Synopsis Pyramid or Ponzi schemes have been in the news of late in India with some high profile arrests also being made. This Article examines the law in this regard and whether it is robust enough to deal with new age retailing such as, multi-level marketing and direct selling.
Introduction Fable time – “Give me only that much wheat as is equal to the squares in a chess board, just one grain for the first square but double the grains for each subsequent square. Thus, there would be 2 for the second square, 4 for the third and so on until the sixty fourth square.” How many grains of wheat do you think there would be at the end? If you think it would be a small number then think again, the answer is a mind boggling figure of 263 i.e., 2 x 2 sixty three times and if all this wheat were to be stocked in a pile it would reach the moon! This is the power of exponential compounding.
What is an example on Maths doing in a legal subject? It illustrates the concept of Pyramid Schemes and why they are often considered illegal. Several of these schemes are of such a nature that for the last level to make money it would need to rope in all the people in the world and yet there may be a loss! These pyramids are the opposite of the popular management phrase “Fortune at the Bottom of the Pyramid” – here it is only the top which makes money while the bottom is often left high and dry and banging on the doors of courts/police stations.
To curb such schemes, the Centre has enacted the Prize Chits and Money Circulation Schemes (Banning) Act, 1978 (“the Act”) declaring them illegal. Let us examine the important features of this Act.
Scheme of the Act
The Preamble to this Act states that it is enacted to ban the promotion or conduct of prize chits and money circulation. Thus, it aims to curb two schemes, the first being prize chits and the second being money circulation schemes. The second type, i.e., money circulation scheme is relevant for this discussion.
Section 3 of the Act bans money circulation schemes and even bans enrolment as members or participation therein. It provides that no person shall:
(a) promote or conduct any money circulation scheme;
(b) enroll as a member to any such scheme;
(c) participate in it otherwise; or
(d) receive or remit any money in pursuance of such or scheme.
Thus, there is a four-pronged ban on promotion/ conducting, enrolling, participating or receiving/remitting money in a money circulation scheme. The penalty for violating this section is imprisonment of a term of up to 3 years and /or a fine of Rs. 5,000. Further, unless there are special and adequate mitigating reasons, the minimum fine is Rs. 1,000 and minimum imprisonment term is 1 year. Hence, it becomes very important to understand what is and is not a money circulation scheme.
Money Circulation Scheme
This brings us to the most important definition contained in section 2(c) of the Act, i.e., money circulation scheme. The Act defines this in an exhaustive manner to mean: “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;”
The definition is worded in a not-too happy manner and can get a bit ambiguous at times. To simplify matters, the Supreme Court in State of West Bengal vs. Swapan Kumar Guha, 1982 (1) SCC 561 has paraphrased and simplified the definition as follows:
“Money circulation scheme means any scheme, by whatever name called,
(I) for the making of quick or easy money, or
(II) 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.”
Let us analyse the above definition to bring out its essential elements:
(a) There must be a scheme but its nomenclature is not material. A scheme may be defined as a systematic choice of action;
(b) It must be for the making of quick or easy money (these two terms carry the maximum significance);
(c) A lternatively, it must be for the receipt of any money or valuable thing as consideration for a promise to pay money;
(d) Both of which are contingent or dependent upon the enrolment of more members into such scheme; and
(e) The payment of the money or valuable thing may be derived from the entrance money or recurring subscriptions of the members of the scheme.
Hence, if one were to strip down the definition to bare bones, it would mean a quick or easy money scheme where earnings are contingent or dependent upon getting more and more members. This is the essence or the core of a multi level marketing or a pyramid scheme. If there is no contingency or dependency on an external event of garnering more subscriptions then it cannot be termed as a money circulation scheme. Even in a case where the returns promised are so ludicrous as long as the return is not contingent, it does not fall foul of the Act. For instance, in the above-mentioned Supreme Court case, a scheme was floated in which the investors were getting returns @ 48% – 12% officially and 36% unofficially / in a clandestine manner. The Apex Court held that such a scheme was not a quick or easy money scheme. It makes no difference whether the transactions are in black money or not. While that would violate the Tax Laws, it certainly would not fall within the mischief of this Act.
The Court also gave some interesting analogies to highlight its views – a lawyer who charges a hefty sum for an SLP lasting 5 minutes, a doctor who charges likewise for a tonsil operation lasting 10 minutes and Chartered Accountants (wonder where the Hon’ble Court got that one from)/Engineers/Architects who charge likewise, all make quick and easy money. Similarly, builders and brokers are notorious for making quick money. Obviously all of these cannot be covered within the purview of the Act since the contingency element is absent.
Hence, the Court denied any prosecution under the Act since there was no mutual arrangement which was dependent on an event or contingent on enrolment of members.
Others Considerations
Another decision of the Supreme Court in Kuriachan Chacko vs. State of Kerala, 2008 (8) SCC 708 examined what were relevant and irrelevant considerations when it came to deciding whether or not a scheme was a money circulation scheme? The Court laid down the following guidelines in addition to those laid down in Guha’s case mentioned above:
(a) In the scheme under question, a member would be entitled to double the amount only if after his enrolment, additional 14 members were enrolled in the scheme. The second ingredient, namely, such payment of money was dependent on the “event or contingency relative or applicable to the enrolment of members into the scheme” was thus very much present.
(b) The definition nowhere provided that a member of the scheme must himself enroll other members and only in that eventuality, the provision of the act would apply. the section does not provide for positive or dominant role to be played by a member of the scheme. the requirement of law is “an event or contingency relative or applicable to the enrolment of members into the scheme” and nothing more. 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 moto (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.
