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2001 WL 35679165 (N.D.Okla.)

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For Opinion See 2001-2 Trade Cases P 73499, 2001-2 Trade Cases P 73498, 2001-2 Trade Cases P 73496, 2001-2 Trade Cases P 73495, 2001 WL 34134696

 

United States District Court, N.D. Oklahoma.

FEDERAL TRADE COMMISSION, Plaintiff,

 

 

SKYBIZ.COM, INC., et al., Defendants.

No: 01-CV-396-K(E).

July 9, 2001.

 

Plaintiff’s Response to Defendant’s Brief Regarding the Significance of Product Value on the Pending Claims and the Relief Sought by the FTC

 

Federal Trade Commission, Southwest Region, 1999 Bryan Street, Ste 2150, Dallas TX 75201-6803, 214 979-9350, Attorneys for Plaintiff, Federal Trade Commission.

 

TABLE OF CONTENTS

 

  1. The Value of The Product Is Irrelevant to the Issue of Deception … 1
    1. Pyramid Analysis Does Not Depend on Value … 2
    2. The “Fact” of Product Value Should Not Mislead the Court’s Analysis … 4
    3. The Defendants, Having Not Emphasized the “Value of the Product” in Perpetrating Their Scheme, Should Not Now Be Permitted to Hide Behind It … 7
    4. The Defendants’ Deceptive Marketing Practices Should Be Enjoined … 8
  2. The Court Has the Power to Create a Remedy That Prevents Further Deception by Defendants … 11
  3. The FTC’s Authority to Enforce The FTC Act’s Prohibition Against Deception Reaches Sales to Foreign Consumers … 12
  4. Appointment of a Special Master … 18

 

TABLE OF AUTHORITIES

 

FEDERAL CASES

 

Alfadda v. Fenn, 935 F. 2nd 475 (2d Cir. 1991) … 14, 18

 

In re Amway Corp., Inc., 93 F.T.C. 618 (1979) … 4, 9

 

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2001 WL 35679165 (N.D.Okla.)

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Branch v. FTC, 141 F. 2d 31 (7th Cir. 1944) … 14

 

EEOC v. Arabian Am. Oil Co,m 499 U.S. 244 (1991) … 15, 16

 

FTC v. Commonwealth Marketing Group, Inc., 72 F Supp. 2d 530 (W.D. Pa. 1999) … 17

 

FTC v. Figgie International, Inc., 994 F. 2d 595 (9th Cir. 1993) … 4, 6

 

FTC v. Five-Star Auto Club, 97 F. Supp. 2d 502 (S.D.N.Y. 2000) … 4

 

FTC v. Magui Publishers, Inc., 1993 U.S. App. LEXIS 28684 (9th Cr. October 22, 1993); … 17

 

FTC v. Simeon Management Corp., 532 F. 2d 708 (9th Cir. 1976) … 9

 

FTC v. U.S. Oil & Gas Corp., 748 F. 2d 1421 (11th Cir. 1984) … 11

 

In re Holiday Magic, 84 F.T.C. 749 (1974) … 2, 10

 

In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975) … 2, 3, 10

 

Leasco Data Processing Equipment Co. v. Maxwell, 468 F. 2d 1326 (2d Cir. 1972) … 14

 

Neiman v. Dryclean U.S.A. Franchise Co., 178 F. 3d 1126 (11th Cir. 1999) … 15, 16

 

Psimenos v. E.F. Hutton & Co., 722 F. 2d 1041 (2d Cir. 1983) … 14, 18

 

SEC v. Briggs, 234 F. Supp. 618 (N.D. Ohio 1964) … 18

 

Simeon Management Corp. v. FTC, 579 F. 2d 1137 (9th Cir. 1978) … 10

 

Webster v. Omnitrition International, Inc, 79 F. 2d 776 (9th Cir. 1996) … 4, 8, 10, 11

 

FEDERAL STATUTES

 

15 U.S.C. § 44 … 14, 16

 

15 U.S.C. § 45(a)(1) … 14, 17

 

15 U.S.C. § 78c(17) … 18

 

Franchise Rule, 16 C.F.R. § 436.1 (1998) … 15

 

Pub.L. 97-290 … 17

 

OTHER

 

Dodge, Understanding the Presumption Against Extraterritoriality, 16 Berk. J. Int’l Law 85, 87 (1998) … 17

 

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Plaintiff Federal Trade Commission (“Commission” or “FTC”) submits this brief in response to the brief of Defendants SkyBiz.com, Inc., World Service Corporation, WorldWide Service Corporation, James S. Brown, Elias F. Masso, and Kier E. Masso, (“Defendants”)[FN1] on the significance of product value and the relief sought. The FTC respectfully submits that product value is irrelevant to whether Defendants have violated the FTC Act and that De-fendants should be enjoined from their deceptive acts and practices. Moreover, broad preliminary equitable relief is appropriate to ensure that effective final relief is available.

 

FN1. “SkyBiz” refers to the enterprise operated by all of the Defendants in this matter.

