Pyramid Schemes – An Introduction

Pyramid Schemes – An Introduction

A pyramid scheme is a non-sustainable business model that involves promising participant’s payment, services or ideals, primarily for enrolling other people into the scheme or training them to take part, rather than supplying any real investment or sale of products or services to the public. Pyramid schemes are a form of fraud.

Pyramid schemes are illegal in many countries including Albania, Australia, Brazil, Bulgaria, Canada, China, Colombia, Denmark, the Dominican Republic, Estonia, France, Germany, Hungary, Iceland, Iran, Italy, Japan, Mexico, Nepal, The Netherlands, New Zealand, Norway, the Philippines, Poland, Portugal, Romania, South Africa, Spain, Sri Lanka, Switzerland, Taiwan, Thailand, Turkey, the United Kingdom, and the United States.

A successful pyramid scheme combines a fake yet seemingly credible business with a simple-to-understand yet sophisticated-sounding money-making formula which is used for profit. The essential idea is that a "con artist" Mr. X, makes only one payment. To start earning, Mr. X has to recruit others like him who will also make one payment each. Mr. X gets paid out of receipts from those new recruits. They then go on to recruit others. As each new recruit makes a payment, Mr. X gets a cut. He is thus promised exponential benefits as the "business" expands.

Such "businesses" seldom involve sales of real products or services to which a monetary value might be easily attached. However, sometimes the "payment" itself may be a non-cash valuable. To enhance credibility, most such scams are well equipped with fake referrals, testimonials, and information. The flaw is that there is no end benefit. The money simply travels up the chain. Only the originator (sometimes called the "pharaoh") and a very few at the top levels of the pyramid make significant amounts of money. The amounts dwindle steeply down the pyramid slopes. Individuals at the bottom of the pyramid (those who subscribed to the plan, but were not able to recruit any followers themselves) end up with a deficit.

The network marketing (NM)or multi-level marketing (MLM) business has become associated with pyramid schemes as "Some schemes may purport to sell a product, but they often simply use the product to hide their pyramid structure." and the fact while some people call MLMs in general "pyramid selling" others use the term to denote an illegal pyramid scheme masquerading as an MLM.

In modern days, it is also called as "Chain Business", "Introduction Business", "Referral Business", "Direct Marketing Business", "Direct Selling through Independent Business owner" etc. 

Money Circulation Scheme means any scheme that promises easy or quick money by way of commissions based on enrolling members into the scheme, no matter whether it involves goods or sales of goods at any stage. In India, The Prize Chits and Money Circulation Scheme (Banning) Act, 1978 bans illegal Money Circulation Scheme by whatever name called. 

The Prize Chits and Money Circulation Scheme (Banning) Act, 1978

Sec.2 (c): "money circulation scheme" means any scheme, by whatever name called, for the making of quick or easy money, or for the receipt of any money or valuable thing as the consideration for a promise to pay money, on any event or contingency relative or applicable to the enrolment of members into the scheme, whether or not such money or thing is derived from the entrance money of the members of such scheme or periodical subscriptions

Sec.3: Banning of Prize Chits and Money Circulation Scheme or enrolment as members or participation herein : - No person shll promote or conduct any prize Chit or Money Circulation scheme, or enroll as a member to any such chit or scheme or participate in it otherwise, or receive or remit any money in pursuance of such chit or scheme"

Sec.10: Offences under this Act to be cognizable: - All offences punishable under this Act shall be cognizable".

Modus Operandi of M.L.M.

Multi-Level Marketing (MLM) is a product camouflaged Money circulation scheme. The modus operandi of MLM is collecting entrance free from the new members, bagging half of the collected fee and distributing remaining among the chain or network. The commission depend on the making others to join in the scheme by them or by their down line members. They confuse enrolling activity with sale. Commissions based on sales activity may be legal but Commissions based on enrolling activity and showing this enrolling activity as "Sales" is illegal, dangerous and thus deserves punishable. 

How to identify Money Circulation Scheme 

Any scheme whatever name called promises commissions or income based on enrollment of new members into the scheme. 

Conditions:

 (i) Enrollment / sponsoring / Introduction of New Members.

 (ii) Promise of income based on the joining of new members.

If conditions (i) and (ii) are satisfied it is money circulation scheme. Whether or not the income derived from entrance fee or other things including so called sale of goods or renewal fee etc. 

