Monday, June 18, 2007

FTC Attempts To Snuff Burnlounge

Hot off the press from Len Clements, Len has been gracious enough to let me post the full version of his most recent update on Burnlounge.

When You Play With Fire...

June 18th, 2007Early last week the Federal Trade Commission announced that they had filed a complaint in a U.S. District Court of California against BurnLounge, Inc. (actually filed on June 6th), a multilevel reseller of downloadable music via "online music stores". The FTC alleges that BurnLounge is an illegal pyramid scheme and is seeking a permanent injunction against the company (halting it's business). According to the FTC, the BurnLounge sales pitch "represented that participants in BurnLounge were likely to make substantial income." BurnLounge recruited participants, says the FTC, by selling them tiered priced "product packages" that are offered for as much as $429.95 per year. The higher priced packages provided BurnLounge distributors with a higher paying status in the BurnLounge compensation plan. The FTC asserts that the BurnLounge compensation plan "primarily provided payments to participants for recruiting of new participants, not on the retail sale of products or services". The FTC has asked the court to halt the "deceptive practices and misrepresentations" and to freeze the defendant's assets (to preserve them for eventual consumer redress). On June 8th the FTC attempted to get the court to issue a temporary restraining order against BurnLounge, which was denied. The Judge ordered that a hearing on the FTC's request for a preliminary injunction and asset freeze would be held this Tuesday (June 19). In addition to naming BurnLounge Inc., the complaint also named Juan (Alex) Arnold, their CEO and Chairman, as well as three high level distributors. BurnLounge announced the resignation of Mr. Arnold today, June 18th. The FTC also acknowledged in their Press Release the "invaluable assistance of the Office of the Attorney General of South Carolina." BurnLounge is a Delaware corporation based in New York City. You can view the FTC's Press Release here:

The actual complaint can be viewed here:

BurnLounge has responded that "We are absolutely certain that our model will stand up to the most rigorous scrutiny", and that, "If there are changes to our operating structure that are warranted and appropriate, we'll consider them."

BurnLounge's public response can be viewed here:

Commentary: In the vast majority of service based MLM programs (long distance calling, legal assistance, medical discount programs, travel, etc.) the actual product or service sold is of such low margin, or low overall cost, that no substantial multilevel income can be derived from it. For example, if an online shopping mall company were to receive an optimistic 15% affiliate fee for all sales made via the malls of each rep, they would likely need to keep 10% (67% of the affiliate fee) to run their business leaving only 5% to pay out in the pay plan. So even if the plan paid 10% down eight levels, this generous appearing plan would actually be paying out 80% of 5% of the sales made through the mall itself (that's a total 4% pay out). Same with a long distance reseller, which maybe gets 1¢ of every 6¢ charged per minute, which is what they would have to run their company on and, with what's left over, pay out in their pay plan.

So how does a company that's paying 5-25% on a $10-$50 monthly sale compete with the "pills & potions" companies that typically pay 40-55% on $75-$150 in monthly sales? They add a "training fee" or some other one time, upfront fee that usually ranges from $100 to the legally mandated limit (for non-franchise opportunities) of $499.99. Then bonuses are paid from this fee which is where the most substantial income is derived.

The challenge with this is that, based on many years of legal precedent, paying compensation for the act of recruiting new distributors is indicative of an illegal pyramid scheme. When this compensation is paid from a purchase that only a distributor would make, even if it's for a genuine product of value, that is still a reward for recruiting since there is no other way to earn the bonus other than to recruit. For example, Equinox actually had fine products. But they were closed down by the FTC (mid-90s) because most of the income was being earned by new distributors "buying in" for $5,000 to over $20,000 in product, which obviously is sales volume only a new recruit would generate. A better example is FutureNet, which sold $195 WebTVs. Since they only got a small piece of the margin on each unit sold, and only part of that went into the pay plan, no significant income could be made by just selling Web TVs. So they added a $495 "internet training" package that new distributors could purchase. That's where the real money was being made - until the FTC shut them down for being an illegal pyramid.

Does BurnLounge do this? Unfortunately yes, it appears they do.

Remember those $29.95 to $429.95 "product packages" offered to new enrollees? BurnLounge not only pays one time bonuses to the sponsor on these packages, they pay monthly commissions upline on them through a binary pay plan. In their own FTC response they claim:

"Our free business model is based on revenue from music and movie downloads. For users who want more features and products, we offer other fee-based packages with extra products such as BurnLounge Presents, BurnLounge University and BurnLounge EventPass."

The FTC seems to be eyeing these music downloading "stores" the same way they viewed the online malls in the cases of BigSmart,, and several others. These web sites are essentially sales aids - and MLM companies are not suppose to pay commissions on sales aids (because only distributors would buy them, thus you must recruit to earn money on them).

The only way BurnLounge will be able to justify paying commissions on these packages is to convince the judge that a very significant number of people are buying these packages who have no interest in the business opportunity. That is, they will have to sell the judge on the idea that money can be made by selling these packages without the act of recruiting a new distributor. That's going to be a very tough sell.

It's amusing how BurnLounge, in direct response to the FTC's action, describes their willingness to "consider" making changes that they feel are "warranted and appropriate". That's not how it really works with the FTC. Most likely, here's what I think will happen: 1) BurnLounge will have to remove the "product packages" from their compensation plan, and by doing so will avoid a permanent injunction; 2) The remaining income potential will not be sufficient to maintain a viable network marketing opportunity; 3) BurnLounge will either add many more tangible products to their program or, most likely, will abandon the MLM model and go direct sales (those licenses they possess are far too valuable to just give up).

We should know soon. I'll let you know what happens after the Tuesday hearing.
Len Clements MarketWave, Inc.

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