In the Matter of the Complaint Against

COLLEGEDALE DIVERSIFIED ENTERPRISES, INC.
P. O. Box 1143
at Collegedale, TN 37315

P.S. Docket No. 14/29;
10/25/83

Cohen, James A.

APPEARANCES FOR COMPLAINANT:
Thomas A. Ziebarth, Esq.
Clark C. Evans, Esq.
Consumer Protection Division
Law Department
United States Postal Service
Washington, DC 20260-1112

APPEARANCE FOR RESPONDENT:
James D. Purple, Esq.
428 McCallie Avenue
Chattanooga, TN 37402-2009

POSTAL SERVICE DECISION

BACKGROUND

Exception to Finding of Fact No. 8 and Conclusion of Law No. 4

Exception to Finding of Fact No. 10

Exception of Finding of Fact No. 12

Exception to Conclusion of Law No. 3

Exception to Conclusion of Law Nos. 5 and 6

False Representation Issues

CONCLUSION

POSTAL SERVICE DECISION

Respondent has appealed from the Initial Decision of an Administrative Law Judge which holds that Respondent's multi-level marketing program is a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. 3005.

BACKGROUND

On August 5, 1982, the Consumer Protection Division, Law Department, United States Postal Service (Complainant), filed a Complaint alleging that Respondent, by means of solicitations for distributors to participate in its multi-level marketing promotion, is engaged in a scheme or device for obtaining money through the mail by means of false representations and a lottery or scheme for the distribution of money by chance. Specifically, in Counts I and II the Complaint alleges that Respondent, directly and through distributors, falsely represents:

"(a) Each distributor participating in Respondent's program is likely to be able to sponsor ten new distributors; and

(b) Each distributors participating in Respondent's program is likely to earn substantial sums of money --as much as $44,000."

In Count III the Complaint alleges in pertinent part:

"10. The multi-level marketing distributorship program used by Respondent contains the elements of prize, chance, and consideration.

11. Respondent thereby is conducting a lottery or scheme for the distribution of money by chance through the mails."

Respondent filed an Answer to the Complaint in which it denied that it makes any false representations and while admitting that its promotion contains the element of consideration, denied that it contains the elements of prize and chance. At a hearing before an Administrative Law Judge, Complainant presented the testimony of Postal Inspector Ben Kilgrow and Roger Lourie, an expert in the area of direct response advertising. Respondent presented the testimony of James Hagerman, its president and owner, and Harry Metzger, one of its distributors. Following the filing of proposed findings of fact and conclusions of law, the Administrative Law Judge issued an Initial Decision in which he found that Respondent's multi-level distributorship program constitutes a lottery of scheme for the distribution of money by chance in violation of 39 U.S.C. 3005. Having reached this conclusion the Administrative Law Judge found it unnecessary to decide the false representation issued raised in Counts I and II of the Complaint. Respondent filed a timely appeal in which it takes issue with the Administrative Law Judge's conclusion that its marketing program is a lottery.

The marketing program operated by Respondent involves the sale of fire extinguishers and automobile burglar alarms through purchaser-distributors. A purchaser-distributor receives commissions from sales made directly by him and sales made by purchaser-distributors solicited by him as well as subsequent purchaser-distributors in his chain through five levels (ID, FOF 2).

The Administrative Law Judge concluded that the necessary elements of a lottery are consideration, prize and chance and that these elements are presented in Respondent's program. In its appeal Respondent has not challenged the conclusion of the Administrative Law Judge that the requisite elements of a lottery or scheme under 39 U.S.C. 3005 are the furnishing of consideration, the offering of a prize, and the distribution of a prize by chance. It does, however, challenge the Administrative Law Judge's findings and conclusions that these elements are present in its program. Respondent specifically takes exception to Findings of Fact 8, 10 and 12, and Conclusions of Law 2 through 6 of the Initial Decision, each of which are hereafter addressed.

Exception to Finding of Fact No. 8 and

Conclusion of Law No. 4

By these exceptions Respondent challenges the Administrative Law Judge's finding and conclusion that its normal method of doing business requires both purchasing and nonpurchasing distributors to furnish valuable consideration to Respondent as a prerequisite to receiving commissions. Respondent argues that the testimony of its president establishes that company policy permits persons to become distributors without purchasing its products or sales brochures. Citing Brooklyn Daily Eagle v. Voorhies, 181 F. 579 (E.D.N.Y. 1910), Respondent further argues that the requirement to sign a distributor's contract or to secure buyers of its products does not constitute consideration "of such sufficient quality and value to support a lottery as required by the relevant case law." Finally it argues that it is engaged in the sale of competitively priced products which carry a money back guarantee and that the price paid for the products does not include payment for participation in its marketing program.

Respondent, in its Answer to the Complaint and in a proceeding instituted in a local court (Resp. Ex. 4), conceded the existence of consideration in its promotional program. In addition, the evidentiary record supports the finding of consideration. Respondent's promotional brochures clearly condition the distributorship opportunity on the purchase of a product (see Comp. Exs. A & B, Resp. Ex. 1). Thus, Respondent's evidence of a company policy which allows a person to become a distributor without purchasing a product is not consistent with the plain language of its advertising materials or any reasonable reading of those materials by a prospective distributor. Moreover, while there is evidence that a very small proportion of purchasers do not become distributors (approximately 2%, Tr. 78), there is no persuasive evidence of any distributors who were not purchasers.

The fact that a distributor will receive a product with the distributorship, does not detract from the finding of consideration. A part of the purchase price paid to Respondent is for the chance to win commissions (prizes) from sales made thorough the distributorship chain. See Horner v. United States, 147 U.S. 449 (1893); Zebelman v. United States, 339 F.2d 484 (10th Cir. 1964); Tenpen Sales Corp., P.O.D. Docket No. 2/35 (D.D. May 10, 1961). Cf., New v. Tribond Sales Corp., 19 F.2d 671 (D.C. Cir. 1927), cert. denied, 275 U.S. 550; Frye v. Taylor, 263 So. 2d 835 (Fla. App. 1972).

Even if nonpurchasers were allowed to become distributors, the necessity to execute a distributor's contract and the requirement to purchase brochures */ and to obtain additional direct sales and distributorships constitutes consideration for the chance to receive further commissions based on sales by distributors past the first level. See Brooklyn Daily Eagle v. Voorhies, supra at 581-82, in which the Court stated "It is only necessary that the person entering the competition shall do something or give up some right.

Accordingly, it is concluded that Finding of Fact No. 8 and Conclusion of Law No. 4 are supported by the record.

Exception to Finding of Fact No. 10

In Finding of Fact No. 10 the Administrative Law Judge found that a distributor's chance of success necessarily diminishes as the market becomes saturated with new distributors since the degree of success of an individual depends largely on the number of distributors in his chain. Respondent views this finding as relating to the lottery element of chance and argues that chance is not involved in its business activity because there is "the possibility of success commensurate with the degree of effort, time and talent invested and market demand." It asserts that as the market approaches saturation for one product the product mix is varied by Respondent. It further alleges that Complainant's expert witness failed to consider the effect of repeat business, the introduction of new products, individual efforts and managing and training downline distributors on the probability of consistent downline distributor sales performance. It refers to a dictionary definition of "chance" as "an event occurring without apparent cause or control" (Resp. Brief at 4, New Webster's Dictionary, at 84 (1975)), and contends the phrase "chance of success" in this finding is a misnomer.

As Complainant notes, Finding No. 10 is not critical to the lottery issue because it addresses a false representation issue, the "likelihood of success" (Comp. Brief at 3). However, whether the finding pertains to the lottery element of chance, or the likelihood of success, it is supported by the record. Although Respondent has added two new products to its promotion since its inception, a larger size fire extinguisher and a burglar alarm system (Resp. Ex. 1), there is no evidence that this would forestall market saturation, and does not rebut Complainant's evidence that the advertised success is not achievable (Tr. 46-52). Respondent's contrary arguments assume matters which the record does not support. As discussed in connection with other exceptions of Respondent, the prospect of a distributor receiving commissions from downline distributors beyond the first level is a matter of chance.