Case Studies:

1. Some companies collect joining fee of Rs.3,000/- to 6,500/- and out of this joining fee, half of the money is directly being credited to the company account and the remaining money is being distributed among the network or chain or in the name of worth of products. The Siphoning of huge money through MLM is unimaginable. For example if a so called Multi National Company is credited Rs.2,500/- from its enrolment fee which claims nearly 13 lakh members, then without any service about Rs.2,600 crore money is being siphoned apart from commissions to uplines including Company in foreign Countries.

2. They conduct meetings for enrollment. They ask their members to prepare list of friends, family members, subordinates, colleagues, neighbours etc. and pursue them to join into the scheme. This wild pursue lead to undue harassment and inducement and ultimately cheating or putting mental torcher.

3. Social relations will be strained if anyone avoids this mental pressure.

4. Here except distribution of entrance fee camouflaged with products, there is no tangible product sale as per consumer choice and there is no consumerism in these schemes.

Court Judgements: 

1. Supreme Court of India - KURIACHAN CHACKO AND OTHERS .Versus STATE OF KERALA which was reported vide (2008)8 SCC 708.

Para No.36. In our opinion, the requirement of law is "an event or contingency relative or applicable to the enrolment of members into the scheme" and nothing more. The plain language of the section does not insist that such enrolment of members must be by the members already enrolled. It is impossible to read into the statutory provision such requirement which is not stipulated by Parliament. Upholding of the argument of the learned counsel would result in rewriting of the section, which is certainly not permissible in our constitutional system.

Para No.37. The event or contingency on the happening of which the amount would become payable must be relative or applicable to the enrolment of the members into the Scheme. It is immaterial by whom such members are enrolled. It may be by members, by promoters or their agents or by gullible sections of the society suo motu (by themselves). The sole consideration is that payment of money must be dependent on an event or contingency relative or applicable to the enrolment of more persons into the Scheme, nothing more, though nothing less. In the present case, the second ingredient is very much present.

Para No.41. The High Court also upheld the argument of the prosecution that the Scheme was a '"mathematical impossibility". The promoters of the Scheme very well knew that it is certain that the Scheme was impracticable and unworkable making tall promises which the makers of the promises knew truly well that it could not work successfully. It could work for some time in that "Paul can be robbed to pay Peter" but ultimately when there is a large mass of Peters, they will be left in the lurch without any remedy as they would by then have been deceived and deprived of their money. 

2. High Court of Andhra Pradesh - M/s.Amway India Enterprises Versus Union of India and others which was reported vide (2007)4 ALT 808(DB).

From the whole analysis of the scheme and the way in which it is structured it is quite apparent that once a person gets into this scheme he will find it difficult to come out of the web and it becomes a vicious circle for him. In any event the petitioners have not specifically denied the turnover they are achieving and the income they are earning towards the initial enrollment of the distributors, the renewal subscription fee and the minimum sales being achieved by the distributors as alleged in the counter affidavit. By no means can it be said that the money which the first petitioner is earning is not the quick/easy money. By promising payment of commission on the business turned out by the down-line members sponsored either directly or indirectly by the up-line members (which constitutes an event or contingency relative to enrollment of members), the first petitioner is earning quick/easy money from its distributors, apart from ensuring its distributor earn quick/easy money. Thus the two ingredients are satisfied in the case of promoter too. We are, therefore, of the considered view that the scheme run by the petitioners squarely attracts the definition of "Money Circulation Scheme" as provided in Section 2(c) of the Act.. 

3. High Court of Karnataka - COMMISSIONER OF INCOME TAX VS. AMARJEET KAUR (January 31, 2006) reported in (2006) ITR 283 (71).

"In our view, this Scheme has all the basic ingredients of money circulation scheme, which is banned under Section 3 of the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, and therefore, the expenditure incurred by the assessee is an expenditure prohibited by law and therefore, in view of Explanation inserted by Finance (No. 2) Act, 1998 to Section 37 (1)of the Act, which has come into force with effect from 1-4-1962, the expenditure shall not be deemed to have been incurred for the purpose of business and therefore, no deduction or allowance can be made in respect of such expenditure in computing the income chargeable under the head "profits and gains of business or profession".

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