The BurnLounge Prosecution Shows How and Why MLM Scams Flout the Law and the FTC

On July 1, 2011 – more than four years after the government brought charges — a federal judge ruled that the multi-level marketing company, called BurnLounge, Inc., operated as an illegal pyramid scheme. The ruling supported the prosecution of BurnLounge by the Federal Trade Commission (FTC). The case against BurnLounge was one of the rare prosecutions the FTC has brought against the ballooning multi-level marketing industry in recent years. Active prosecutions came to an abrupt halt in 2001 when President George W. Bush named an Amway-related attorney to head the FTC, and since then some FTC officials have become lobbyists for the MLM industry. So, this case was seen as significant and unusual. It was a rare prosecution, and even more rare, one that went all the way to a trial. It was reportedly prompted by the office of the South Carolina Attorney General. The state of South Carolina was a BurnLounge hotbed. The scheme’s superstar recruiter was a former U of SC football hero. In just a few years, he gained nearly a million dollars as a BurnLounge recruiter while the court found that at least 97% of all recruits lost money.

BurnLounge sold music downloads, like i-Tunes offers. It claimed to be a blend of i-Tunes, MySpace and PayPal, just as all MLMs claim to have some new or breakthrough business model. When it opened, BurnLounge was all the rage in the music industry, especially among aspiring musicians. BurnLounge spokesmen were famous role models for young people. Basketball star Shaquille Oneal was a spokesman along with actor and musician, Justin Timberlake. As noted, the hottest BurnLounge recruiter — and a defendant in the FTC prosecution — was former University of South Carolina football star, Rob DeBoer.

In its design, in reward plans, in company leadership and in its claims and promises. BurnLounge was created out of the common cloth of the MLM industry. It was not unusual. It was a typical scheme. The pay plan was classic MLM, including its “rollup” provisions so that when those below eventually quit (which most will ultimately do in all endless chain schemes) the rewards they generated flowed up to those above. In this way, the losses of the many at the bottom could continue to benefit the few at the top.

The scheme offered several entry packages, as most MLMs do, which were disguised as “product purchases.” They include products, but were clearly the price of admission to the pay scheme. The complex pay plan, described by the Judge as “byzantine” — as all MLM pay plans are — established levels of rewards based on sales volume and “structure” of recruitments, like all MLMs do. It used the common MLM trick of the “binary” plan, requiring the recruitment of two other participants for qualification, who must, in turn, do the same.

To a hopeful and uninformed musician or a needy consumer, BurnLounge looked legitimate! Some of the BurnLounge leaders were former founders and executives with Excel Communications, a legendary MLM that sold long distance phone service. Excel had never been prosecuted for fraud. It had risen like a rocket and made billionaires and millionaires of the founders and those who “got in early”. Could not BurnLounge do the same, with the same leadership? Excel fell just as quickly as it rose, eventually going into bankruptcy. The latter part of Excel’s story was seldom told. The founders of that short-lived scheme were presented as MLM heroes and they leveraged their fame for credibility in founding BurnLounge.

Hundreds, maybe thousands, of aspiring artists’ careers were derailed when they were led to believe that BurnLounge was their ticket to fame and success. No need to do concerts and market their albums. They could just buy into BurnLounge; build a downline of friends, family and a few fans, (if they had any); feature their own music on their BurnLounge website; and let the money roll in as the recruiting expanded “endlessly.” To get support and public attention for a personal music website is, of course, very difficult. But BurnLounge websites had the advantage of offering an income attraction to supporters. Followers could become marketers too and get a piece of the action as others joined later. They key was to get positioned early. Your best friend could be your ticket to wealth!

All these descriptions of BurnLounge seemingly add up to criminal fraud, a calculated plan to financially harm consumers with deception, and carried out on a colossal scale. Tens of thousands of people already were robbed in broad daylight. This would appear to be a clear and present threat to the community and a free and open marketplace. Yet the U. S. Justice Department never went after this fraud. Instead, the FTC brought civil charges under the FTC Act, citing Section 5, a broad provision against “unfair and deceptive trade practices.” The FTC claimed BurnLounge was a pyramid scheme, and therein lies the problem. In the eyes of the FTC, perpetrating an enormous pyramid scheme, such as BurnLounge, is not a crime, just an “unfair practice.”

You see, in America there is no law explicitly against running a pyramid scheme. In fact, there is no national law that even defines a pyramid scheme. Pyramid schemes cause extensive financial and social harm and require cruel and calculating deception. But, they are also magical cash machines for those who start them and join them early. With no crime associated with running such frauds, and such a powerful financial incentive for establishing them, it is perhaps understandable that an entire American “industry” would develop to run pyramid schemes, disguising them as legitimate businesses. To accomplish this, a specialized new business model developed in the late 1960s and 1970s, called “multi-level marketing.” The new model filled the void left by the absence of a clear-cut law against pyramid marketing. It disguised the money transfer in “endless chains” with product purchases, a form of money laundering.

To run these pseudo-businesses, like BurnLounge, the black arts of mass deception, mind control, camouflage, diversion, and evasion must be employed. People’s dreams of success and recognition are conjured. Group pressure is deftly manipulated to induce purchasing and recruiting, and a way of thinking and a language are taught that diverts the participants from seeing the true source of the promised profits — perpetual infusion of new investments from new investors.