Exception of Finding of Fact No. 12

Finding of Fact No. 12 is a conclusory finding that "Respondent's marketing program constitutes a lottery or scheme for the distribution of money by chance." Respondent argues that the commissions paid to its distributors are not prizes distributed by chance but are "earnings from distributor participation in the marketing program." It therefore argues that it is not engaged in a lottery enterprise (Resp. Brief at 4).

Respondent's the program is a chain promotion under which commissions are dependent on the efforts of unknown persons over which the participant has no control (Tr. 52). Thus, as discussed under subsequent exceptions, prize and chance are elements of Respondent's program.

4. Exception to Conclusion of Law No. 2

In Conclusion of Law No. 2 the Administrative Law Judge concluded that a prior Judicial Officer decision, Tenpen Sales Corp., P.O.D. Docket No. 2/35 (D.D. May 10, 1961), was factually similar to the present case (ID at 9). Respondent contends that its promotion differs substantially from Tenpen in that its products are not overpriced, it does not require the purchase of a product or any financial investment, and it does not require its distributors to maintain an inventory or distribute its products.

While some of the distinctions pointed out by Respondent do exist, they are not legally significant. There are basic similarities in the two promotions which justify the Administrative Law Judge's reliance on Tenpen. Like the promoter in Tenpen, Respondent requires the purchase of its products. Both Respondent's program and the program considered in Tenpen involve consideration for the opportunity to participate in the chain distributorship and receive commissions determined principally by the efforts of others over whom the participant exercises no control and has no connection. Thus, both programs contain the elements of prize, chance and consideration. Accordingly, no error is found in Conclusion of Law No. 2.

Exception to Conclusion of Law No. 3

The Initial Decision contains two separately numbered Conclusions of Law No. 3. The first refers to the case of Zebelman v. United States, 339 F.2d 484 (10th Cir. 1964), as being a similar marketing scheme which was held to constitute a lottery. The second concludes from Tenpen and Zebelman that the amount of commissions that a buyer-distributor will receive in Respondent's scheme is dependent on chance.

Respondent asserts that in Zebelman commissions beyond first level distributors were held to be a matter of chance since the original distributor could not control whether the buyers he found would be able to find additional buyers. It argues that its promotion is different because its distributors contact, train and manage the distributors below them and, for a fee, its distributors are supplied detailed information as to their downline organizations, including names, addresses and sales performance. It contends that the distributors' success is the result "of a cause and effect relationship between effort and talent on the one hand and sales on the other" (Resp. Brief at 6). It also contends that there is control of the downline sales performance as much as the sales manager of General Motors controls the success of firstline automobile sales in each of its dealerships.

There is no basis for Respondent's comparison of the General Motors distribution methods and its own marketing plan. There is no persuasive evidence that Respondent or distributors under its chain exercise control over downline distributor efforts or activities, or that its distributors contact, train and manage the other downline distributors in the chain. Respondent, in arguing that it supplies detailed information to its distributors, apparently relies on a statement in its brochure (Resp. Ex. 1; Tr. 63) that for a nominal charge a distributor may request a computer printout of the names of downline distributors under his chain. This does not establish that the distributors have obtained or will obtain the names and engage in training and management activities. In fact, Respondent's brochure suggests that little effort is needed. For example, after describing the multi-level distributorship commissions, the brochure states: "No real selling is involved. You just give the brochure to friends and the product and marketing program practically sell themselves. There is no product to stock and no money to collect. People order directly from us and we ship directly to them" (Resp. Ex. 1, p. 2; the same statement is also in the earlier brochures, Comp. Exs. A & B, p. 2).

Moreover, Respondent offers no training or instruction program to its distributors, only the brochures. Respondent's President testified, "We don't tell people how to conduct their business" (Tr. 82, 83), and that he designed the program so "people could hold their job and be doing this without disturbing his normal activities of everyday life. A minimum amount of time and effort" (Tr. 82). He also admitted that no help had been given to distributors other than those at the first level to whom he sold products (Tr. 88-89). Thus, the dominant element in receiving commissions based on sales beyond the first level is, as it was in Zebelman and Tenpen, based on chance and not on skill or effort. See also Public Clearing House v. Coyne, 194 U.S. 497 (1904); New v. Tribond Sales Corp., 19 F.2d 671 (D.C. Cir. 1927); United States v. McKenna, 149 F. 252 (W.D.N.Y. 1906).

