Webster v. Omnitrition Intern., Inc.

• Citation: 79 F.3d 776
• Decision Date: 04 March 1996
• Docket Number: Nos. 94-16477,94-16478,s. 94-16477
• Parties: Fed. Sec. L. Rep. P 99,071, 96 Cal. Daily Op. Serv. 1419, 96 Daily Journal D.A.R. 2427 Shaun WEBSTER and Robert Ligon, Plaintiffs-Appellants, v. OMNITRITION INTERNATIONAL, INC.; Jim Fobair; Roger Daley; Charles Ragus; and Jerry Rubin, Defendants-Appellees. Shaun WEBSTER and Robert Ligon, Plaintiffs-Appellants, v. Douglas ADKINS; and Gardere & Wynne, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

Page 776

79 F.3d 776

Fed. Sec. L. Rep. P 99,071, 96 Cal. Daily Op. Serv. 1419,

96 Daily Journal D.A.R. 2427

Shaun WEBSTER and Robert Ligon, Plaintiffs-Appellants, v. OMNITRITION INTERNATIONAL, INC.; Jim Fobair; Roger Daley;

Charles Ragus; and Jerry Rubin, Defendants-Appellees.

Shaun WEBSTER and Robert Ligon, Plaintiffs-Appellants, v. Douglas ADKINS; and Gardere & Wynne, Defendants-Appellees.

Nos. 94-16477, 94-16478.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Sept. 12, 1995.

Decided March 4, 1996.

Richard M. Heimann and Karen E. Karpen, Lieff, Cabraser & Heimann, San Francisco, California, for plaintiffs-appellants.

William Christopher Carmody, Dallas, Texas; Robert T. Sullwold, Orrick, Herrington & Sutcliffe, San Francisco, California; Edward King, San Francisco, California, for defendants-appellees.

Appeal from the United States District Court for the Northern District of California; Saundra B. Armstrong, District Judge, Presiding.

Before CHOY, BEEZER and DAVID R. THOMPSON, Circuit Judges.

BEEZER, Circuit Judge:

We consider what constitutes an inherently fraudulent pyramid scheme for purposes of several federal antifraud statutes.

Shaun Webster and Robert Ligon represent a class of participants (collectively "Webster") in a "multi level marketing" program promoted by Omnitrition International, Inc. ("Omnitrition"). Webster alleges that Omnitrition, Roger Daley, Charles Ragus, James Fobair and Jerry Rubin operated an inherently fraudulent pyramid scheme under both California and federal law. Webster amended the complaint to add as defendants Omnitrition's outside counsel, Douglas Adkins, and his law firm, Gardere & Wynne, L.L.P. (collectively "Attorney Defendants").

The district court granted summary judgment in favor of all defendants, holding that Omnitrition's program was not a pyramid scheme as a matter of law. The court also held that the federal securities claims against the Attorney Defendants were barred by the statute of limitations.

Webster appeals, claiming that there are disputed issues of material fact as well as errors of law. We have jurisdiction and we affirm in part and reverse in part.

I

Omnitrition is a corporation which operates a "multi level marketing" program, selling nutritional supplements, vitamins and skin care products. Members of Omnitrition's retail sales force are known as "Independent Marketing Associates" ("IMAs").

The first level of IMAs are referred to by Omnitrition as "distributors." There is no charge to become a distributor, and distributors have no quota of products they must purchase or sell. A distributor has the right to buy products at a discount from Omnitrition for use or resale and to recruit others into the program. A distributor can qualify to become a "Bronze Supervisor" by ordering a minimum amount (several thousand dollars) in products, measured by suggested retail price, from Omnitrition in one or two (consecutive) months. ¹ In order to remain a supervisor, an IMA must continue to meet the minimum order requirements each month.

Bronze Supervisors are entitled to receive a "Royalty Override Bonus" on up to three generations of "downline" supervisors, i.e. people the supervisor recruits who themselves also meet the minimum monthly order requirements to be supervisors. The "Royalty Override Bonus" gives the Bronze Supervisor a 1 to 4% commission on orders placed by downline supervisors. Supervisors and those they recruit must continue to purchase a minimum amount of products each month from Omnitrition to qualify the supervisor for commissions. Beyond the Bronze Supervisor level are Silver, Gold, and Diamond supervisors, who can recruit more supervisors into the program and earn the right to royalties on up to six levels of downline supervisors.

Omnitrition has three policies which are supposed to encourage retail sales. First, to order products, IMAs must certify that they have sold at least 70% of products previously purchased. This requirement can be met either by retail sales to end users or by sales to downline IMAs. Second, to qualify to earn commissions on downline orders, supervisors must certify that they have made sales to ten retail customers in the past month. It is undisputed that Omnitrition randomly calls some customers listed by supervisors to confirm that the sales have occurred. Third, if an IMA resigns from the program, Omnitrition will buy back unsold inventory for 90% of invoice price, with the caveat that Omnitrition will only repurchase consumable products that are less than three months old.

