Case 2:07-cv-03654-GW-FMO Document 431 Filed 07/01/11 Page 1 of 31 Page ID #:4082
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF CALIFORNIA
FEDERAL TRADE COMMISSION,
Plaintiff,
v.
BURNLOUNGE, INC., et al.,
Defendants.
No. CV 07-3654-GW(FMOx)
STATEMENT OF DECISION
Case 2:07-cv-03654-GW-FMO Document 431 Filed 07/01/11 Page 2 of 31 Page ID #:4082
FEDERAL TRADE COMMISSION v. BURNLOUNGE, INC. et al., Case No. 07-3654
STATEMENT OF DECISION
Plaintiff Federal Trade Commission (“FTC”) brought this action claiming that Defendants BurnLounge, Inc. (“BurnLounge”), its Chief Executive Officer and Chairman – Juan Alexander Arnold (“Arnold”), and independent retailers John Taylor (“Taylor”) and Rob DeBoer (“DeBoer”) violated Section 5(a) of the Federal Trade Commission Act (“FTC Act”), 15 U.S.C. § 45(a), by promoting a pyramid scheme, making deceptive income claims, and failing to disclose (when soliciting consumers to participate in the BurnLounge program) that participants were not likely to earn any substantial income. The matter proceeded to a bench trial on December 9, 2008, which concluded on December 22, 2008. During the trial, the Court received live and deposition testimony of 28 witnesses, including Defendants Arnold, DeBoer, and Taylor, and three expert witnesses. Following the trial, the Court requested and received supplemental briefs. After carefully considering the testimony of the witnesses, the joint stipulations of fact by the parties, the exhibits introduced into evidence, the pre- and post-trial written submissions of the parties, and the oral arguments of counsel, the Court issues the following Statement of Decision.
I. FINDINGS OF FACTS
(a) Venue and Jurisdiction
Venue in this District is proper pursuant to Section 13(b) of the FTC Act (15 U.S.C. § 53(b)) and 28 U.S.C. § 1391. All Defendants do not reside in the same judicial district, but a substantial portion of the events giving rise to the claimed violations have occurred in the Central District of California. Defendant BurnLounge promoted, recruited, sold, and operated its business in the Central District. Declaration (“Decl.”) of Bruce Gale, Trial Exhibit (“Ex.”) 347 ¶ ¶ 2-7, 9; Exs. 1-3 & 8, § 7.1.2; Decl. of Michael Liggins, Ex. 337, ¶ 8; Decl. of Michael Marino, Ex. 349, ¶ 5; Ex. 33, p. 21; Decl. of Roberto Menjivar, Ex. 351, ¶¶ 2, 7; Ex. 37, pp. 45, 53. BurnLounge also operated a customer service office in Rancho Santa Margarita, California. See Transcript of the Trial Testimony (“Tr.”) of Bernard Rivera, Day 2 PM at 14:11-23; Ex. 242, p. 3. In addition, Arnold (BurnLounge’s CEO) resides in this District. See Final Pretrial Conference Order (Proposed) (“FPO”), Stip. 5(e) at page 3, Docket Item Number (“Doc. No.”) 353-2; Arnold Tr. Day 3 PM at 136:23-24.
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(b) The Parties
Plaintiff FTC is an independent agency of the United States created by the FTC Act. 15 U.S.C. § 41. The FTC is charged with enforcement of Section 5(a) of the FTC Act, 15 U.S.C. § 45(a), which prohibits unfair and deceptive acts and practices in and affecting commerce. FPO, Stip. 5(a)-(b).
Defendant BurnLounge is a Delaware corporation that began making sales in late 2005. FPO, Stip. 5(c)-(d). BurnLounge had net revenues as follows: $2,158,027 in 2005, $19,158,872 in 2006, and $6,830,764 in the first six months of 2007. Exs. 64, 66. More than 60,000 people paid to participate in the BurnLounge enterprise. Ex. 1051.
Defendants Arnold, Taylor and DeBoer all promoted the BurnLounge business opportunity. DeBoer Tr. Day 3 PM at 34:17-35:25; Taylor Tr. Day 2 PM at 125:11-126:19; Arnold Tr. Day 4 AM at 61:25-62:21.
