Music service changes business model for FTC

Digital music vendor BurnLounge changes its business model after an FTC complaint.

A digital music service accused by the U.S. Federal Trade Commission of running an illegal pyramid scheme has changed its business model and has worked out an agreement with the agency, the company said.

BurnLounge has eliminated the "network marketing" portion of its business that was targeted by the FTC, the company said.

The FTC's complaint accused BurnLounge of making deceptive earnings claims for members who paid between US$29.95 and US$429.95 a year for one of the company's product packages. Members were supposed to be paid to sell digital music and movies to others, but the FTC alleged that BurnLounge's compensation program primarily provided payments for the recruiting of new participants, not on the retail sale of products.

Most BurnLounge members would lose money if they only sold music and didn't recruit other members, the FTC alleged.

BurnLounge said it has reached an agreement with the FTC. But FTC spokeswoman Claudia Bourne Farrell, said Friday she couldn't comment on the matter until the judge in the case signs an order dealing with the agency complaint. The FTC has negotiated with BurnLounge, she confirmed.

The FTC, in a complaint filed in U.S. District Court for the Central District of California June 6, sued BurnLounge and four individuals, including the company's former CEO and three BurnLounge members who had marketed subscriptions to others, said D.J. Poyfair, lead outside counsel for BurnLounge and a partner with Shughart Thomson & Kilroy PC. Three of those four, including former CEO Alex Arnold, have not approved a proposed agreement with the FTC.

The judge in the case endorsed the agreement Tuesday, but the final language has not yet been officially approved, Poyfair said. A hearing for the three defendants who have not signed on to the agreement is set for July 5, he said.

BurnLounge had been moving toward eliminating the multilevel marketing portion of its business, but the FTC complaint forced its hands, Poyfair said.

FTC complaints of this nature typically result in a company being shut down with an injunction, but BurnLounge survived intact, Poyfair said. "This is a big deal in terms of FTC litigation history," he said. "This was, from business standpoint, a huge win for BurnLounge."

BurnLounge announced June 18 that it that it had accepted the resignation of CEO Arnold, replacing him with Grant D. Johnson, a founding managing partner at Benevolent Capital, a hedge fund, and the owner of music label Tomato Records. Then on June 21, the company said it was changing its business model by dumping its network marketing plan and increasing rewards for the sale of music by members.

"Network marketing was a unique channel to promote our products, but the strategic decision to voluntarily remove this part of our business was the right decision on all fronts," Johnson said in a statement. "We are aggressively moving forward and will focus on our new free model to help fuel the next evolution of business growth."

BurnLounge disputed the FTC's allegations, but changing the business model was the best way to move forward, BurnLounge said.

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