Exception to Conclusion of Law Nos. 5 and 6

By Conclusion of Law No. 5, the Administrative Law Judge held that Respondent's scheme contains the elements of a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. 3005. By Conclusion of Law No. 6, he concluded that the False Representation Order authorized by that statute should be issued against Respondent.

Respondent asserts that these conclusions of the Administrative Law Judge, as well as the provisions of 39 U.S.C. 3005 as written and applied, violate its constitutional rights. It also asserts that the statute is overbroad, vague and contrary to the public interest, and as applied constitutes an interference with private enterprise and an unnecessary burden on interstate commerce. Finally, it contends that uniform enforcement of the Administrative Law Judge's decision would bar all multi-level marketing programs and most traditional marketing programs.

The public policy expressed in 39 U.S.C. 3005 against use of the mail for schemes involving lotteries, drawings and games of chance is one of long standing. Prohibitions against using the mail for such purposes and criminal sanctions therefor have long been upheld as constitutional. See e.g., Horner v. United States, supra; In re Rapier, 143 U.S. 110, 134 (1892). The authority of the Postal Service, and the statutory scheme for issuance of a False Representation Order where either false representations or a lottery has been found under the statute have also been held to be constitutional. E.g. Public Clearing House v. Coyne, supra; Donaldson v. Read Magazine, 333 U.S. 178, 190-91 (1948); United States Postal Service v. Athena Products, Ltd., 654 F.2d 362 (5th Cir. 1981), cert. denied, 456 U.S. 915. Thus, there is no merit to Respondent's policy or constitutional arguments.

The Administrative Law Judge held that the facts presented establish that Respondent's marketing program contains the elements of a lottery and therefore, under 39 U.S.C. 3005 is a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. 3005. Whether other marketing programs fall within the coverage of 3005 is dependent on the manner in which they are conducted and the facts established in any proceeding brought under the statute. See F.C.C. v. Am. Broadcasting Co., 347 U.S. 284, 290 (1954). Respondent's argument in this regard goes beyond the facts of this case and would require consideration of programs which are not the subject of the Complaint or within the scope of this proceeding.

False Representation Issues

Respondent's appeal from the Initial Decision takes exception to the holding that its marketing program is a lottery. Although Complainant filed a reply brief it did not file a cross appeal or request a ruling on the false representation issues. It did, however, state that the record supports a finding that Respondent's advertising and promotional materials make false representations about the likelihood of substantial earnings by participants. In view of the conclusion reached in this decision upholding the Initial Decision on the lottery issue, no ruling need be made on the false representation issue. Nevertheless, in reviewing the entire record on appeal, the false representation allegations have been considered. The record establishes that the representations alleged in Counts I and II of the Complaint are made in Respondent's advertising brochures (Comp. Exs. A & B; Resp. Ex. 1) and that they are materially false (see e.g. Tr. pp. 46-52, 79-81). Thus, even if Respondent's program had not been found to violate the lottery portion of 39 U.S.C. 3005, an order under the statute would be issued based on a finding that Respondent makes the false representations alleged in the Complaint.

CONCLUSION

After consideration of the entire record and Respondent's exceptions to the Initial Decision, it is concluded that Respondent is engaged in the conduct of a lottery or scheme for the distribution of money by chance in violation of 39 U.S.C. 3005. Accordingly, an order under 39 U.S.C. 3005 is being issued with this decision.

* Ten free brochures were furnished with the product and additional brochures could be purchased at either 5 or 10 depending on the quantity ordered. (See ID, FOF 2)


Jeffrey A. Babener
Babener & Associates
121 SW Morrison, Suite 1020
Portland, OR 97204
Jeffrey A. Babener, the principal attorney in the Portland, Oregon law firm of Babener & Associates, represents many of the leading direct selling companies in the United States and abroad.

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