Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca9-12-56228/USCOURTS-ca9-12-56228-0/pdf.json

Nature of Suit Code: 890
Nature of Suit: Other Statutory Actions
Cause of Action: 

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FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

FEDERAL TRADE COMMISSION,

Plaintiff-Appellee,

v.

BURNLOUNGE, INC., a Corporation;

JUAN ALEXANDER ARNOLD, an

individual,

Defendants-Appellants,

and

JOHN TAYLOR, an individual; ROB

DEBOER, an individual,

Defendants.

No. 12-55926

D.C. No.

2:07-cv-03654-

GW-FMO

FEDERAL TRADE COMMISSION,

Plaintiff-Appellee,

v.

BURNLOUNGE, INC., a Corporation;

JUAN ALEXANDER ARNOLD, an

individual, ROB DEBOER, an

individual,

Defendants,

No. 12-56197

D.C. No.

2:07-cv-03654-

GW-FMO

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2 FTC V. BURNLOUNGE, INC.

and

JOHN TAYLOR, an individual,

Defendant-Appellant.

FEDERAL TRADE COMMISSION,

Plaintiff-Appellant,

v.

ROB DEBOER, an individual,

Defendant-Appellee,

and

JOHN TAYLOR, an individual,

Defendant,

BURNLOUNGE, INC., a Corporation;

JUAN ALEXANDER ARNOLD, an

individual,

Defendants.

No. 12-56228

D.C. No.

2:07-cv-03654-

GW-FMO

OPINION

Appeal from the United States District Court

for the Central District of California

George H. Wu, District Judge, Presiding

Argued and Submitted

December 6, 2013—Pasadena, California

Filed June 2, 2014

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FTC V. BURNLOUNGE, INC. 3

Before: Harry Pregerson, Marsha S. Berzon,

and Morgan Christen, Circuit Judges.

Opinion by Judge Christen

SUMMARY*

Federal Trade Commission

The panel affirmed the district court’s order granting a

permanent injunction against BurnLounge, Inc.’s continued

operation based on the court’s holding that BurnLounge’s

multi-level marketing business was an illegal pyramid

scheme in violation of § 5(a) of the Federal Trade

Commission Act. 

BurnLounge operated a multi-level marketing business

that offered participants the ability to become “Independent

Retailers” of music and other merchandise. Independent

Retailers could earn points redeemable for music or

merchandise, or they could pay an additional fee to become

“Moguls” and earn cash rewards.

The panel held that BurnLounge’s scheme satisfied both

prongs of the Webster v. Omnitron International, Inc., 79

F.3d 776 (9th Cir. 1996), pyramid scheme test because

Moguls paid for the right to sell products, the rewards

BurnLounge paid were primarily for recruitment, and Moguls

were clearly motivated by the opportunity to earn cash

* This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.

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4 FTC V. BURNLOUNGE, INC.

rewards from recruitment. The panel also held that the

district court did not abuse its discretion in admitting the

Federal Trade Commission’s expert testimony because the

testimony was relevant and reliable.

COUNSEL

Lawrence B. Steinberg (argued) and Efrat M. Cogan,

Buchalter Nemer, P.C., Los Angeles, California, for

Defendants-Appellants BurnLounge, Inc. and JuanAlexander

Arnold.

W. James Jonas III, W. James Jonas III, P.C., San Antonio,

Texas, for Defendant-Appellant John Taylor.

No appearance for Defendant/Cross-Appellee Rob DeBoer.

Burke W. Kappler (argued), Attorney; John F. Daly, Deputy

General Counsel for Litigation; and David C. Shonka, Acting

General Counsel, Federal Trade Commission, Washington,

D.C.; Chris M. Couillou and Dama J. Brown, Federal Trade

Commission, Atlanta, Georgia, for Plaintiff-Appellee/CrossAppellant Federal Trade Commission.

M. Jeffrey Hanscom and Joseph Mariano, Direct Selling

Association, Washington, D.C.; Deborah T. Ashford, Philip

C. Larson, and Catherine E. Stetson, Hogan Lovells US LLP,

Washington, D.C., for Amicus Curiae Direct Selling

Association.

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FTC V. BURNLOUNGE, INC. 5

OPINION

CHRISTEN, Circuit Judge:

BurnLounge, Inc. operated a multi-level marketing

business that offered participants the ability to become

“Independent Retailers” of music and other merchandise. 

