United States: 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.


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:

  1. They could simply buy music and merchandise.
  2. 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.
  3. 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, almost $26 million of which was attributable to membership package sales and membership fees.  More than 90% of members never recouped their investments, and the FTC's expert testified that, under the best of circumstances, 87.5% of members would not be expected to do so.  The expert reasoned that, as is generally true with pyramid schemes, the BurnLounge financial model required an open-ended ability to recruit new members to remain profitable beyond the first few levels of participation.

In 2007, the Federal Trade Commission filed suit against BurnLounge to enjoin its operations as illegal under Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45(a)(1), and to seek disgorgement from the company and various insiders to fund consumer redress.  By stipulated preliminary injunction the Mogul program was suspended and the assets of the individual defendants were frozen. 

In 2012, following a bench trial, the U.S. District Court for the Central District of California declared the entire BurnLounge operation to be an illegal pyramid scheme, based upon the finding that a "majority" of BurnLounge's business was derived from Moguls, and the Mogul program was itself an illegal pyramid scheme.  The district court also found the individual defendants jointly and severally liable for more than $16 million in disgorgement for consumer redress.


The U.S. Court of Appeals for the Ninth Circuit affirmed the district court's finding of a violation of the FTC Act and generally upheld the district court's imposition of a remedy.1 The appeals court applied the analysis it developed in Webster v. Omnitrition Int'l, Inc., 79 F.3d 776 (9th Cir. 1996), in which it found an MML program is an illegal pyramid scheme where participants pay the company for (1) the right to sell a product and (2) the right to receive compensation for recruiting other participants into the program, where such rewards are unrelated to sale of the product to ultimate users.

The first prong of the Omnitrition test was easily satisfied by the requirement that Moguls purchase a membership package to host webpages that would resell BurnLounge music, merchandise, and memberships. 

The appellate court also confirmed, after a much lengthier analysis, that the Mogul Program satisfied the second prong of the Omnitrition test, which the court construed as requiring that the "focus" of the program be the recruitment of new members, rather than to deliver profit from the sale of products or services to consumers.2  Thus, Moguls were required to recruit new members in order to obtain eligibility for several types of cash bonuses and were motivated to do so "primarily" by the opportunity to earn cash rewards.3  The court found evidence of this motivation in two facts:  dramatic differences in the package-purchasing patterns of Moguls and Independent retailers (who could not earn cash from recruiting), and the steep drop in BurnLounge's sales after the district court initially enjoined the Mogul program. 

The court of appeals also addressed the question of how to treat Moguls' purchases for their own use that were required before the Moguls could receive cash rewards.  To the extent such purchases were deemed sales to ultimate users, per Omnitrition's second prong, they would support the lawfulness of the program.  Rejecting the positions that both BurnLounge and the FTC advanced, the court acknowledged these purchases should be treated as having been made to "ultimate users," but ignored them under the Omnitrition analysis nevertheless because the purchases did not reflect "consumer demand for the merchandise."4

The Ninth Circuit's opinion hardly reflects an exercise in the drawing of bright lines, relying as it does on a standard that looks to the "focus" of the BurnLounge program and the "primary" reason why Moguls sought to recruit new members.  Indeed, the court expressly declined to provide further guidance, noting that because the program at issue "clearly" failed the Omnitrition test "we do not need to decide the degree to which rewards would need to be unrelated to product sales in a case presenting a closer question."5

Notably, the court of appeals did not base its liability finding on the district court's determination that the BurnLounge scheme was a financial success only for those at the top of the pyramid (the district court had found 93.84% of Moguls never recouped their investment). This may be viewed as suggesting that proof of the near-inevitability that a substantial number of participants in a scheme will not make money is not essential to a prima facie showing that a scheme is an illegal pyramid.  And at some level, this conclusion would be consistent with the mathematical fact that pyramid schemes can be profitable for all only on the assumption of a limitless supply of new members.  But with so much in the court's opinion left to judgment calls as to motivation and intent, it is fair to say that the facts of financial performance have not yet been rendered conclusively irrelevant.


While enforcement actions against pyramid schemes have been undertaken for decades, the application of that law to the online environment is still in its early days.  And there is reason to believe that more cases will follow, as social media and the availability of bulk spam emails offer two conditions that are essential to the creation and growth of pyramid schemes:  the ability of a promoter to reach many potential pyramid scheme participants at low cost, and the participants' timeless belief that they can do the same, and make a fortune in the process.  The potential significance of the BurnLounge opinion is underscored by the participation of the Direct Selling Association as amicus curiae.  Among other things, the association argued that the test ultimately embraced by the court of appeals was too broad, sweeping "many legitimate MLMs" into the category of illegal pyramids.6

Many business models prevalent on social media are MLMs.  Indeed, entire websites address the promotion of MLMs via social media.  See, e.g., http://www.mlmsocial.com/home.php (MLM Social:  The Social Network for Network Marketers).   For these entities, the BurnLounge decision will provide guidance but not complete peace of mind.  Also worth noting is the ease with which MLMs and pyramid schemes reaching U.S. consumers may be operated substantially or entirely offshore, complicating enforcement efforts.  Such complications can be significant, although as seen in certain cases of offshore gambling operations, the U.S. Government is willing to press difficult cases if sufficiently motivated.

Regardless, businesses concerned about enforcement efforts would be well advised to assess whether regulators might see their financial motivations as related primarily to the recruitment of more members, and the extent to which the model can be predicted to impose overwhelming odds of losses on a foreseeably significant number of participants. 

A copy of the published decision of the court of appeals on liability appears here, and its unpublished decision on remedies appears here.


1 The Court of Appeals remanded certain calculations to the district court for adjustment and/or clarification.

2 Slip Op. at 12-13, 15, 18.

3 The court of appeals' analysis also disposed of BurnLounge's argument that, taking the language of the second prong of the Omnitrition test literally, liability could only attach where members earned fees exclusively for recruiting new members.

4 Id. at 19.

5 Slip Op. at 18.

6 Id. at 18.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
21 Nov 2018, Seminar, New York, United States

“Big data” is changing our economy. It has allowed Amazon, Google, Facebook and many others to redesign traditional business models and to create new or improved products and services with greater utility for consumers and often at very little cost.

24 Nov 2018, Speaking Engagement, New York, United States

Each year, the New York Region of IFA hosts a panel and reception at the NYU Law School. This year’s panel will include a discussion of the TCJA international provisions.

27 Nov 2018, Speaking Engagement, New York, United States

Employment Managing Associates, Alexandra Stathpoulos and Alexandra Heifetz are presenting at the University of California, Berkeley School of Law’s FORM+FUND Series.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions