When is it pyramid selling?

If a salesman can make more money by recruiting other salesmen than by selling, chances are it is illegal

Straits Times, November 10, 1999
By Leslie Koh

IF A salesman can make more money from receiving commissions for recruiting other salesmen than actually selling something, then he is likely to be taking part in a pyramid-selling scheme, and this is illegal.

This was a feature of the franchisee referral scheme that e-commerce firm S888.com had, which attracted the attention of the authorities in July and prompted the Government to amend the law governing pyramid selling.

This is how the S888.com scheme worked:

Franchisees paid the company upfront fees of $27,000 or $33,000 in 11 instalments, for website space to sell their products over the Internet. Like franchisees in the real world, they could recoup their investments through online sales.

But the company's referral scheme also allowed them to recommend other franchisees to the scheme, for which the firm paid them $3,000 for every new franchisee they recruited.

This applied up to five levels down the chain, so franchisees would still receive $3,000 for new recruits that their recruits got in turn. The difference between this and pyramid selling, which is illegal here, is a technical one. The S888.com franchisees received their commissions from the company directly. In pyramid selling, recruiters get a commission from the new recruits.

A Finance Ministry spokesman said yesterday that while S888.com had not contravened the Multi-Level Marketing and Pyramid Selling (Prohibition) Act, it had broken the spirit of the law.

He noted that pyramid selling schemes were self-perpetuating: sales agents could make money just from recruiting more agents rather than selling actual goods or services.

In S888.com's case, franchisees could easily recoup their investments by just recruiting another nine franchisees, if they had paid the $27,000 upfront fee, or 11, if they had paid the higher $33,000 fee. Insurance or door-to-door sales is not considered pyramid selling because the bulk of the payments come from sales of a firm's products and not from recruitment commissions.

After a public outcry, S888.com suspended its franchisee referral scheme in July. Its chairman, Mr David Chang, said that he had started it to help investors break even more quickly.

He said: "As in any other business or retail shop, it'll take you one or two years to recover your capital.

"We allowed franchisees to get some money from recruiting others, to help defray initial investment costs."

Pyramid Selling Act

THE Multi-Level Marketing and Pyramid Selling (Prohibition) Act was introduced in 1973 to ban schemes which have many layers of distributors who earn more from recruiting new salesmen rather than selling products. Those who promote or participate in such schemes can be fined up to $30,000 and may also/or be jailed up to five years.

The Act was prompted by the winding up of a cosmetics company called Holiday Magic in April 1973, for breaching a section of the Companies' Act by promoting pyramid-selling.

It had sold its products through multi-level distributors, and it ended up with hundreds of distributors and few direct buyers.

"Franchise holders" paid investments of nearly $10,000 and got $1,200 for new recruits. But few actually sold the products successfully, as they were expensive.

The Act has not been changed in the last 26 years. Several directors of firms were charged under the Act in the late 80s and early 90s. Home Affairs Minister Wong Kan Seng recently told Parliament that over the past three years, the police received an average of nine complaints of alleged pyramid selling each year. None of these cases were substantiated.