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Kugler v. Koscot Interplanetary Inc.

Decided: July 26, 1972.

GEORGE F. KUGLER, JR., ATTORNEY GENERAL OF NEW JERSEY, PLAINTIFF,
v.
KOSCOT INTERPLANETARY, INC., A FLORIDA CORPORATION, AND GLENN W. TURNER, DEFENDANTS



Mehler, J.s.c.

Mehler

This is an action brought by the Attorney General under the Consumer Fraud Act, N.J.S.A. 56:8-1 et seq. , the New Jersey Antitrust Act, N.J.S.A. 56:9-1 et seq. , and the Corporation Act, N.J.S.A. 14A:13-11.

The defendants are Koscot Interplanetary, Inc. (Koscot), a Florida corporation, which is engaged in the sale and distribution of cosmetics through non-exclusive distributorships throughout the United States, and Glenn W. Turner, who founded Koscot, and at all times relevant to this action was chairman of its Board of Directors and its principal, if not sole stockholder.

The Attorney General charges that defendants have employed fraudulent and deceptive practices in connection with the sale of Koscot distributorships to residents of New Jersey and that its multilevel distribution program is predicated upon a referral sales and pyramiding concept which is inherently fraudulent and deceptive within the meaning of N.J.S.A. 56:8-2. At the commencement of this action that section provided, in pertinent part, as follows:*fn1

The act, use or employment by any person of any deception, fraud, false pretense, false promise, misrepresentation, or the knowing, concealment, suppression, or omission of any material fact with intent that others rely upon such concealment, suppression or omission, in connection with the sale or advertisement of any merchandise or with the subsequent performance of such person as aforesaid, whether or not any person has in fact been misled, deceived or damaged thereby, is declared to be an unlawful practice; * * *.

The Attorney General is specifically authorized to bring an action under the Consumer Fraud Act by N.J.S.A. 56:8-8, which at the time of the commencement of this action provided, in pertinent part, as follows:*fn2

Whenever it shall appear to the Attorney General that a person has engaged in, is engaging in or is about to engage in any practice declared to be unlawful by this act he may seek and obtain in an action in the Superior Court an injunction prohibiting such person from continuing such practices or engaging therein or doing any acts in furtherance thereof. * * * In addition, the court may vacate or annul the charter of a corporation created by or under the laws of this State, revoke the certificate of authority to do business in this State of a foreign corporation, and revoke any other licenses, permits or certificates issued pursuant to law to such person which have been or may be used to further such unlawful practice. The court may make such orders or judgments as may be necessary to prevent the use or employment by a person of any prohibited practices, or which may be necessary to restore to any person in interest any moneys or property, real or personal which may have been acquired by means of any practice herein declared to be unlawful.

The charge that defendants have violated the New Jersey Antitrust Act is predicated on the allegation that the limitation which Koscot imposes on its distributors in contracts with them are unlawful restraints of trade, specifically in violation of N.J.S.A. 56:9-3, which declares that --

Every contract, combination in the form of trust or otherwise, or conspiracy in restraint of trade or commerce, in this State, shall be unlawful.

Authority to institute proceedings in this court to prevent and restrain violations of the Act is granted to the Attorney General by N.J.S.A. 56:9-10(a).

The charge under the Corporation Act, N.J.S.A. 14A:13-11, is predicated on the allegation, which is not disputed, that Koscot, a foreign corporation, did business in New Jersey in 1969 without a certificate of authority issued by the Secretary of State.

