Thursday, September 27, 2012

Scam Study: Burnlounge

(Photo credit: Fuzzytek)
EDITOR'S NOTE: Scam Study is a quick summary of the various proven Ponzi or pyramid schemes. It is meant to be a summary, with relevant scam factor analysis. 


Burnlounge was supposedly an online music store founded in 2004 by Alex Arnold, Ryan Dadd, and Stephen Murray. It was described as a MLM online music sales with its own download / subscription / chat client to users, but also allowed almost anyone to open their own "online music storefront" by purchasing a storefronts. It was marketed as iTunes meets eBay meets MySpace (remember, this was before Facebook became famous). It entered public beta in 2005, and formally launched in 2006, FTC said it's a pyramid scheme in 2007, and charged its execs as well as several high ranking affiliates for running it. The case went before a judge in 2008, and a final judgment was entered in 2012, that Burnlounge is indeed a pyramid scheme. 

Burnlounge has two general types of affiliates: Burnlounge Retailer, and Mogul. The former can only earn "credit", while the latter can earn cash. 

Burnlounge Retailer create "Burnpages", i.e. custom mixes of music they like from Burnlounge's catalog (which are licensed), but can only earn credits to be spent on more Burnlounge products. There are three sublevels of retailer: basic, exclusive, or VIP.  Basic lets you create Burnpages. Exclusive gets you monthly subscription of a DVD video news magazine, as well as downloads, while VIP gets you special access to venues and set of "music history" DVD. 

Any retailer (any level) can become a mogul by paying $6.95 per month, and perform some one-time sales goals like "sell two exclusive or VIP packages". They may get more if they meet some other sales goals. Moguls earn commission from sales of music, as well as recruiting other people to join as retailers or moguls. 

Moguls gets paid on "sales" done by their downlines through 6 levels, though Burnlounge use the term "rings" instead of levels and the term "concentric retail" instead of "multi-level marketing". However, the mechanics are the same. Moguls obviously gets paid for selling music through their own burnpages. 

Burnlounge Statistics

By the time FTC launched the lawsuit against the company, Burnlounge had recruited 62250 members, of which, 99.7% were moguls, and 67% of those are of the VIP level affiliate the most expensive one. 

In its two-plus years of operation, Burnlounge took in $28.4 million, of which, only $1 million was sales to NON-affiliates. Burnlounge, in the same period, paid out $17.45 million in "commission", and VAST majority went to the top affiliates. The top 6% grossing mogules nabbed 85% of all paid out commission. The "failure rate" for all mogul positions (defined as failing to make back money put in) is over 93%. 

Another interesting data point is when FTC launched the lawsuit, sales of music and positions dropped precipitously. If people are actually buying music for their own use the FTC lawsuit should not affect it. FTC says this means people are not buying music for the music, but merely to qualify commission as part of sales requirements for moguls. 

Problems with Burnlounge Model

Burnlounge, from the very beginning, failed to distinguish between a customer and an affiliate. Its unofficial motto is to "turn music fans into entrepreneurs". As the numbers have shown above, vast majority of the members have joined for the income opportunity, not for their love of music. 

Burnlounge has TWO components: selling music, and selling positions (moguls or non-mogules). In practice, vast majority of sales is of positions, not music. Thus, it is, in effect, members selling membership. Thus, FTC is correct in stating that large portion of Burnlounge is operating as a pyramid scheme. While the existence of a non-income level (retailer) is available, it remained a tiny portion of the operation, and thus, is irrelevant to the actual business model. 

Furthermore, while the company has a policy of not allowing income claims, every top affiliate (esp. the ones charged) made them, multiple times, while being recorded, and many of them are completely false, including claims of "making 20K a week", or "made 700K a year". 

Some Controversy over Burnlounge Decision

The Burnlounge decision is not without its controversies. Some in MLM disagree with the judge's decision and the FTC victory. 

Burnlounge lawyer claimed that the positions offered are more like subscriptions and the recruiting is completely optional. Thus, the bonuses, such as music history, news magazine, and so on should be counted as product sales. 

FTC explained that the higher level affiliateship are proof of pyramid schemes because the comp plan is biased toward better rewards for sales of affiliate positions, but not toward music. As the value to bonuses included in those positions are not proven, it's pretty clear that the positions themselves, not what came with the positions, are the product being sold, and the best reason to buy the positions is so you can sell the positions. 

Whether this pyramid scheme behavior is the intent or not is NOT important. The fact is the company worked that way, thus it is a pyramid scheme. 

Burnlounge is also interesting that FTC choose to charge the head of Burnlounge, the "right-hand man", and one top affiliate, While it is obvious that the head needs to be charged, the other two are a bit problematic. In case of Mr. Taylor, he was "retailer 001" the first person in the ring (tip of the pyramid) and actually contributed capital for the company to startup, and has both stock and stock options, and thus, is more than "merely an investor". However, a top affiliate, DeBoer, is also charged. The court ended up fining him 150K as disgorgement of illegal profit even though he cleared over 900K in profit. The court believe the disgorgement number would have been higher, but FTC failed to provide proof of that. 

Warning Signs of Burnlounge

Burnlounge has several problems which serves as warnings to all MLM business and affiliates

  • Is there real customers, or is it more about recruiting?
  • Would you buy the membership if it did NOT have a "you can make money" component?
  • is there a clear separation between customers, and affiliates? 
  • Are there potentially bogus income claims? 
  • Is it really operating the way they SAY they are? 
  • Would I be held responsible if I was a top affiliate in a pyramid scheme? 


Burnlounge Final Judgement

The MLM Attorney Kevin Thompson discusses Burnlounge and more

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