Independent Retailers could earn points redeemable for music

or merchandise, or they could pay an additional fee to

become “Moguls” and earn cash rewards. The Federal Trade

Commission filed suit against BurnLounge alleging violation

of § 5(a) of the Federal Trade Commission Act (FTCA). 

Section 5(a) states: “unfair or deceptive acts or practices in or

affecting commerce, are hereby declared unlawful.” 

15 U.S.C. § 45(a)(1). The operation of a pyramid scheme

constitutes an unfair or deceptive act or practice in or

affecting commerce for the purposes of § 5(a). See In re

Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1178, 1181

(1975).

BurnLounge, Juan Alexander Arnold (CEO and creator of

BurnLounge), and John Taylor (participant in the

BurnLounge scheme) appeal the district court’s order

granting a permanent injunction against BurnLounge’s

continued operation based on the court’s finding that

BurnLounge was an illegal pyramid scheme. BurnLounge

and Arnold also appeal the district court’s denial of their

motion to exclude the testimony of Dr. Peter Vander Nat, the

FTC’s expert. We have jurisdiction over this appeal pursuant

to 28 U.S.C. § 1291. We agree with the district court that

BurnLounge was an illegal pyramid scheme in violation of

the FTCA because BurnLounge’s focus was recruitment, and

because the rewards it paid in the form of cash bonuses were

tied to recruitment rather than the sale of merchandise. We

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6 FTC V. BURNLOUNGE, INC.

also hold that the district court did not abuse its discretion by

admitting Vander Nat’s testimony because his testimony was

relevant and reliable. Accordingly, we affirm on these issues. 

We discuss the district court’s consumer harm calculation and

the FTC’s cross-appeal in a separate memorandum

disposition.

I. BACKGROUND

BurnLounge operated from 2005 to 2007 and sold music,

music-related merchandise, and packages of music-related

merchandise. Customers could participate in BurnLounge in

three ways: they could buy music and merchandise; they

could buy a package to become an Independent Retailer with

the ability to earn credits redeemable for music and

merchandise; or they could buy a package and pay an

additional fee to become a Mogul with the ability to earn

credits redeemable for cash. In 2007, the FTC commenced

this action and the parties stipulated to a preliminary

injunction that prohibited BurnLounge from continuing to

operate its Mogul program. After a bench trial, the district

court concluded that BurnLounge and the individual

defendants had violated FTCA § 5(a), issued a permanent

injunction, and imposed monetary awards against the

defendants.

A. BurnLounge’s Business

1. The basics of BurnLounge

The evidence at trial showed that BurnLounge’s business

had two primary aspects—its Retailer program and its Mogul

program. Individuals could become Independent Retailers of

online music by purchasing one of BurnLounge’s three

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FTC V. BURNLOUNGE, INC. 7

packages: Basic ($29.95 per year); Exclusive ($129.95 per

year plus $8 per month); or VIP ($429.95 per year plus $8 per

month). Each package provided the Retailers with access to

a ready made and customizable web page, called a

“BurnPage.”1 A BurnPage was the vehicle through which

Retailers sold music, music-related merchandise, or packages

of music-related merchandise to customers in return for

“BurnRewards.” More expensive packages included more

merchandise for personal use by the Retailer.2

Individuals

who participated as Retailers could redeem BurnRewards for

music or merchandise.

Retailers could pay an additional monthly fee of $6.95 to

become Moguls. Once qualified, Moguls could redeem

BurnRewards for cash rather than music or merchandise.3

The Mogul program was the only aspect of BurnLounge that

the district court found to be a pyramid; accordingly, this

opinion focuses on the Mogul program.

1 These web pages were technically called “BurnLounges,” but the

district court called them“BurnPages” to avoid confusion. We followthat

convention.

2 For example, the Basic package included a sample copy of

BurnLoungeMagazine and an annual subscription toBurnLounge’s online

publication; the Exclusive package added a monthly DVD and other

merchandise; and the VIP package added an event pass and the

BurnLounge University DVD set.

3

In addition to buying a package and paying the monthly Mogul fee, to

become qualified to redeem BurnRewards for cash a Mogul had to:

(1) sell two Exclusive or VIP product packages; (2) sell two music albums

to non-Moguls; and (3) on a continuing basis, have sold at least two

albums to non-Moguls in the previous month.

