Two recent developments, the collapse of the Saradha group in West Bengal and the arrest of senior executives of Amway India in Kerala, have highlighted serious shortcomings in the Indian legal framework. One, the main legal weapon available to the government in this regard, the Prize Chits and Money Circulation Schemes (Banning) Act of 1978, is unable to stop early enough operations that defraud large numbers of poor people. Two, there is no clarity on whether provisions of this law are applicable to multi-level marketing operations like Amway. Three, if multi-level marketing operations are legitimate, then can an attempt to clearly say so create a loophole that fraudulent operators can exploit?
Multi-level marketing is big business worldwide; it clocked gross revenues of $154 billion in 2011 (about Rs 8.7 lakh crore at the current exchange rate) and includes well-known firms such as Amway, Herbalife, Avon and Tupperware. However, multi-level marketing remains controversial even in the heartland of laissez-faire, the United States. Late last year, Bill Ackman, a hedge fund founder, announced with great fanfare he was going short on Herbalife, calling it an "illegal pyramid scheme". In 2010, Amway agreed to pay $56 million, without admitting guilt, to former distributors to settle a class action lawsuit alleging the firm was engaged in an "illegal scheme" in which distributors rarely sold to outside customers but mostly to new distributors who must bring in new recruits to make money. The US' Federal Trade Commission (FTC), the appropriate regulatory authority in that country, recently filed a lawsuit against Fortune Hi-Tech Marketing, a network marketing company. This is the first such suit the FTC has filed since 2006, and since 1994 it has brought only around a dozen suits against pyramid schemes running multi-level marketing operations. The FTC has long held that Amway-type multi-level marketing is not illegal per se but its attempt to tighten rules to fish out wrongdoers has been unsuccessful because of lobbying by large multi-level marketers. The whole issue is whether a multi-level marketer is running a pyramid scheme in which distributors make more money by recruiting sellers than by selling the products themselves. The difference between a pyramid scheme and a legitimate multi-level marketing operation is compensation. If most of it comes from recruitment and not sales to outside customers, then there is a problem.
Rules-focused Indian regulators should note that the FTC has deliberately avoided creating a definition of a pyramid scheme because any such attempt will provide those wrongly motivated to structure their business so as to get around the technical definition. It took the Reserve Bank of India eight years, three Supreme Court verdicts and a change in regulations to finally win against Peerless. The Securities and Exchange Board of India's battle with Sahara is still on. All that a law can do is allow the regulator to investigate when it sees certain signs and suspects mala fide intent. But a lot of damage (poor people duped) can be done before a prima facie case can be made and a stay on operations obtained. This is the central dilemma.