The Attorney General seeks the following relief: (1) A declaration that specific practices complained of are in violation of N.J.S.A. 56:8-2; (2) an accounting of all moneys received by Koscot from New Jersey residents in connection with the sale to them of distributorships; (3) a declaration that the contracts between Koscot and its New Jersey distributors are null and void as being violative of the public

policy of New Jersey as embodied in N.J.S.A. 56:8-2, 56:8-2.2, and N.J.S.A. 56:9-3, 56:9-4(a); (4) restoration by defendants of all moneys acquired by practices violative of N.J.S.A. 56:8-2 or N.J.S.A. 56:8-2.2 from persons who entered into contracts with Koscot; (5) a declaration that defendants have engaged in contracts, combinations or conspiracies in restraint of trade or commerce in New Jersey in violation of N.J.S.A. 56:9-3 and have combined or conspired to monopolize trade or commerce in violation of N.J.S.A. 56:9-4(a); (6) injunctive relief barring the specific practices allegedly violative of N.J.S.A. 56:8-2, 56:8-2.2 and N.J.S.A. 56:9-3, 56:9-4(a); (7) imposition of civil penalties against defendants as provided in N.J.S.A. 56:8-13, N.J.S.A. 56:9-10, and N.J.S.A. 14A:13-11, and (8) revocation of Koscot's certificate of authority to transact business in New Jersey.

I

Koscot, whose principal office is in Orlando, Florida, was incorporated in 1967. Although it began to do business in New Jersey in 1969, it did not obtain a certificate of authority to do so from the Secretary of State until November 10, 1971. From February 1969 to February 1971 Koscot offered for sale and sold distributorships in New Jersey, as it had been doing elsewhere, which entitled the purchaser to participate in the Koscot marketing plan in two capacities, namely, "retail", i.e., the sale of cosmetics, and "wholesale", i.e., the recruitment and sale of further distributorships.*fn3 Both segments of the marketing plan provided for the compensation of distributors through a system of commissions related either to the sale of the product or the sale of distributorship positions.

The marketing program which was in effect in New Jersey may be characterized as a multilevel distribution plan. During the initial period of operation here the program consisted of four positions, known as Director, Supervisor, Coordinator and Beauty Advisor. Persons on each of the levels were permitted to sell products at rental with buying discounts ranging from 35% for Beauty Advisors to 65% for Directors. Directors and Supervisors were encouraged to solicit investments from potential participants in order to earn finder's fees ranging from $500 to $2500.

Beginning in the fall of 1969, the marketing plan was modified both as to form and substance. The position of Co-ordinator, which was the second level retail position, was eliminated and the highest position became known as Distributor in lieu of Director. Under the new plan, the system worked essentially as follows: To become a Supervisor one paid $2,000 to Koscot, for which he was credited with inventory of a like dollar amount at retail value. To become a Distributor one paid $5,000 to Koscot and was credited with inventory of a like dollar amount at retail value. Both investment levels provided for company training courses. A Supervisor obtained a buying discount of 55% on future purchases of product and a Distributor obtained a 65% buying discount. They could sell the product themselves and earn the full discount or engage Beauty Advisors, who sold product at a buying discount of 40% obtained through their sponsoring Supervisor's or Distributor's account. Thus a Supervisor, on sales made by him, earned a commission of 55% and on the volume of retail sales made by his Beauty Advisor earned an override or commission of 15%. A Distributor earned a full commission of 65% on sales made by himself and an override or 25% commission on the volume of retail sales made by his Beauty Advisor. Additionally, he became entitled to a 10% commission on the volume of sales made by or through his Supervisor.

The "wholesale" aspect of the new marketing plan operated as follows: A Supervisor was paid a finder's fee by Koscot

when he obtained a new Supervisor. A Distributor who enrolled a new Supervisor received $700 from Koscot, $500 of which was paid as a finder's fee, the additional $200 representing a 10% override on the new recruit's mandatory new product order of $2,000. A Supervisor could move up to the level of Distributor only by purchasing an additional inventory of $3,000 and by sponsoring another Supervisor as his replacement in his sponsoring Distributor's organization. Such a move-up produced for the sponsoring Distributor commissions totalling $2,850. Thus, finder's fees and commissions had no connection with retail sales made to the ultimate consumer, but were paid solely for bringing new investors into Koscot's marketing program.