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8 FTC V. BURNLOUNGE, INC.

2. BurnLounge bonuses

BurnLounge offered Moguls the opportunity to earn three

types of BurnRewards bonuses that could be redeemed for

cash. Each type of bonus had a separate set of requirements

that had to be met before Moguls were eligible to receive the

bonus.

a. Concentric Retail Bonuses

Moguls received “Concentric Retail Bonuses” for music,

merchandise, and package sales made through their own

BurnPage and through the BurnPages of their downline

recruits. Downline recruits included participants recruited by

Moguls and those recruited by earlier recruits. This sequence

created a hierarchy, with those whom a Mogul directly

recruited in the first “Ring” of the hierarchy, those whom the

recruits recruited in the second Ring of the hierarchy, and so

on, for up to six Rings. To qualify for a Concentric Retail

Bonus for sales made by recruits in each Ring of the

hierarchy, a Mogul had to sell at least the number of packages

corresponding to that Ring number. For example, to qualify

for Concentric Retail Bonuses for sales made by recruits in

the fourth Ring, a Mougl had to sell at least four packages. 

The Mogul also had to have made a certain number of music

album sales in the previous month, and the Mogul’s hierarchy

must have made a certain number of album sales in the

previous month.

b. Product Package Bonuses

Moguls received “Product Package Bonuses” for selling

product packages. Moguls received these bonuses in

increasing amounts for the sale of Basic, Exclusive, and VIP

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FTC V. BURNLOUNGE, INC. 9

packages ($10, $20, and $50 respectively). To qualify for

this bonus, Moguls must have sold at least two music albums

to non-Moguls in the previous month and have a positive

BurnRewards account.4

c. Mogul Team Bonuses

Moguls earned “Mogul Team Bonuses” by accruing

“Mogul Team Points.” Mogul Team Points were accrued by

selling premium packages (Exclusive or VIP). Once a Mogul

accrued enough Mogul Team Points, the points were

automatically converted into a Mogul Team Bonus paid in

BurnRewards, which could be converted to cash. The amount

of cash earned for each Mogul Team Bonus depended on the

type of package the Moguls originally purchased and the

amount of music the Moguls sold. A VIP Mogul, who paid

the $429.95 yearly fee, could earn a $50 bonus with no

additional music sales. An Executive Mogul, who paid the

$129.95 yearly fee, could earn a $25 bonus, or a $50 bonus if

that Mogul also sold $500 worth of music. A Basic Mogul,

who paid the $29.95 yearly fee, was not eligible for a Mogul

Team Bonus unless that Mogul sold $500 worth of music (for

a $25 bonus) or $1,000 worth of music (for a $50 bonus).5

4 All Retailers and Moguls had BurnRewards accounts, which were like

bank accounts for the BurnRewardsthey earned or purchased with a credit

card.

5 BurnLounge argues on appeal that the district court did not take into

account the fact that, in 2006, it made a major policy change to the sales

requirements for receiving bonuses. BurnLounge failed to raise this issue

until its Rule 59 motion. The district court rejected it because

BurnLounge could have raised the issue at trial. Even though this issue

was not fully litigated in the district court, we have considered it and

conclude that it does not change our analysis.

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10 FTC V. BURNLOUNGE, INC.

B. District Court Proceedings

After a bench trial, the district court issued a statement of

decision. It provides a comprehensive review of

BurnLounge’s merchandise, bonus system, and advertising

materials. The district court described BurnLounge’s bonus

system as “a labyrinth of obfuscation.” It found there was a

93.84% failure rate for all Moguls, meaning 93.84% of

Moguls never recouped their investment. The district court

also found that BurnLounge’s marketing focus was on

recruiting new participants through the sale of packages. The

district court ruled that BurnLounge’s expert, David Nolte,

provided estimated values of the merchandise in the

BurnLounge packages that were not credible or supported by

the evidence. It found that BurnLounge’s products had some

value, but concluded that the evidence did not support a

finding that the products were worth what was charged for

them.

The district court found that because purchasing a

package was required for participation as a Retailer or Mogul,

and because Moguls earned cash for selling packages,

“[Moguls] by default received compensation for recruiting

others into the program.” The district court concluded that “a

majority of the BurnLounge business (consisting of the

Mogul program and related elements) was a pyramid

scheme.”