 

  1. The Value Of The Product Is Irrelevant to the Issue of Deception.

 

The complaint in this cause charges defendants with the deceptive marketing of a business opportunity, not the sale of a worthless product. [FN2] Whether a product has value is irrelevant to both a pyramid analysis and an analysis of misrepresentations or omissions regarding the income potential of whether a scheme is a pyramid does not depend on the product’s alleged value. Second, the alleged “fact” of value should not lead the Court away from the issue: deceptive marketing. Third, the Defendants, having emphasized the money to be made from the SkyBiz compensation program over the value of the Web Pak when they marketed their scheme to victims, should not now be permitted to rely on “product value” to shield their deception. Fourth, whether the product has value does not govern whether the De-fendants should be prohibited from deceptively marketing a business opportunity to sell the product. No case holds that the value of a product is a defense to the conduct of a pyramid scheme.

 

FN2. Defendants assert that their evidence of product value is uncontroverted. While the value, if any, of defendants’ SkyBiz e-Commerce Web Pak is not relevant to any issue before the Court, it is worth noting the evidence in the record that defendants’ customers considered the Web Pak to be of little or no value apart from the business opportunity. PX 5 ¶ 10; PX 12 ¶ 8; PX 227; Transcript of June 26, 2001 [Ken Klein, Darlene L. Syrell] at _____; Transcript of June 27, 2001 [Kathy Nelson] at _____. See also PX 1 at p. 8 (only 428 customers purchased the Web Pak without becoming associates); PX 69 (App No 1664-65 ¶ 9, 1680, 1734) and PX 73 (App No 2254) (most websites not used by purchasers).

 

  1. Pyramid Analysis Does Not Depend on Value

 

More than a quarter century of jurisprudence makes clear that the alleged value of a product is not relevant to the analysis of whether a marketing program is a pyramid scheme. The sole issue is the creation of a scam in which the structure of the compensation plan ensures that the vast majority of participants will not realize the promised rewards. A plan which holds out the opportunity of making money, by means of recruiting others, with that right to recruit being passed on as an inducement for those others to join, and being passable by them ad infinitum, contains an intolerable potential to deceive.

 

In re Holiday Magic, 84 F.T.C. 749, 1037 (1974) (App No 3342-3343).

 

The seminal case on pyramid schemes is In re Koscot Interplanetary, Inc., 86 F.T.C. 1106 (1975) (App No 3057-3121). Koscot is often cited for the proposition that the characteristic of a pyramid scheme is “the right to receive in return for recruiting other participants into the program rewards which are unrelated to the sale of the product to ultimate users.” Koscot, 86 F.T.C. at 1180 (App No 3112). Note, however, that Koscot assumes that a sale of a product has taken place and that, therefore, the product must have some market value. [FN3] But even recognizing that a sale must have taken place, Koscot pointedly ignores product value in its analysis. Instead, it focuses on whether the scheme promised “rewards unrelated to the sale of the product.” The opinion explains why:

 

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FN3. Defendants assert that “In Koscot Interplanetary, Inc., the Commission found that the company was formed without a product to sell, it was formed solely to recruit more people.” Defendant’s Brief at 5. The opinion itself belies this statement. In fact, the Koscot opinion adopts the findings of the ALJ, who notes that the company was organized to sell cosmetics – not unlike Amway – in a wholesale-to-retail structure:

 

For several years the respondents have been engaged in the advertising, offering for sale and sale of distributorships and franchises and of various products and services, including a line of cosmetics, toiletries, and associated items sold and distributed under the trade name Koscot. In doing so, respondents have caused their products to be shipped from their places of business in various States to purchasers ….

 

Koscot, 86 F.T.C. 1106, 1128 (1975) (ALJ’s Opinion, para. 29) (App No 3074-3075). The ALJ does note that “for approximately a year following the … institution of the marketing plan, respondents were engaged solely in the marketing of distributorships,” but thereafter began the sale of cosmetics. Koscot, 86 F.T.C. at 1132 (App No 3077).

 

[E]ven where rewards are based upon sales to consumers, a scheme which represents indiscriminately to all consumers that they can recoup their investments by virtue of the product sales of their recruits must end up disappointing those who can find no recruits capable of making retail sales.

 

Koscot, 86 F.T.C. at 1180 (App No 3112). The opinion in that case concludes that Koscot’s scheme was an illegal pyramid because “recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed.” Koscot, 86 F.T.C. (App No 3112).

 

The Amway decision, upon which Defendants rely, demonstrates the continued judicial focus on inherently deceptive structure of a pyramid scheme, rather than the issue whether the underlying product has “value.” In 1979, the FTC declined to hold that the best known multilevel marketing program in history was a pyramid. In re Amway Corp., Inc., 93 F.T.C. 618 (1979) (App No 2967-3056). The decision of the Commission runs many dozens of pages and ultimately concludes that Amway’s structure was not inherently deceptive. However, nowhere in this analysis does the issue of product value play a part: only the structure of the compensation plan does. The opinion takes pains to restate the Koscot characteristics and explains how Amway survives the analysis, without regard to product value. The key to the Amway decision is that “a sponsoring distributor receives nothing from the mere act of sponsoring. It is only when the newly recruited distributor begins to make wholesale purchases … and sales … that the sponsor begins to earn money from [the] recruit’s efforts. Amways, 93 F.T.C. at 716 (App No 3040). Thus the Amway decision assumes, but ignores in its analysis, that the products have value to consumers.

