5th Circuit: No Class Action About Multi-Level Marketing Program

5th Circuit: No Class Action About Multi-Level Marketing Program

By David Coale of Lynn Tillotson Pinker Cox

Can victims of a claimed pyramid scheme, in the context of a large multi-level marketing program, bring a class action? A Fifth Circuit panel recently said “no” in Torres v. S.G.E. Management, No. 14-20128 (Oct. 16, 2015). Judge E. Grady Jolly wrote the majority opinion, joined by Judge Edith Brown Clement, while Judge Jacques Wiener dissented.

This opinion should have significant immediate impact because multi-level marketing programs (Amway, Herbalife, etc.) are widespread in the modern economy, and the details of their operations affect millions of people involved with those businesses.

By rejecting the plaintiffs’ theory that the defendants’ failure to disclose the program’s claimed illegality created a common legal issue for the class, the Torres opinion significantly restricts the availability of class actions about multi-level marketing programs.

Torres dealt with the “Ignite” program to market Stream Energy’s electricity services to potential customers. The plaintiffs were “Independent Associates” in that program, who paid a fee to participate, and whose ultimate success “depend[ed] primarily on recruiting a ‘downline; of other IAs who, in turn, recruit other IAs and customers into the Ignite program.”

Alleging that “the clear majority of IAs have lost money as a result of participating in Ignite” (although “a small number of individuals have made significant sums of money”), the plaintiffs alleged that Ignite was an illegal pyramid scheme. They sought damages for fraud under RICO, arguing that its promoters misrepresented that Ignite was a legitimate business when it was not.

The district court certified a class. It acknowledged that each class member could not show that he or she had received a common misrepresentation about Ignite, which had been heavily promoted in many ways. But the district court accepted the plaintiffs’ theory that the class members could show a common misrepresentation by nondisclosure, in that Ignite and Stream had not disclosed the alleged illegality of the program.

The district court reasoned: “Because it can rationally be assumed . . . that the legality of the Ignite program was a bedrock assumption of every class member, a showing that the program was actually a facially illegal pyramid scheme would provide the necessary proximate cause.”

The Fifth Circuit disagreed and decertified the class. It began with its earlier opinion in Sandwich Chef v. Reliance Nat’l Indem. Ins. Co., which decertified a class alleging that insurance companies charged excessive premiums, and had noted: “[T]he plaintiffs and the defendants negotiated the insurance policies in individualized transactions; and evidence . . . suggested that the plaintiffs could have voluntarily assented to the illegal rate structure[].” 319 F.3d 205 (5th Cir. 2003).

The Court found that “[a] pyramid scheme is no different from the insurance regime in Sandwich Chef” because class members could have joined it in hopes of profiting, even though they knew the scheme was illegal and potentially harmful to others.

As to the plaintiffs’ argument that class members would not knowingly have joined an illegal scheme, the Court observed: “Plaintiffs have cited no case law that has adopted such an elevated view of human nature. . . . While many of the Plaintiffs might have decided to invest in the scheme in the belief that it was legal, it is equally possible that many of the Plaintiffs chose to invest in the scheme in the belief that, legal or illegal, it provided them with an opportunity to make money.”

The majority concluded by noting the wide variety of representations made in marketing the program: “Some . . . touted its legitimacy, whereas other presentations undermined that legitimacy.”

The dissent warned that the majority’s reasoning “will vaccinate illegal pyramid schemes against all civil litigation[.]”

On the substantive issues, the dissent criticized the majority for over-reliance on “the theoretical possibility of prior knowledge of illegality[.]” But the dissent’s main point was the practical effect of the decision, noting that “because individuals who are duped into joining such schemes uniformly invest relatively few dollars, none will possibly be able to afford to litigate their individual claims separately.”

Thus, “[a]bsent the availability of a class action, there simply will be no possibility of court challenges to such pyramid schemes.”

David Coale is a partner at Lynn Tilotson Pinker & Cox.