Defendant Arnold is and was the CEO and Chairman of the Board of Directors of BurnLounge. FPO, Stip. 5(c)-(d). During his tenure, he earned $593,732.01 in salary and bonuses. Richard Piemonte Tr. Day 8 at 139:15-143:17. He also received reimbursements for certain business expenses. FPO, Stip. 5(h). Arnold beneficially owned 43.7 percent of the voting stock of BurnLounge. Ex. 242, p. 47; see also Ex. 242, p. 31. BurnLounge was the brainchild of Arnold (Arnold Tr. Day 3 PM at 142:25-143:5), and he was its “boss” and “ultimate authority.” Stephen Murray Tr. Day 6 PM at 41:15-19; Arnold Tr. Day 4 AM at 12:3-15.
Defendant Taylor is a resident of Houston, Texas. John Taylor Tr. Day 2 PM at 120: 17-19; FPO, Stip. 5(j). He was a BurnLounge “VIP Mogul” (which is defined in subsections (d), (c) and (h), infra). Taylor Tr. Day 2 PM at 124:9-10. He held the first position in the binary structure of BurnLounge’s compensation plan and sometimes referred to himself as “Retailer 001.” Id. Day 2 PM at 124:11-20; see also Ex. 330 at page 2 marked as D0016447. Taylor’s income from BurnLounge totaled $620,139.64. Id. Day 2 at 152:17-21; Ex. 191. He was not an employee or an officer of the company. Taylor had participated along with Arnold in various “network marketing” companies between 1995 and 2004. Id. Day 2 PM at 121:7-122:21. Taylor also assisted in raising capital funds for BurnLounge and owned stock and stock options in the company. Id. Day 2 PM at 123:18-124:8.
Defendant DeBoer is a resident of Irmo, South Carolina. DeBoer Tr. Day 3 PM at 29:7-8; FPO, Stip. 5(j). He first became involved with BurnLounge on a part-time basis in October of 2005. Id. Day 3 PM at 34:17-21 and 93:8-24; FPO, Stip. 5(k). He had no prior dealings with either Arnold or Taylor. He did not leave his prior employment with a sports equipment marketing company associated with the University of South Carolina and began working full-time as a BurnLounge independent retailer until March of 2006. Id. Day 3 PM at 29:12-15, 95:4-6. His income earned from BurnLounge totaled $909,293.69. Id. Day 3 PM at 37:4-10. He was not an employee, officer, decision maker or shareholder of the company. Id. Day 3 PM at 95:12-24. Although he did attend and give presentations at some BurnLounge events across the country, he made his own
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arrangements and paid his own expenses. Id. Day 3 PM at 96:3-14.
(c) The BurnLounge Concept
BurnLounge was allegedly envisioned as a retailer of digital content designed to integrate music downloads, social networking, and entrepreneurship through the creation of multiple, customized, online purchase points. See Ex. 1 at 20 (“What we’re doing at BurnLounge [is] combining … the digital downloads of iTunes, the entrepreneurship of eBay, and the connectivity, the social networking of … MySpace.”) The company licensed music from the five major record labels through an agreement with LoudEye and (later) Muze. Murray Tr. Day 6 AM at 120:18-121:2, 150:12-151.3, Day 6 PM at 93:21-94:17; Ryan Dadd Tr. Day 7 at 5:19-8:9, 12:20-13:13, 111:15-18. This license accounted for a myriad of major and independent recording label artists’ songs, which BurnLounge customers could purchase typically for $0.99 per song or $9.90 per album. (But see footnote 11, infra.) Marie Jimenez Tr. Day 7 at 158:4-7; see also Ex. 8, § 6.2.2. Before this action was filed, BurnLounge purportedly had agreements in place to add movies, advertising, and other digital content to its offerings; but supposedly due to the present dispute, none of these items were ever actually in place to be sold at retail. Murray Tr. Day 6 PM at 7:12-8:10, 50:14-52:3; Dadd Tr. Day 7 at 83:16-84:20.