Through the period of active solicitation of new distributors in New Jersey Koscot sold 624 Supervisor positions and 387 Distributor positions. The total investment by New Jersey residents in these positions exceeded three million dollars.

The principal, if not the sole, method of recruiting distributors was by means of a public presentation known as the Golden Opportunity meeting, supplemented by a charter flight program to Koscot's home office in Orlando, Florida, known as the GO (for Golden Opportunity) Tour. The form and substance of Golden Opportunity meetings were in all material respects uniform and in accordance with Koscot directives. The format for these meetings was set forth in a script prepared and published by Koscot. Those who conducted the meetings followed the script in accordance with Koscot training and policy.

Golden Opportunity meetings consisted of several segments. They included a general introduction, a film about Turner and the origins of Koscot, the "Alice" portion devoted to retail sales by Beauty Advisors, a discussion of the retail income to be earned by Distributors and Supervisors, a presentation of the wholesale aspect of the program, and finally, a comprehensive review known as the "double back."

Large earnings of a size to allure the hearers was the theme of the Golden Opportunity meetings. Some of them were presented without sufficient basis or information to support and justify them. The bases of others were contrary to the fact. Thus, although there were numerous representations regarding the number of customers a Beauty Advisory might expect to have at a party,*fn4 the number of parties per month and the re-order potential which was said to be 100%*fn5 with the Beauty Advisors themselves earning over $8,000 a year "working far less hours than the average woman and earning far more," defendants had neither experience in marketing nor the results of independent studies to justify the representations.

Having established the potential earnings of Beauty Advisors, the presentation then proceeded to a discussion of incomes to be realized by Supervisors and Distributors through retail sales. The presentation was such as to lead a hearer to believe that building a sales organization of Beauty Advisors was not difficult, although, as appears from the evidence, it was extremely difficult to engage and retain girls to work as Beauty Advisors. The hearers were then informed that before long a Supervisor could expect to earn retail sales commissions of over $17,000 a year and a Distributor could soon expect to earn over $50,000 a year from retail sales. It was fiatly stated that many Koscot Distributors were presently earning "this kind of money ($50,000) and more," although no Koscot Distributor had ever achieved annual retail sales commissions in excess of $50,000.

Although the statements relative to retail sales related to the retail aspects of Koscot, it is perfectly clear that the figures presented were intended to induce the hearers to purchase Supervisor and Distributor positions by leading them to believe they would earn these exceedingly large projected commissions.

The defendants contend that the statements were not intended as representations to be relied on, but were intended as projections or illustrative examples of the way the system worked. It is their position that "if one accepts the average figure as a premise, any hypothetical construct [sic] built on that premise will form a valid syllogism." I find it difficult to understand why a "valid syllogism" may not also be deceptive and misleading. If a syllogism begins with a false premise, it will result in a false conclusion. I find also that caveats or warnings that not every one would earn such incomes were inconspicuous and ineffective especially in view of the admitted fact that no one had earned such large amounts from retailing Koscot products.

Defendants also contend that the examples or projections should be considered "mere puffery" and as such are to be tolerated as commonplace in modern business. It must be noted that the Consumer Fraud Act was enacted for the very purpose of preventing some practices which may indeed be pursued in modern business. As Dr. Westing, a professor of business at the University of Wisconsin Graduate School of Business, testified, there are degrees of exaggeration, some of which can be harmful. As an example, a statement that someone is earning $50,000 when in fact no one is or it is not feasible may readily be harmful. As was said in Goodman v. Federal Trade Commission , 9 Cir. , 244 F.2d 584, 603 (1957), statements made to prospective purchasers which are aimed to induce a purchase by them may not be characterized as mere "puffery." There the court said:

It should be added that we are not in the realm of civil torts. Even in that realm the old rule of caveat emptor has been abandoned, in favor of the more ethical attitude that one dealing with another in

business had the right to rely upon representations of facts as the truth. And the Supreme Court has applied with great consistency this approach in dealing with the Federal Trade Commission by stating, in a leading case:

"The fact that a false statement may be obviously false to those who are trained and experienced does not change its character, nor take away its power to deceive others less experienced. There is no duty resting upon a citizen to suspect the honesty of those with whom he transacts business. Laws are made to protect the trusting as well as the suspicious. The best element of business has long since decided that honesty should govern competitive enterprises, and that the rule of caveat emptor should not be relied upon to reward fraud and deception." (Emphasis added).

