Earlier this week, the Federal Trade Commission (FTC) filed its reply brief (attached) with the Ninth Circuit in the BurnLounge appeal.  In all, there are positives and negatives for the industry in the brief.

As you will recall, DSA’s amicus brief (attached as filed 1/11/13) took no position on the merits of BurnLounge, instead the brief focused solely on the ramifications of an overly broad application of one sentence in the definition of a “Prohibited Marketing Scheme” in the District Court’s amended final judgment and order that was the subject of this appeal: “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 sentence has potentially significant adverse consequences for DSA’s many legitimate direct-selling company members because it appears to prohibit compensation based on purchases by participants or on sales by one participant to another.  

DSA’s amicus aimed to educate the Ninth Circuit on the possible ramifications of the single sentence and its potential to harm hundreds of legitimate businesses—and millions of their consumers and salespersons—by endorsing the conclusion that legitimate direct-selling companies that base compensation at least in part on product purchases by direct salespersons for their personal consumption and use are unlawful “pyramid schemes.”

The FTC relied heavily on the earlier decisions in Koscot and Omnitrition to address the definition of a pyramid scheme in its brief:

A pyramid scheme arises where individuals pay money to a business “in return for which they receive (1) 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.”

Relying on the In re Amway decision of 1979, the FTC outlined its view on what differentiates a legitimate MLM company from a pyramid scheme stating:

the primary purpose of a pyramid scheme[s] is to reward associates for the recruitment of others, while the purpose of legitimate MLMs is to encourage retail sales to end-consumers.

Additionally, the FTC argued the facts of BurnLounge are distinguishable from those in Amway in that BurnLounge had no policies in place to prevent inventory loading and to promote retail sales. 

The FTC’s brief discussed the issue of internal consumption on pages 33 – 47.  Of some concern is the FTC’s analysis of what constitutes sales to “ultimate users.”  The FTC cites the Ninth Circuit’s language in Omnitrition, stating:

this Court in Omnitrition definitively ruled that “ultimate users” are the external customers for the business’s ostensible product, not the business’s own internal sales force.

However, in line with DSA’s amicus brief, the FTC goes on to state:

Taylor [defendant] objects to the court’s definition of “Prohibited Marketing Scheme” in the Final Amended Order and Judgment. Taylor Br. 13. He claims that this definition, which excludes internal sales from “sales to ultimate users,” will have a “potentially significant adverse consequences” if it used to classify as a pyramid every activity where one participant sells to another.

But this definition is already embedded in the definition of a pyramid scheme. Omnitrition, 79 F.3d at 783. And the district court’s order, when read in context, clearly ties the definition of sales to rewards for recruiting consistent with governing law; it is not a blanket prohibition on paying rewards for internal sales. Dkt. 474 at 5 [3 ER 0028]. More importantly, this definition was formulated by the court under its broad authority to fashion relief after finding that BurnLounge had violated Section 5. As such, it is well within the court’s remedial discretion in this case, regardless of the proper treatment of “internal” sales in other contexts.  Indeed, this order is consistent with orders entered in other pyramid scheme cases, including Koscot itself. See Koscot, 86 F.T.C. at 1186, ¶ 2, 1975 WL 173318, *63.  For these reasons, Taylor’s argument about potential consequences is without basis. (emphasis added)

These statements bolster our argument regarding internal consumption as the FTC illustrates the definition of sales used by the District Court is “not a blanket prohibition on paying rewards for internal sales.”  Additionally, the FTC’s argument of the definition being properly formulated by the Court after finding BurnLounge had violated Section 5 is consistent with DSA’s brief stating “That prohibition has been used as a remedial measure in certain circumstances involving proven pyramid schemes.”

Overall, there are a number of points in the brief with which the industry can agree.  Based on the FTC’s arguments, it is certainly foreseeable for the Ninth Circuit to find for the FTC, upholding the District Court’s findings that BurnLounge is a pyramid scheme, while at the same time supporting the position put forth in DSA’s brief regarding internal consumption as the two are not mutually exclusive.

We will be scheduling a meeting of the Lawyers Council presently to discuss the FTC’s brief and DSA members’ analysis of it.