge operated a multi-level marketing business that offered participants the ability to become retailers of music and other merchandise ("Merchandise") by purchasing a package. Packages provided participants with a webpage and the right to sell Merchandise through the webpage. Participants were compensated for selling Merchandise and also for selling packages to new participants. By default, payment was in the form of points redeemable for more Merchandise, but for an additional monthly fee, participants could convert their points to cash, which was the preferred choice for the vast majority of participants. Specifically, participants could be paid in three ways:

Concentric Retail Bonuses. These bonuses were based on Merchandise sales made on the participant's webpage and on the webpage of downstream recruits up to six degrees away. The latter was only available if the participant sold the same number of packages as the number of degrees away the recruit was. In other words, for a participant to be paid for sales made by a direct recruit's recruit (two degrees), the participant must have also previously sold at least two packages. Product Package Bonuses. These were paid for selling packages to new recruits with some incidental requirements that Merchandise also be sold. Mogul Team Bonuses. These were paid solely for selling premium packages to new recruits regardless of whether Merchandise was ever sold. To determine whether BurnLounge was an illegal pyramid scheme, the court applied a two-prong test developed by the FTC and adopted by the Ninth Circuit in Webster v. Omnitrition, 79 F.3d 776 (9th Cir. 1996). The test asks whether...