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Do multi-level marketing firms need a regulator?

Do multi-level marketing firms need a regulator?

Speakasia  |  Amway  |  Supreme Court

Niraj Kumar  |  New Delhi 

The recent arrest of the top officials of for allegedly duping its 1.2 million investors (or panelists as calls them) of Rs 1,300 crore again underlines the need for a regulator for all businesses that sell goods or services based on the multi-level marketing (MLM) model. It is important to note that not all ‘panelists’ of are against the company. Going by the reports, there is one SpeakAsia Panelist Association claiming to have support of 150,000-200,000 members, which is showing complete solidarity with the company. Neither the arrests nor the show of solidarity point to the criminality or innocence of SpeakAsia as the case may be. However, these two extremely polarised views on the issue definitely point towards a gaping hole in the regulatory framework.

It is not for the first time that a company that sells its products or services using an MLM framework has got marred into a controversy – Amway, Japan Life and many more have courted controversy and legal proceedings in the past. Given the way regulatory framework operate for these businesses, such controversies would keep cropping up unless the regulatory framework changes from being reactive to being pro-active.

Typically, in multi-level marketing (also known as direct selling using network marketing) a person gets rewarded not only for selling the goods and services by himself but also for referring other members to join the business and for the further referrals by that other member and so on. Usually all those that sell their products or services by this method project a pyramid type structure wherein the person at the top is shown as earning huge quantity of money on account of business done by people below him which in trade jargon is called ‘down-line’. Innumerable offering multi-level marketing schemes that present lucrative opportunities to their participants to make quick money have come up time and again and many a time questions have been raised on the legality –- at times on the business model per se and at other times on the scheme being promoted.

Apart from general view that such schemes are fraudulent, the business organised on the lines of multi-level-marketing is often perceived as a money circulation scheme and thus in violation of the Prize Chits and Money Circulation Scheme (Banning) Act, 1978 (“the Act”).

The issue whether a business model based on MLM or network marketing by its very nature of organisation is bad in law or not came up for judicial scrutiny in the case of RMP Infotech Private Ltd. v. Apple FMCG Marketing Private Ltd. A Division Bench of Madras High Court opined that MLM schemes cannot be declared outright illegal, unless the scheme in question has elements that render it illegal.

As regards the elements that render a particular scheme illegal, the in the case of State of West Bengal v. Swapan Kumar evolved a two-pronged test that finds basis in Section 2(c) of the Act. To hold a particular scheme illegal in law, (a) it must be proved that the scheme is for making quick and easy money and (b) the chance or opportunity of making quick and easy money depends upon the enrolment of members into the scheme.

The test laid in the Swapan Kumar ruling has been applied subsequently by courts in adjudicating upon the legality of different multi-level-marketing schemes. Surprisingly, the only two cases where the courts evaluated MLM schemes in details came to the conclusion that schemes in question were bad in law. One such decision was by the [Kurianchan Chako v. State of Kerala] wherein the scheme in question was held to be a ‘mathematical impossibility’. The other decision of the Andhra Pradesh High Court [Writ Petition nos. 20470 and 20471 of 2006] wherein scheme of India was viewed as “so ingeniously conceived that the inducement for aggressive enrolment of new members to earn more and more commission is inherent in the scheme. By holding out attractive commission on the business turned out by the downline members, the scheme provides for sufficient inducements for its members to chase for the new members in their hot pursuit to make quick/easy money.”

Thus, as far as law is concerned, the principles are well laid down and position is very clear and ideally in such a scenario there is very little scope for confusion or controversies. However, the sole reason why we have had repeated controversies concerning such schemes is the way and manner in which the Act is implemented.

The Act is a central legislation and the States have been empowered to govern it. The Act bestows on Police the power to search any premises that may be suspected to be used to promote or conduct any money circulation scheme, seize all things found in these premises and to take into custody all such persons that are concerned or against whom the complaint has been made.

The problem with the scheme of implementation of the Act as far as multi-level marketing is concerned is that the Police more often then not is approached only after the crisis has reached its crescendo and as the nature of business involves a network of persons, the number of complainants or complaint is generally huge. Thus the Police is required to act under tremendous pressure and there is no time to first determine whether the multi-level marketing scheme in question is a money circulation scheme or not – a prerequisite required by the Police to take any action under the Act. What follows can be best described as a 'knee-jerk’ reaction.

A possible solution to this problem lies in the Act itself. The Act in its transitional provision envisage a role for the Reserve Bank of India as the specialised agency in consultation with whom the States were required to wind-up chit fund and money circulation schemes prevalent at the time the Act came into force. The Act also provided for States to frame rules in consultation with the Reserve Bank of India for the purposes of carrying out the provisions of the Act. It is pertinent to point out that the Act was enacted pursuant to findings of a study group constituted by the Reserve Bank of India to examine in-depth certain provisions of the Reserve Bank of India Act, 1934.

Thus when the Act was enacted the had an important role in the formulation of policies or rules under the Act. However, in practice does not figure anywhere in the determination of the issues as to whether any multi-level marketing scheme has elements of money circulation scheme or not. As the issue largely hinges on the financial model followed in the scheme, ideally as the specialist body should determine this issue and this determination should not be left to the Police or the Courts.

Unfortunately, RBI instead of taking a pro-active role chose to take a back seat and came out with a Circular in 2003 eliminating its role in the implementation of the Act. This act of RBI was discussed in the 8th though in a different context [(proceedings other than questions and answers) Title: Shri S. Jaipal Reddy called the attention of the Minister of Finance and Company Affairs to reported illegal schemes of Japan Life of India and steps taken by the Government in regard thereto.]

Today we have several multi-level marketing schemes operating in the country with no certainty whether these schemes conform to the Act or not. Further, many of these schemes are operational in more that one States. This may lead to a situation where the company running a multi-level marketing is subjected to multiple prosecutions. There could also emerge a scenario where the same scheme is held good in law by one State and bad in another. In case of Speak Asia complaints were filed in more than one State.

As any popular scheme involves large number of individuals who earn their livelihood from such schemes and a subsequent finding of the scheme being illegal may adversely impact them, it is important that we move from the present reactive to a pro-active determination mechanism. In order to achieve this and also to overcome a situation of multiple prosecutions being launched against the same scheme by different States, the following is suggested:

1. RBI shall be frame general rules under the Act on multi-level marketing schemes which may be notified by the States at their option;

2. The rules shall require all multi-level marketing operating in the States that has notified the rules to get their scheme evaluated by the RBI before commencement of the business;

3. For the already existing schemes, the rules shall provide for a two year window to get the scheme evaluated by the RBI

These steps will go a long way in ending the uncertainty that multi-level marketing business model currently faces and will reassure many who earn their livelihood by being part of such business. This will also ensure that no money circulation scheme camouflaged as genuine business will be able to dupe lay investors or members. Further, this will bring succour to the promoters of multi-level marketing schemes from any Police action that may be initiated at the behest of disgruntled members of the scheme.

The author is a Partner with DSK Legal, a Mumbai-based firm with offices in Delhi and Bangalore. Views are personal






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First Published: Tue, September 13 2011. 16:26 IST