 

The complete absence of product value from the legal analysis continues through the most recent pyramid cases. No court has considered it: not Webster v. Omnitrition Int’l, Inc, 79 F. 3d 776 (9th Cir. 1996), not FTC v. Five-Star Auto Club, 97 F. Supp.2d 502 (S.D.N.Y. 2000). In a different kind of Section 5 case, FTC v. Figgie Int’l, Inc., 994 F. 2d 595 (9th Cir. 1993), the court faced down the “product value” defense succinctly: liability under the Federal Trade Commission Act “is premised not on the fact that Figgie sold [products], but on the dishonest or fraudulent practices it used to sell them.” Thus, the issue is not product value but deception in the sale of the scheme.

 

  1. The “Fact” of Product Value Should Not Mislead the Court’s Analysis

 

Only one expert testified about whether SkyBiz’s scheme is a pyramid and inherently deceptive. [FN4] Dr. Peter Vander Nat testified that because of the structure of the compensation scheme, SkyBiz’s scheme is both inherently deceptive and a pyramid. PX 2. It is important to note that Dr. Vander Nat’s conclusion is not premised on or affected by product value. Nowhere in Dr. Vander Nat’s analysis regarding whether SkyBiz is a pyramid does the variable “value” appear, nor need it. This is because, according to Dr. Vander Nat, the very structure of the compensation plan guarantees that

 

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94% of all Associates who succumb to SkyBiz’s misrepresentations about the business opportunity will not recoup their investment no matter what the product value – or pricing – is (PX 2 (App No 3, ¶ 7)):

 

FN4. Defendants claim that Dr. Chiasson determined that SkyBiz is a “fair value.” Defendants correctly and very carefully assert that Dr. Chiasson “determined pricing” based on the “predicted market price” There is no indication that Dr. Chiasson was competent to determine market value or that he did in fact make a determination of value, as opposed to a determination of “pricing.” In fact, even where Dr. Chiasson speaks of “fair market value,” (“My conclusion was that SkyBiz has a fair market value…”), it is clear that he is talking about competitive pricing (“…given predictions based on the competitive surveys … of their competitor products).” PX 226 at 1428:16-18. In any event, in the Canadian criminal proceeding, unlike the instant case, product value can be an issue.

 

Unbeknownst to general participants – and whatever the product may or may not be worth – the terms of the compensation plan secure the result that the vast majority will fail to obtain monetary rewards.

 

PX 2 (App No, 18 ¶ 33). Regardless whether the product is worth more or worth less, the very structure of the SkyBiz pyramid guarantees that the same percentage of people will lose. Under the SkyBiz structure, 94% of all Associates will fail to recoup their investment no matter what the price or value of the product is because of the mathematics of the SkyBiz structure. See PX 2 (App No 12-14, ¶ ¶ 22-25).

 

Defendants faced with charges of violation of Section 5 often argue that their products have value. Courts have not found the argument to be compelling. In one recent case, the Ninth Circuit Court of Appeals used the example of a “rhinestone merchant” to explain why product value was not relevant:

[There is nothing dishonest about selling rhinestone jewelry; it has some value. However, it is dishonest to represent that rhinestone jewelry is actually diamond, and to charge diamond prices for it.

 

Figgie Int’l, 994 F.2d at 604. Thus the focus must not be on value, but on the representations made in the sale. The court continues:

Customers who purchased rhinestones sold as diamonds should have the opportunity to get all of their money back…. The seller’s misrepresentations tainted the customer’s purchasing decision. If they had been told the truth, perhaps they would not have bought rhinestones at all, or only some…. The fraud in the selling, not the value of the thing sold, is what entitles customers in this case to full refunds or to refunds for each [product] that is not useful to them.

 

Figgie Int’l, 994 F.2d at 606.

 

Similarly, Dr. Vander Nat noted that the alleged value of the SkyBiz product does not properly define the issue. He notes that inherent value does not necessarily affect a buying decision: “Even though a commodity may have some market value, there may still be any number of people who would not be willing to pay the current market price.” PX 2 (App No 18, ¶ 34). However, if the seller adds some additional value-such as a lottery ticket in addition to a piece of jewelry- “many people may now decide to pay $110 for the package, while they would not have bought the commodity alone.” Id.

 

It should be noted that Dr. Vander Nat’s assertion that the SkyBiz scheme produces “determined” losses-that is, ensures losses–for approximately 94% of its participants, remains completely unchallenged by Defendants.

 

  1. The Defendants, Having Not Emphasized the “Value of the Product” in Perpetuating Their Scheme, Should Not Now Be Permitted to Hide Behind It

 

Although the Defendants now claim that SkyBiz sold a product with “value,” they certainly did not emphasize the value of their Web Pak when they marketed the product to Associates. In CD ROMs and videotapes and on the

 

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