(c) The scheme in question 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 fully 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.’
(d) It must be evident for any discerning mind that this scheme cannot work unless more and more subscribers join and the amount paid by them as unit price is made use of to pay the previous subscribers. The system is an inherently fragile system which is unworkable.
(e) Foolish, gullible and stupid persons alone may fall for the scheme without carefully analysing the stipulations of the scheme. it would be totally erroneous to assume that the offence of cheating would not lie if the persons deceived are gullible, unintelligent and stupid persons.
(f) The Court rejected the argument that the promoters had no contumacious intention and they embarked on the venture without any culpable motive on the honest assumption that the tickets sold through them will win prizes and sufficient commission will be available to pay double the amount to all the unit holders
Gift Schemes
It is trite nowadays to see advertisements proclaiming “Free Gifts” (the issue of Gifts being Free we will deal with on another day). Do such schemes fall foul of the act? the decision of the Bombay high Court in State of Maharashtra vs. Shivji Kesra Patel, 1988 Mh.LJ 488 dealt with one such issue. A dealer in motor cycles sponsored a gift scheme under which a group of 200 members had to deposit certain monthly instalments for 30 months. Lucky draws were to be held from time to time and the winners would receive a free motor cycle. At the end of 30 months the balance members would have to buy the motor cycles by paying the prevailing market price less instalments contributed. The high Court observed that this was a money circulation scheme. Predominant in the scheme was the element of chance for a very small number of 30 out of 200 members. For the larger remaining 170 members there was nothing but loss of interest for 30 months. Hence, prosecution of the partners of the dealer firm was upheld.
Thus, all schemes providing gifts under a pyramid scheme would be well advised to check the applicability of this act.
- Multi-level Marketing schemes another facet of the act which has gained popularity in recent times is its applicability to multi-level marketing schemes. High profile cases, such as, Amway, Speak Asia, QNet, etc. have seen equally high level arrests being made by the police. In a multi-level marketing scheme, there is no chain of wholesalers, retailers, dealers, etc. instead, the manufacturer sells highly priced products (usually consumer/FmCG products) directly to consumers through a chain of consumers-cum-agents. Each agent buys more products from another agent and also endeavours to garner more customers/make more agents. More the number of agents he makes, the higher would be the commission which he as well as those higher to him in the chain would earn. these agents are usually, laymen, housewives, retirees, etc. the big attraction for the agents is the `earn from home’ concept and the huge success stories of people who have made millions by selling the products. a typical multi-level marketing scheme would have a long chain of agents linked end- to-end. The shorter the chain lesser the earnings for everyone. these schemes have often been called “the greater fool schemes” – you will make money till you find a fool greater than you or greedier than you! The manufacturers have tried to distinguish their schemes as being direct selling and not being covered within the ambit of the act.
However, so far the Courts have not bought their argument on the grounds that the major money comes not from selling products but from making more members. According to some press reports, the economic offences Wing of the Police is probing over 60 multi-level marketing schemes in mumbai alone which have allegedly duped investors of over Rs. 3,000 crore. Some of these schemes were promising returns as high as 500% to investors!
The need of the hour is specific regulation dealing with multi-level marketers or direct selling and not cover them within the omnibus provisions of the act. taking a cue, Kerala and Rajasthan have enacted Guidelines for direct selling. For instance, the Kerala Guidelines provide as follows:
(a) They define Direct Selling to mean the marketing of consumer products/services directly to the consumers away from the permanent retail locations, usually through explanation or demonstration of the products by a direct seller or by mail order sales.
(b) Pyramid Schemes are defined as a scheme or arrangement which also includes any money circulation scheme involving sale of goods and services, where a person for a consideration acquires the opportunity to receive a pecuniary benefit which is not dependent on the volume of goods or services sold or distributed but is based wholly or partly upon the inducement of additional persons to participate in such a scheme or arrangement.
(c) Some of the conditions laid down for a valid direct selling are as follows and those sale activities not following these would not be considered as direct selling and would be dealt appropriately under relevant provisions:
- the direct Selling entity should be a legal entity authorised to conduct business in India and which files all returns as mandated by law.
- it should be a valid licensee or a permitted user of a registered trademark which identifies the promoter, goods or services distributed.
- it should maintain a website with complete details of their products/services.
- It shall not require a direct seller to purchase any product or collect any membership fee as a condition precedent for enrollment.
- the compensation to direct sellers shall only be based
on the quantum of sale of goods and services.
- a consumer must be provided a 30 day money back refund policy.
Interestingly, these Guidelines have not been issued under the Prize Chits and Money Circulation Schemes (Banning) Act, 1978 (“the Act”) ??
Conclusion
There is no limit to human ingenuity and human greed! Ponzi schemes, Pyramid schemes, etc., would continue to thrive on account on these two factors. What is needed is a clear cut law and a dedicated regulator dealing with such schemes. Also, the law must clearly spell out the exclusion conditions for direct selling so that genuine entities are not unduly harassed. The State would have to balance its objectives of protecting innocent investors but at the same time providing a conducive environment for doing business through innovative channels. At the same time, is it not the duty of the investors to do their homework before blindly jumping for get rich quick schemes? doesn’t a 500% return promise sound utopian? after all something which sounds too good to be true, is normally so. Investors would do well if they were to remember and adopt the words from the title of jane austen’s famous novel “Sense and Sensibility”!!