II. STANDARD OF REVIEW

We review a district court’s findings of fact after a bench

trial for clear error. See Fed. R. Civ. P. 52(a)(6); Allen v.

Iranon, 283 F.3d 1070, 1076 (9th Cir. 2002). Under this

deferential standard “we will accept the [district] court’s

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FTC V. BURNLOUNGE, INC. 11

findings of fact unless we are left with the definite and firm

conviction that a mistake has been committed.” Allen,

283 F.3d at 1076. We review the district court’s conclusions

of law de novo. FTC v. Garvey, 383 F.3d 891, 900 (9th Cir.

2004). We review the district court’s decision to admit expert

testimony for abuse of discretion. Gen. Elec. Co. v. Joiner,

522 U.S. 136, 143 (1997).

III. DISCUSSION

In Webster v. Omnitrition International, Inc., our court

approved the FTC’s test for determining whether a multilevel marketing (MLM) business is a pyramid scheme: a

pyramid scheme is “characterized by the payment by

participants of money to the company 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.” 79 F.3d 776, 781 (9th Cir. 1996) (quoting

Koscot, 86 F.T.C. at 1180). Not all MLM businesses are

illegal pyramid schemes. To determine whether a MLM

business is a pyramid, a court must look at how the MLM

business operates in practice. See id. at 783–84; see also

United States v. Gold Unlimited, Inc., 177 F.3d 472, 479–82

(6th Cir. 1999); In re Amway Corp., 93 F.T.C. 618, 716

(1979).

A. Prong 1: Participants in the BurnLounge business

paid money in return for the right to sell a product.

Moguls were required to purchase a package (Basic,

Exclusive, or VIP) in order to access a BurnPage. BurnPages

provided Moguls with the ability to sell music, merchandise,

and packages. The sale of packages thus conveyed “the right

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12 FTC V. BURNLOUNGE, INC.

to sell a product,” which satisfies the first prong of

Omnitrition. 79 F.3d at 781 (citation omitted).

B. Prong 2: BurnLounge participants paid money in

return for the right to receive rewards for recruiting

other participants into the program, which were

unrelated to the sale of the product to ultimate users.

Satisfaction of the second prong of the Omnitrition test is

“the sine qua non of a pyramid scheme” and is characterized

by “recruitment with rewards unrelated to product sales.” Id.

at 781. In Omnitrition, this court found that a MLM business

was a pyramid scheme because “[t]he mere structure of the

scheme suggests that Omnitrition’s focus was in promoting

the program rather than selling the products.” Id. at 782

(emphases in original). The FTC has explained that in a

pyramid, “participants purchase the right to earn profits by

recruiting other participants, who themselves are interested in

recruitment fees rather than the sale of products.” Amway,

93 F.T.C. at 716–17.

Here, the FTC presented ample evidence to support the

district court’s finding that BurnLounge was an illegal

pyramid scheme. It did so by showing that: (1) Moguls were

required to recruit new members in order to become eligible

for all three types of cash bonuses and (2) Moguls were

motivated by the opportunity to earn cash rewards, as shown

by data illustrating the sharp difference in package purchasing

patterns of Moguls and non-Moguls, and by the fact that

BurnLounge’s sales plummeted after the Mogul program was

enjoined.

We agree with the district court that the FTC provided

sufficient evidence to prove that BurnLounge’s focus was

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FTC V. BURNLOUNGE, INC. 13

recruitment and that the rewards it paid, in the form of cash

bonuses, were primarily for recruitment rather than for sales

of merchandise. Recruiting was built into the compensation

structure in that recruiting led to eligibility for cash rewards,

and more recruiting led to higher rewards. For example,

Moguls could not convert their rewards to cash until they

became qualified Moguls, and Moguls had to sell two

premium packages to become qualified. Selling packages

was a way of recruiting new Moguls—in fact, it was the only

form of recruitment—because purchasing a package was

necessary to become a Mogul and earn cash rewards. Also,

96.8% of the participants who bought packages became

Moguls, which is strong evidence that package purchases

were motivated by the opportunity to earn cash.