Defendants also say that the ever increasing flow of retail sales and commissions --

is too simplistic for anyone to believe. For one thing, it ignores a basic factor. Not even a naive Koscot distributor believes that ipso facto he has a substantial clientele regularly repurchasing cosmetics. In this type of product area much depends on one's attitude toward the product, developing a liking to it, and consuming first what remains of cosmetics of other producers. One does not at once abandon the brands one has been using and plunge wholeheartedly into Koscot products without first experimenting and comparing products both as to quality, appearance and cost. . . . So much depends on factors beyond the control of anyone in Koscot.

I find that none of these limiting factors of potential income was mentioned at the presentation and that their absence or omission further added to the misleading and deceptive character of the projections. It is also to be noted that the statute may be violated even though one has not in fact been misled or deceived by an unlawful act or practice.

The prospect of earning commissions by recruiting others was offered by defendants as a substantial inducement to join the Koscot marketing program. This wholesale aspect of the program was stressed at the Golden Opportunity and GO Tour meetings and at the business management schools which new Distributors and Supervisors were obliged to attend for four days, 60% of the time being devoted to the wholesale aspect. It was there that they learned various techniques to recruit prospective investors. One was the cold

canvass method, which involved approaching strangers to induce them to attend Golden Opportunity meetings. Another was the curiosity approach by which one would stop a stranger and ask how he would like to double or triple his income and earn $50,000 a year. Distributors and Supervisors were instructed to appear to be successful by driving expensive automobiles and displaying $100 bills.

In an endeavor to earn wholesale commissions, they made every effort to bring prospects to Golden Opportunity meetings and to have them sign contracts at the conclusion of the meeting. There, representations were made to the effect that annual earnings from $26,000 to $52,000 and more were available to Distributors by their helping people they sponsored to become successful Distributors. Yet only five New Jersey Distributors earned more than $26,000 in one year as the result of sponsoring new Distributors.

High pressure salesmanship was employed. False enthusiasm was invoked. A Go Go Go chant and a money hum were characteristics of the meetings. And checks for wholesale commissions were passed out.

A prospect who did not sign following a meeting but evinced an interest in obtaining further information was induced to go on a GO Tour,*fn6 to which he was told to bring a certified check. While on the plane great efforts were made to "close" prospects, that is, have them sign contracts before the plane landed in Florida. A theme of Koscot was "Get the check." On the plane references were made to the success of others. Large amounts of money were displayed;

money was flashed up and down the aisle amid talk of success and at times piles of cash and contracts were dropped in the laps of prospects, particularly those who still appeared to be reluctant, because "money excites people." Many signed contracts before they disembarked.

Upon arriving in Florida the prospects, who had come from New Jersey and other parts of the country, were taken on a tour of the company facilities, after which they attended a large Opportunity meeting conducted by Koscot personnel. References were made to the position of Golden Eagle, which apparently represented one whose commissions exceeded $150,000. Below the Golden Eagle were Silver and Bronze Eagles followed deprecatingly by a Buzzard, so called because his commissions totalled a mere $20,000, although in fact this amount was substantially in excess of the earnings of the overwhelming majority of Koscot distributors.