Fobair, Daley and Ragus are corporate officers of Omnitrition. Rubin, now deceased but appearing by the executor of his estate, was alleged to be involved in the creation and promotion of the marketing program. Adkins, a partner at Gardere & Wynne, is outside counsel and Assistant Secretary of Omnitrition. Adkins appears in a promotional videotape produced by Omnitrition, in which he states that Omnitrition is "not a pyramid scheme," gives advice on how to sell the nutritional products within the constraints of FDA guidelines, and makes other promotional statements concerning Omnitrition.

Webster and Ligon are former Omnitrition IMAs. Each filed class actions, Ligon in the Southern District of Texas and Webster in the Northern District of California, on behalf of all IMAs in Omnitrition's program who lost money. The two actions were consolidated in the Northern District of California and the district court certified the class. Webster's amended complaint alleges that Omnitrition's marketing program is actually a fraudulent pyramid scheme violative of federal securities laws, state unfair sales practice and fraud laws and the Racketeer Influenced and Corrupt Organizations Act ("RICO") (18 U.S.C. § 1961 et seq.).

The district court granted summary judgment for all defendants on the ground that Webster had failed to raise a triable issue of fact as to whether Omnitrition's program was a pyramid scheme; the district court held that Omnitrition's policies designed to encourage retail sales took the program outside the definition of fraudulent pyramid schemes. Most of the remainder of the district court's reasons for granting summary judgment depend on this determination.

The district court determined that Omnitrition distributorships were not securities within the purview of the federal securities laws because their return did not depend primarily on the efforts of others. The district court further held that, because the program was not fraudulent, its operation and promotion did not constitute predicate acts under RICO. Finally, the district court determined that Webster had failed to provide evidence of several elements of the state law claims.

The district court granted summary judgment to the Attorney Defendants holding that the limitation period of the statute of limitations had expired on the federal securities claims. Webster timely appeals.

II

We review a grant of summary judgment de novo. Atwood v. Newmont Gold Co., 45 F.3d 1317, 1320 (9th Cir.1995). We determine whether the district court correctly applied the relevant substantive law and, viewing the evidence in the light most favorable to the nonmoving party, whether there are genuine issues of material fact. Jesinger v. Nevada Federal Credit Union, 24 F.3d 1127, 1130 (9th Cir.1994).

The central issue is whether Omnitrition's marketing program is a pyramid scheme. Operation of a pyramid scheme constitutes fraud for purposes of § 12(2) of the Securities Act of 1933, § 10 of the Securities Exchange Act of 1934 and various RICO predicate acts. Because the record contains sufficient evidence to present a genuine issue of disputed material fact as to whether Omnitrition promotes a pyramid scheme, we reverse the grant of summary judgment.

A.

Pyramid schemes are said to be inherently fraudulent because they must eventually collapse. See, e.g., S.E.C. v. International Loan Network, Inc., 968 F.2d 1304, 1309 (D.C.Cir.1992). Like chain letters, pyramid schemes may make money for those at the top of the chain or pyramid, but "must end up disappointing those at the bottom who can find no recruits." In re Koscot Interplanetary, Inc., 86 F.T.C. 1106, 1181 (1975), aff'd mem. sub nom., Turner v. F.T.C., 580 F.2d 701 (D.C.Cir.1978).

The Federal Trade Commission has established a test for determining what constitutes a pyramid scheme. Such contrivances

are characterized by the payment by participants of money to the company in return for which they receive (1) the right to sell a product and (2) the right to receive in return for recruiting other participants into the program rewards which are unrelated to sale of the product to ultimate users.

Id. (emphasis in original). The satisfaction of the second element of the Koscot test is the sine qua non of a pyramid scheme: "As is apparent, the presence of this second element, recruitment with rewards unrelated to product sales, is nothing more than an elaborate chain letter device in which individuals who pay a valuable consideration with the expectation of recouping it to some degree via recruitment are bound to be disappointed." Id. We adopt the Koscot standard here and hold that the operation of a pyramid scheme constitutes fraud for purposes of several federal antifraud statutes.

B.

Omnitrition argues that because it does not charge for the right to sell its products at the "distributor" level, as a matter of law the first Koscot element is not met. We disagree.

Omnitrition's argument improperly focuses only on the "distributor" level of Omnitrition's program. The program is unquestionably not a pyramid scheme if only the distributor level is taken into account; the participant pays no money to Omnitrition, has the right to sell products and has no right to receive compensation for recruiting others into the program. The distributor level, however, is only a small part of the entire program. Taking...