Moguls were required to sell packages to receive

Concentric Retail Bonuses at each level of their downline

hierarchy. Product Package Bonuses were cash rewards

received for selling packages to new members. Moguls

received more lucrative bonuses if they sold premium

packages. Moguls were also eligible to receive Mogul Team

Points, with the goal of receiving Mogul Team Bonuses, by

selling packages to new participants. The district court found

that Mogul Team Bonuses were “[t]he most lucrative.” This

finding is supported by the record: in 2006, BurnLounge paid

a total of $2,726,965.50 in Concentric Retail Bonuses and

four times that amount, nearly$8,480,975.00, in Mogul Team

Bonuses. Concentric Retail Bonuses were paid for the sale of

music and packages (though the bonus was based on only a

percentage of the first $29.95 of each package). In contrast,

Mogul Team Points accrued only for the sale of packages, so

they primarily rewarded recruiting new participants. The fact

that BurnLounge paid approximately four times more in

Mogul Team Bonuses than Concentric Retail Bonuses

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14 FTC V. BURNLOUNGE, INC.

supports the district court’s finding that Moguls had a strong

incentive to recruit new participants. This incentive was the

danger our court warned of in Omnitrition, where we stated,

“The promise of lucrative rewards for recruiting others tends

to induce participants to focus on the recruitment side of the

business at the expense of their retail marketing efforts,

making it unlikely that meaningful opportunities for retail

sales will occur.” Omnitrition, 79 F.3d at 782 (citing Koscot,

86 F.T.C. at 1181).

That BurnLounge motivated Moguls through cash

rewards earned by recruiting other participants is exemplified

by the sharp difference between Moguls’ and non-Moguls’

package purchase patterns. BurnLounge’s own data showed

that 67% of Moguls bought VIP packages, 28.8% bought

Exclusive packages, and just 4.2% bought Basic packages. 

In contrast, 17.3% of non-Moguls bought VIP packages,

17.2% bought Exclusive packages, and 65.5% bought Basic

packages. If package purchases were driven by the value of

the merchandise included in the packages rather than by the

opportunity to earn cash rewards, one would expect to see

comparable numbers of Moguls and non-Moguls buying the

same packages. Further, 96.6% of non-Moguls (56,017

people) did not purchase any of the packages at any

time—they just bought music and other merchandise.

The district court’s finding that BurnLounge paid rewards

for recruitment unrelated to product sales is also supported by

the effect the preliminary injunction had on BurnLounge’s

revenues. After the parties entered into a stipulated

preliminary injunction in July 2007 that stopped BurnLounge

from offering the ability to earn cash rewards, BurnLounge’s

revenues plummeted. BurnLounge still offered packages, but

its revenues decreased from $476,516 in June 2007 to

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FTC V. BURNLOUNGE, INC. 15

$10,880 in August 2007. The dramatic decline in revenue

after the ability to earn cash rewards was eliminated provides

further evidence that the sale of BurnLounge packages was

primarily directed at participants who were interested in the

Mogul program, where it was possible to earn cash rewards.

Recruiting and rewards for recruitment were integral to

BurnLounge’s business structure, and there was ample

evidence that Moguls were meant to be, and were, primarily

motivated by the opportunity to earn cash rewards for

recruitment. As in Omnitrition, the evidence in this case

shows that BurnLounge’s “focus was in promoting the

program rather than selling the products.” Omnitrition,

79 F.3d at 782 (emphases in original). The district court did

not err by holding that BurnLounge was an illegal pyramid

scheme.

1. The Omnitrition test does not require that the

rewards be completely unrelated to the sale of

products.

BurnLounge argues that the second prong of the

Omnitrition test “requires that the rewards be completely

unrelated to sales of bona fide products.” The second prong

of the pyramid test requires the FTC to show that the scheme

provides “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.” Id. at 781 (citation

omitted). This test does not require that rewards be

completely unrelated to product sales, and BurnLounge

provides no support for its argument that the test should be

interpreted this way.

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16 FTC V. BURNLOUNGE, INC.

First, reading “completely” into the test would be

inconsistent with the outcome in Omnitrition. See id. at 782

(holding Omnitrition was likely a pyramid scheme because

of its recruitment focus, notwithstanding the fact that

Omnitrition made some retail sales).