Once this new industry was established, teams of lawyers specialized in obscuring and protecting pyramids were hired paid for with the ill-gotten funds. Police and politicians were bought off with same source of money. A trade organization on K Street in Washington DC, was taken over by the new pyramid selling businesses to pressure state and federal regulators and politicians to keep multi-level marketing “unregulated.” All this came about in the absence of an effective law against pyramids and little or no enforcement of broader anti-fraud laws applied to large-scale endless chain scams.

So, in 2007, the US government was severely handicapped in making its pyramid scheme case against BurnLounge. No one was to be charged with a crime. No one would go to jail. And, based on the FTC’s past performance, enforcement of a successful ruling would be neglected and would not prevent the leaders of this scheme from starting new ones, under new names. Perhaps some money might ultimately be recovered and returned to victims, but the FTC prosecution under Section 5 would do little or nothing to prevent more of the same type of schemes from continuing its virus-like spread. Past prosecutions under Section 5 have done nothing to stop the proliferation of pyramid schemes. Indeed they mushroomed during the Recession with their false income promises.

But, why did prosecution of BurnLounge take four years? The extreme delay is yet another sign of regulatory breakdown and consumer endangerment. Justice delayed is justice denied. But the delay may be explained by the nature of the government’s prosecution. Ruling on Section 5 of the FTC Act this Judge had to render an opinion about the nature of pyramid schemes without a law against them or even an FTC Rule that defines or bans them. He had to rely on confusing and inconsistent past court decisions. This required a tedious, painstaking, and time consuming analysis of superficial factors. For example, he had to ponder not just the actions and consequences, but also “motives” of the tens of thousands of consumers who signed up. Were they music lovers and seekers of quick fortune? What was the true value of the BurnLounge entry packages? He had to evaluate the market price of original works of art. How much is an unknown artist’s music worth? What about a future Bruce Springsteen? How much company revenue came from enrollment fees versus product sales, and what constitute a “product” sale? Was a purchase made by a salesperson a retail sale or part of a business investment? Could the average person make money, or was success reserved, by design, for the top levels? Even if 97% of those who joined lost money, and that percentage always would lose – as the data showed – is the business illegal? Were its income “testimonials” vicious lies or mere advertising “puffery”? Experts in music , finance, the law, and accounting testified, and some came to contradictory conclusions. Under the FTC Act, the determination of what a pyramid scheme is and how to identify one is like measuring how many angels can dance on the head of pin. And the outcome would have just about as much impact on people’s lives as that Medieval argument did.

And then, when all was said and done, if it were determined to be technically illegal under Section 5, exactly how much damage was caused? How should the harm be calculated? The Judge had to measure this in cold accounting — money paid in and money paid out, not true life terms. What is a derailed career worth? What price is applied to dashing a person’s life dreams? What about deferred education, divorces, family breakups due to people being induced to recruit loved ones into the fraud, their “warm list”? Finally, who was ultimately culpable, just the wily founders and top recruiters? What about those just below them who duped their friends and family? What about the sports stars and musicians and actors who served as pitchmen?

The Judge came to valid and obvious decision, but in the process, the core of the scam – business opportunity fraud — was neatly avoided, thus allowing such scams to continue. Already, the lawyers of other MLM schemes are plotting to re-interpret the “pyramid” decision and to add new levels of camouflage to avoid its possible implications for the similar schemes they represent.

We now all know about scams “too big to fail” but the proliferation of MLMs, hundreds of them that rope in millions of people and billions of dollars each year, implicating religious, sports, political and business leaders, points to scams “too big to jail.” Does the FTC dare acknowledge that its inaction in enforcement, its failure to promote an anti-pyramid marketing law and its negligence in adopting a rule for “business opportunity” scams have led to an epidemic of fraud in America? An epidemic that we have exported worldwide? Can it put the Genie back in the bottle?

The Judge’s decision was a vindication for the FTC and a victory for tens of thousands of consumers who were victimized, and many more who would have been victimized by BurnLounge if it had continued. But, the larger reality of this case is terribly different from that positive outcome. The facts of the case, the time taken for the prosecution, and the hair splitting analysis required of the Judge should be frankly recognized, not as a blow for consumer protection, but as a flaming indictment of flawed, inadequate regulation of pyramid selling schemes, called multi-level marketing.

The judge’s ruling on BurnLounge probably does provide more ammunition to the FTC for prosecuting some of the more obvious MLM scams, the ones that rely on their salespeople for virtually all their revenue, with little retail business and the ones whose products are obviously priced higher than similar goods, but only if the prosecutorial will of the FTC were strengthened.

Despite this favorable ruling by a federal court judge, signs indicate little change at the FTC. Ironically, the FTC staff has just announced that it opposes covering “multi-level marketing” under a proposed rule to regulate “business opportunity” schemes. So, the largest purveyor of business opportunities to consumers — the multi-level marketing industry — will be specifically exempted from the rule.

Despite taking four years to play out, the ruling does confirm that these blatant and obvious MLM scams — and there are so many of them — operate outside the law, function as calculated financial traps for millions of people, and are promoted by world class scam artists. The decision shows this to be true, even if the FTC never prosecutes the schemes and their cunning promoters smilingly assure people that they offer the ”greatest opportunity in the world