Koscot denies liability for any misrepresentations which they say may have been made or fraudulent practices which they say may have been conducted by distributors, on the ground that they were independent contractors. I find this contention to be without merit. Although the contracts between Koscot and its distributors provide that each distributor agrees to the following:

I shall be in business on my own account as an independent contractor. I am not an employee, servant, agent or legal representative of Koscot Interplanetary, Incorporated. * * *

it is well established that courts of equity will go behind the form of a contract or relationship to its substance. In the present case, the statements and omissions of the distributors at Golden Opportunity meetings are those taken from the Distributor's Training Manual supplied by Koscot for use by the distributors to persuade or induce others to enter into distributorship contracts directly with Koscot. Many, if not most, of the Golden Opportunity meetings and GO Tours were organized and conducted by the Koscot State Director, who was an employee of Koscot, or by area subdirectors,

who were persons chosen by the State Director for this purpose. Golden Opportunity meetings in Orlando, held on the first leg of the GO Tour, were repetitions, by Koscot employees, of the Golden Opportunity meetings held in the State.

Not only were the words and diagrams used those supplied by Koscot, but even the mood and atmosphere of the meetings were set according to the directions found in the Distributor's Training Manual. The contractual relationship entered into by new distributors who were signed up at the meetings and on tours was between Koscot and the distributors. The consideration ($5,000 or $2,000) was forwarded directly to Koscot. So anxious was the company for these moneys that no applicant was ever rejected. It is plain that the expansion of Koscot's marketing program came about through the active recruitment of distributors by those already participating in the program as distributors.

The major portion of Koscot's revenues was derived from the sale of distributorships rather than from the sale of cosmetics. According to Dr. Westing, such revenue accounted for a substantial amount of Koscot's capitalization, which he characterized as a contribution by distributors on an interest-free basis; money which the company used for its operations. Consequently, the company, as well as the distributors, benefited from the conduct of its distributors.

It is clear that whether or not the statements were made by independent contractors or agents, they were authorized and even directed by Koscot. Having so controlled the situation for its own benefit, Koscot may not now, on the basis of a contract which it drafted, disclaim liability and hold out its "independent contractors" as a shield for its wrongdoing. Thaxton v. Commonwealth , 211 Va. 38, 175 S.E. 2 d 264 (1970), a case involving Koscot. As the court said in Goodman, supra , at p. 592 of 244 F.2d, in reviewing the action of the Federal Trade Commission in a consumer fraud sales action in which a similar defense was interposed:

Here, the agent was clothed with apparent and, we think, real authority to speak and act for and on behalf of the principal, and the latter is bound thereby. We know of no theory of law by which the company could hold out to the public these salesmen as its representatives, reap the fruits from their acts and doings without such liabilities as attach thereto.

Koscot's distribution program is predicated upon a referral sales and pyramiding concept, a practice which is known as referral or pyramid sales. It is an arrangement whereby one is induced to buy upon the representation that he can not only regain his purchase price, but also earn profits by selling the same program to the public. It thus involves the purchase of the right to sell the same right to sell.

A pyramid type practice is similar to a chain letter operation. Such a program is inherently deceptive for the seemingly endless chain must come to a halt inasmuch as growth cannot be perpetual and the market becomes saturated by the number of participants. See e.g., State by Lefkowitz v. ITM Inc. , 52 Misc. 2 d 39, 275 N.Y.S. 2 d 303 (Sup. Ct. 1966). Thus many participants are mathematically barred from ever recouping their original investments, let alone making profits. Four State legislatures have specifically legislated against pyramid sales. Va. Code Annot. 59.1-67.1, 67.2, 67.3; Pa. Stat. Annot. 73 Purdon Sec. 201-1 et seq.; Iowa Code Annot. Sec. 713.24, subd. 2, par. b; Fla. Stat. Annot. Sec. 849.091. New Jersey has not by name proscribed referral or pyramid sales However, N.J.S.A. 56:8-8 gives the Attorney General the broad power to prosecute a practice "of any * * * deception, fraud, false pretense, false promise, misrepresentation, or the knowing, concealment, suppression, or omission of any material fact. * * *." See N.J.S.A. 56:8-2. In Kugler v. Romain , 58 N.J. ...


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