Second, courts applying the Koscot/Omnitrition test have

consistently found MLM businesses to be illegal pyramids

where their focus was on recruitment and where rewards were

paid in exchange for recruiting others, rather than simply

selling products. See Gold Unlimited, 177 F.3d at 476, 481

(affirming conviction based on finding that participants

bought gold and received cash payments for recruiting others

to both buy gold and recruit others to do so, because rewards

were paid for recruitment rather than product sales); Stull v.

YTB Int’l, Inc., No. 10-600-GPM, 2011 WL4476419, at *4–5

(S.D. Ill. Sept. 26, 2011) (denying motion to dismiss where

plaintiffs adequatelyalleged that pyramid existed by showing

focus on recruitment and payment of rewards in return for

product sales, because buying the product was synonymous

with being recruited into the scheme); FTC v. Equinox Int’l

Corp., VC-S-990969HBR(RLH), 1999 WL 1425373, at *6

(D. Nev. Sept. 14, 1999) (ordering preliminary injunction

after finding Equinox was likely a pyramid because “rewards

are received by purchasing product and recruiting others to do

the same”); In re Holiday Magic, Inc., 84 F.T.C. 748,

1028–30 (1974) (finding a pyramid where rewards were paid

to participants when they recruited others, and recruits also

had to purchase product); Peterson v. Sunrider Corp., 48 P.3d

918, 930 (Utah 2002) (“Even where a marketing plan

formally bases commissions on sales, the plan may still be

found illegal if, in practice, profits come primarily from

recruitment.”) (applying federal law to interpret Utah’s

Pyramid Scheme Act); cf. Amway, 93 F.T.C. at 715–17

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FTC V. BURNLOUNGE, INC. 17

(finding no pyramid where rewards were paid for product

sales and not for the mere act of recruiting others).

Third, in Koscot, participants joined the scheme by

buying inventory, and participants earned rewards by

recruiting others to join the scheme, i.e., by getting recruits to

buy inventory. Koscot, 86 F.T.C. at 1178–79. BurnLounge

participants joined the scheme by buying packages, which

included a BurnPage and merchandise. Participants earned

rewards by recruiting others to join the scheme, i.e., by

recruiting new participants to buy packages. In each of these

scenarios, the participants sold something (inventory or

packages), but the rewards the participants received in return

were largely for recruitment, not for product sales.

In contrast, in Amway the FTC found that a MLM

business was not an illegal pyramid scheme. Amway, 93

F.T.C. at 716–17. Though Amway created incentives for

recruitment by requiring participants to purchase inventory

from their recruiters, it had rules it effectively enforced that

discouraged recruiters from “pushing unrealistically large

amounts of inventory onto” recruits. Id. at 716. BurnLounge

argues that “[t]he only difference between Amway and

BurnLounge is that BurnLounge did not require inventory

purchases.” This argument is unpersuasive because

BurnLounge required Moguls to purchase a product package

to get the chance to earn cash rewards, provided cash rewards

for the sale of packages by a Mogul’s recruits, and had no

rules promoting retail sales over recruitment.

The second prong of the Omnitrition test does not require

that rewards for recruiting be “completely” unrelated to the

sale of products. If it did, any illegal MLM business could

save itself from liability by engaging in some retail sales. 

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18 FTC V. BURNLOUNGE, INC.

Such an outcome would be clearly contrary to our case law:

a pyramid scheme “cannot save itself simply by pointing to

the fact that it makes some retail sales.” Omnitrition, 79 F.3d

at 782.

The rewards BurnLounge paid were primarily for

recruitment, not for the sale of products. Because the

outcome in this case is clear under 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.

2. The meaning of “ultimate users.”

BurnLounge also argues “that the existence of internal

consumption (in this case a Mogul’s purchase of a product

package for use, not resale) does not constitute proof of a

pyramid.” Likewise, the Amicus and Appellant Taylor argue

that if internal sales do not count as sales of products to

ultimate users for the purpose of calculating rewards, then

many legitimate MLMs will be incorrectly characterized as

pyramids. These arguments also arise from the second prong

of the Omnitrition test: “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.” Id. at

781 (citation omitted).

BurnLounge claims that when recruits bought packages,

they were “ultimate users” and it argues that since these sales

were to “ultimate users,” any rewards paid on these sales

were related to the sales of products to ultimate users. The

FTC counters that “internal sales to other Moguls cannot be

sales to ultimate users consistent with Koscot.” Neither of

these arguments are supported by the case law.