Defendants marketed BurnLounge as a “Multi-Level Marketing” (“MLM”) business opportunity from September 2005 through June 2007, when this action was filed. Ex. 330. They recruited participants to the program by selling “turn-key” (i.e. ready to begin operating) websites which allowed users to customize their own online music store by choosing the layout, appearance, and featured music. See section 1.2 of BurnLounge, Inc.: Statement of Policies and Procedures (“BurnLounge Policies”) which was admitted at trial as Exhibit 8; Bernie Rivera Tr. Day 2 PM at 58:23-59:18; Taylor Tr. Day 2 PM at 153:14-154:2. Purchasing a website was one of the prerequisites to become a BurnLounger Retailer (i.e. one who could earn the equivalent of non-cash credits towards the purchase of BurnLounge’s products and services) or a “Mogul” (i.e. one who had the rights to possibly earn monetary commissions from BurnLounge). Ex. 8 § 2.2-2.2.1. During this time BurnLounge was in operation, 60,269 people joined the enterprise as “Moguls.” Ex. 331.
(d) The BurnLounge System
BurnLounge created a network of web pages (“BurnPages”) for the sale of digital music downloads and other products. See Ex. 8 § 1.2. To sell its music, BurnLounge made exclusive use of independent BurnLounge “Retailers” who managed their own BurnPages, selected music to feature and otherwise customized the appearance of their sites. Rivera Tr. Day 2 PM at 58:23-59:18; Taylor Tr. Day 2 PM at 153:14-154:2; see
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also Ex. 8 § 1.2. Customers wishing to purchase music from BurnLounge could not purchase it from the company directly, but had to visit the BurnPage of an independent Retailer/Mogul. Ex. 8 § 1.2
Retailers paid a fee of $29.95 per year to operate their BurnPages. Ex. 8 § 2.5; see also DeBoer Tr. Day 3 PM at 84:19-24. In addition to music, Retailers could sell “product packages,” which gave purchasers the ability to become Retailers themselves and create their own BurnPages. Ex. 8 § § 2.1, 2.3. Product packages could not be purchased directly from the company but only through the BurnPages of a sponsoring independent Retailer/Mogul. Id. at § 2.3.
There were three product packages available to consumers: “Basic” ($29.95), “Exclusive” ($129.95 plus $8.00 per month), and “VIP” ($429.95 plus $8.00 per month). FPO, Stip. 5(t)-(v). The Basic Package consisted of: 1) a turn-key BurnPage, 2) editing and customization software, 3) access to the BurnLounge resource center, 4) a sample copy of “BurnLounge Magazine,” and 5) an annual subscription to “FrontBurner Magazine,” which was an online website. FPO Stip. 5(t); Murray Tr. Day 6 PM at 21:4-15. The Exclusive Package added: 1) a year-long subscription to “BurnLounge Presents” which was a monthly bundle of 10 songs selected by BurnLounge and available for download by the Retailer, 2) a monthly DVD featuring mostly independent artists, again selected by BurnLounge’s A&R Department, and 3) an annual subscription to “BurnLounge Magazine.” FPO Stip 5(u). The VIP Package added: 1) the “Event Pass” which provided for, among other things, front-of-the-line admission and access to VIP lounges at certain concert events, mostly at venues operated by Live Nation such as the “House of Blues” music halls and various amphitheaters (Caroline Burruss Tr. Day 6 PM at 113:11-17, 117:22-118:18), and 2) “BurnLounge University,” a boxed set of six educational DVDs documenting the history of the music industry. FPO, Stip. 5(v).
Anyone who operated a BurnPage was designated as a “Retailer” at no additional charge and could see products through his/her e-commerce website in return for “Burn-Rewards” but could not (without more) participate in the BurnLounge Compensation Plan for cash payments. FPO, Stip. 5(w). To be eligible to participate in the cash portion of the Compensation Plan, the Retailer (in addition to purchasing a Product Package) had to pay a monthly fee of $6.95 whereupon he/she was designated as a “Mogul.” Id., Stip. 5(w) and (x).
BurnLounge, in April of 2007 (approximately 6 weeks before the filing of this action), began to offer free BurnPages, which were less sophisticated than those originally offered through the Basic Package, but which did include the ability to sell downloads and earn BurnRewards. Murray Tr. Day 6 AM at 127:23-128:25, Tr. Day 6 PM at 5:9-8:1.
In return for sales of music and product packages, Retailers earned BurnRewards, points which were redeemable to pay for BurnLounge fees, downloadable music, and other merchandise, but which were not equivalent to cash. FPO Stip. 5(w); Ex. 8 § § 6.1, 6.8. BurnLounge Retailers had the option at any time of choosing to pay the fee to become a “Mogul,” which allowed him/her to convert his/her BurnRewards into cash on
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a $1 per point basis, after meeting certain minimum qualifications.