In the Fifth Circuit of the United States Court of Appeals, bringing a class action lawsuit against an alleged pyramid schemes just got a heck of a lot harder. According to one of the three Circuit Judges presiding over the case, the court’s decision gives illegal pyramid schemes a “Teflon coating” and protects them “not only from class actions but from any suits claiming fraud.” The entire opinion can be read here.
The case, titled Torres v. S.G.E. Mgmt. LLC (Stream Energy), was a class action suit against the multi-level marketing program Ignite Energy. Plaintiffs were formerly participants in the multi-level marketing venture Ignite, an MLM designed to promote energy services. The Plaintiffs claimed they participated in the venture and ultimately lost money as a result of Ignite’s false misrepresentations that it was a legitimate business. The backbone of Plaintiff’s cause of action rested upon their allegations that Ignite violated the Racketeer Influenced and Corrupt Organizations (“RICO”) Act through mail and wire fraud activity. In order to prove fraudulent mail and wire activity caused their injury, i.e., the loss of their money due to fraudulent promotions online, the law required that Plaintiffs prove they relied on Ignite’s fraudulent misrepresentations claiming to be a legitimate business.
In order to understand the issues surrounding the case, certain legal background and context are necessary. Before a large number of people (“class”), all with a common interest in a particular matter, can sue or be sued, the Federal Rules of Civil Procedure demand what’s called “class certification”. Basically, class certification requires, among other things, that there be questions common to all members of the class. Additionally, these common questions must predominate over any questions that affect only individual class members. As an example, if an individual ate a moldy hamburger at a restaurant, it would not be a “common” issue that would justify class certification. On the flip side, if an individual was overcharged 5% on a cell phone bill, and that strategy was used for all other customers, the “common interest” would certainly exist to justify class certification.
Because class certification requires proof that questions exist common to all members and not just individuals, Plaintiffs could only bring a class action lawsuit by offering proof that every single person within the class invested money in Ignite under false pretenses that it was a legitimate company. As with all class action lawsuits, Plaintiffs faced an uphill battle.
They got the class certified
However, a District Court in Texas certified Plaintiffs class and circumvented the onerous burden of individual member proof by holding that Plaintiffs only had to show Ignite was a pyramid scheme. In doing so, the district court was basically allowing the Plaintiffs to certify the class on the inference that class members’ decision to pay money and join could not be explained by anything but a common reliance on Ignite representing a legitimate business. In the District Court’s mind, it very logically concluded that no one in their right mind would consciously choose to join a pyramid scheme that would result in financial loss for the majority of its participants. Ignite appealed the District Court’s decision.
But not so fast
In a shocking and bizarre turn of events, the Fifth Circuit overturned the District Court’s decision. The Fifth Circuit held that the Plaintiffs would have to rely on individualized proof, meaning they would have to prove every single class member relied on Ignite’s misrepresentations and ultimately lost money. Using the evidence Plaintiffs provided in order to show Ignite was operating as a pyramid scheme, the Court ruled Plaintiffs were put on notice of the fraud. In other words, the Court held that Plaintiffs knew or should have known Ignite was pyramid. Furthermore, the Fifth Circuit disagreed with the District Court’s inference that no rational person would join a pyramid scheme, finding that “an investor could reasonably choose to knowingly invest in a pyramid scheme in the hope that they would make money.” In other words, since there’s a market of idiots out there that would knowingly participate in an illegal scheme (hypothetically), Plaintiffs were unable to prove that EVERY single class member was duped by way of Ignite’s alleged misrepresentations.
In my opinion, the Court’s embarrassing opinion serves to give pyramid organizers a free pass. In his dissenting opinion, Judge Wiener voices my concerns with the Court’s decision. While Ignite may have ultimately been exonerated by the court, we now have no way of knowing for sure. In essence, this decision will protect the people behind pyramid schemes from future class actions (in the Fifth Circuit) by requiring that Plaintiffs prove each and every member lacked ANY awareness of potential fraud. This is a task so burdensome, it’s basically impossible. As Justice Wiener laments, “this leads to the majority’s stripping these and future Plaintiffs of any means to pursue class actions against pyramid schemes in this Circuit.” This is a good example of where the Justice system failed the very people it is supposed to protect. Whether Ignite is a pyramid scheme or not, this decision only serves to embolden pyramid operators by way of an added layer of protection.
What do you think? Fair outcome?