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FTC V. BURNLOUNGE, INC. 19

In Koscot, the FTC found a cosmetics MLM business was

a pyramid scheme because it focused on recruiting new

participants, rather than encouraging retail sales to

consumers, and new participants had to buy large amounts of

inventory, ostensibly for resale. 86 F.T.C. at 1179. When

participants in Koscot bought inventory, they could have used

some of it personally, arguably making them “ultimate

users.” In Amway, though some internal consumption of

inventory was common, Amway was not found to be an

illegal pyramid scheme. See Amway, 93 F.T.C. at 716–17,

725 n.24. BurnLounge is correct that when participants

bought packages in part for internal consumption (to obtain

the ability to sell music through BurnPages and to use the

package merchandise), the participants were the “ultimate

users” of the merchandise and that this internal sale alone

does not make BurnLounge a pyramid scheme. But it is

incorrect to conclude that all rewards paid on these sales were

related to the sale of products to ultimate users.

Whether the rewards are related to the sale of products

depends on how BurnLounge’s bonus structure operated in

practice. See Omnitrition, 79 F.3d at 781. In practice, the

rewards BurnLounge paid for package sales were not tied to

the consumer demand for the merchandise in the packages;

they were paid to Moguls for recruiting new participants. 

The fact that the rewards were paid for recruiting is shown by

the necessity of recruiting to earn cash rewards and the

evidence that the scheme was set up to motivate Moguls

through the opportunity to earn cash. Rewards for recruiting

were “unrelated” to sales to ultimate users because

BurnLounge incentivized recruiting participants, not product

sales. The FTC and other courts have consistently applied the

Omnitrition test in this way. See Gold Unlimited, 177 F.3d at

476, 481; Stull, 2011 WL 4476419, at *4–5; Equinox Int’l,

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20 FTC V. BURNLOUNGE, INC.

1999 WL 1425373, at *6; Holiday Magic, 84 F.T.C. at

1028–32; Peterson, 48 P.3d at 930.

BurnLounge and Arnold cite a passage from an FTC

advisory letter, Exhibit 3 at trial, to argue that proof of

internal consumption does not establish that BurnLounge was

a pyramid. Read in its entirety, the relevant passage of the

letter is consistent with the district court’s analysis. The

relevant passage reads:

Much has been made of the personal, or

internal, consumption issue in recent years. In

fact, the amount of internal consumption in

any multi-level compensation business does

not determine whether or not the FTC will

consider the plan a pyramid scheme. The

critical question for the FTC is whether the

revenues that primarily support the

commissions paid to all participants are

generated from purchases of goods and

services that are not simply incidental to the

purchase of the right to participate in a

money-making venture.

As discussed above, the rewards BurnLounge paid to Moguls

were primarily in return for selling the right to participate in

the money-making venture—the Mogul program. The

merchandise in the packages was simply incidental.

The district court correctly applied the Omnitrition test

and its conclusion that BurnLounge was an illegal pyramid

scheme was amply supported by the evidence. The fact that

some sales occurred that were unrelated to the opportunity to

earn cash rewards does not negate the evidence that the

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FTC V. BURNLOUNGE, INC. 21

opportunity to earn cash rewards was the major draw of the

BurnLounge Mogul scheme.

C. Vander Nat’s Testimony

BurnLounge and Arnold moved to strike the testimony of

FTC expert Dr. Peter Vander Nat as inadmissible under

Daubert v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579

(1993).6 The district court denied the motion. The district

court did not abuse its discretion by admitting Vander Nat’s

testimony, and we affirm its ruling.

The admission of expert testimony is governed byFederal

Rule of Evidence 702. The Supreme Court in Daubert held

that “the trial judge must ensure that any and all scientific

testimony or evidence admitted is not only relevant, but

reliable.” 509 U.S. at 589. This is a flexible inquiry and

several factors must be considered. Id. at 593–94. In Kumho

Tire Co., LTD v. Carmichael, the Supreme Court held that the

trial court’s gatekeeping function explained in Daubert

applies not only to scientific testimony, but to all expert

testimony. Kumho Tire, 526 U.S. 137, 147 (1999). And the

Court emphasized that the Daubert factors are not an

exhaustive checklist; rather, the trial court must base its

inquiry on the facts of each case. Id. at 150. When we

consider the admissibility of expert testimony, we are mindful

that there is less danger that a trial court will be “unduly

impressed by the expert’s testimony or opinion” in a bench

trial. Shore v. Mohave Cnty., State of Ariz., 644 F.2d 1320,

1322–23 (9th Cir. 1981).

6 Although Taylor briefed this issue on appeal, we can find no record

that he joined the motion in the district court.

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22 FTC V. BURNLOUNGE, INC.

Vander Nat’s testimony was relevant because he testified

about whether BurnLounge was a pyramid and about the

amount of consumer harm. His testimony was also reliable

given his doctorate in economics and advanced degree in

mathematics, which he called on to interpret BurnLounge’s

sales data; his previous experience analyzing pyramids; his

previous experiences testifying in court in five similar cases

and providing expert deposition testimony in seven similar

cases; his published article on the difference between

pyramids and legal MLMs; and his personal experience

spending several weeks analyzing BurnLounge’s business

model.

BurnLounge and Arnold argue that the district court’s

reliance on Vander Nat’s mathematical projections and

formulas was an abuse of discretion because “Ger-Ro-Mar

teaches that the math is not itself sufficient.” BurnLounge’s

reliance on Ger-Ro-Mar, Inc. v. FTC, 518 F.2d 33 (2d Cir.

1975), is misplaced. In that case the Second Circuit found

that the FTC “relied solely upon an abstract mathematical

theorem without any attempt to relate the theory to the

marketplace.” Id. at 38. Here, the FTC used Vander Nat’s

analysis of BurnLounge’s own data to show how

BurnLounge’s business worked in practice. BurnLounge’s

data convincingly illustrated the disproportionate rate at

which Moguls were motivated by the chance to earn cash

rewards rather than the merchandise BurnLounge included in

the packages. Vander Nat was qualified to testify and it was

proper for the district court to decide that his testimony would

be helpful to the trier of fact (here the court). See Daubert,

509 U.S. at 591–92.

BurnLounge and Arnold also argue that Vander Nat did

not base his analysis on the definition of “pyramid” accepted

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FTC V. BURNLOUNGE, INC. 23

by this court in Omnitrition, and that he used his own fourpronged test. This argument fails because Vander Nat

testified about pyramids in terms that do not materially differ

from those used by this court in Omnitrition: he explained

that a “pyramid scheme is an organization in which the

participants obtain their monetary rewards primarily through

enrolling new people into the program rather than selling

goods and services to the public.” The “four-prong test”

referred to by Appellants included Vander Nat’s

consideration of BurnLounge’s terms and conditions,

marketing materials, an optimal scenario for the BurnLounge

model (illustrating the results if all participants performed at

their best), and BurnLounge’s sales data. This was not a new

four-prong test, and Vander Nat’s consideration of these

characteristics of the business was permissible. The Sixth

Circuit relied on similar expert testimony regarding a MLM

business’s “marketingmaterials, organizational structure, and

recruiting policies” in another pyramid case. See Gold

Unlimited, 177 F.3d at 475, 481.

Finally, BurnLounge had a sufficient opportunity to cast

doubt on Vander Nat’s testimony at trial because it crossexamined him for two days. See De Saracho v. Custom Food

Mach., Inc., 206 F.3d 874, 880 (9th Cir. 2000).

We conclude that the district court did not abuse its

discretion by admitting Vander Nat’s testimony given the

flexible inquiry permitted by Daubert and Kumho’s

instruction that trial courts base their inquiry on the facts of

the case.

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24 FTC V. BURNLOUNGE, INC.

IV. CONCLUSION

We affirm the district court’s holding that BurnLounge

was an illegal pyramid scheme, in violation of § 5(a) of the

FTCA. BurnLounge’s scheme satisfied both prongs of the

Omnitrition test because Moguls paid for the right to sell

products, the rewards BurnLounge paid were primarily for

recruitment, and Moguls were clearly motivated by the

opportunity to earn cash rewards from recruitment. We reject

the argument raised by BurnLounge and Arnold that the

district court abused its discretion when it admitted Vander

Nat’s testimony because the testimony was relevant and

reliable. The district court’s decision as to these two issues

is AFFIRMED.7

7 We discuss the district court’s consumer harm calculation and the

FTC’s cross-appeal in a separate memorandum disposition.

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