CNA Explains: What are pyramid schemes and are they legal in Singapore?
After 52 Singaporeans were arrested in China over pyramid scheme suspicions, CNA spoke to lawyers to find out more about such schemes.
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SINGAPORE: Fifty-two Singaporeans have been arrested and detained in Guangxi, China, over their suspected involvement in a pyramid scheme, Singapore authorities said on Friday (Sep 4).
CNA spoke to lawyers to break down what pyramid schemes are and their legality in Singapore.
What are pyramid schemes and how do they work?
Fraudulent pyramid schemes can be distinguished from legitimate multi-level marketing (MLM) sales structures.
In an MLM, independent, non-salaried distributors earn revenue through direct sales and recruitment, said lawyer Tania Chin, partner at Lighthouse Law.
They also earn a commission from sales made by new representatives they recruit into the business.
“Individuals pay an entry fee or purchase a starter pack of goods. They are then incentivised to build a ‘downline’ by persuading friends, family and others to sign up under them,” she said.
“When the new recruits buy or sell inventory, the original distributor receives a percentage of the profit.
“This structure runs indefinitely, where we will then see the earliest participants at the top earning the most from the base of new recruits at the bottom.”
However, in a pyramid scheme, participants make money solely by recruiting new participants, according to the US Securities and Exchange Commission.
Are MLM schemes allowed in Singapore?
No. It is a criminal offence to promote or participate in an MLM scheme. Offenders can be jailed for up to five years and fined up to S$200,000.
However, there is legislation excluding certain schemes and arrangements from the MLM prohibition. These include insurance agencies and master franchises, said Ms Chin.
“In order for a scheme to be legitimate, you have to apply for it to be scrutinised and approved and excluded (from the prohibition),” said lawyer Andy Yeo, managing director of his eponymous law firm.
“Just because it is a financial or franchise label alone, it cannot be sufficient for you to be excluded.”
Are MLM schemes legal in other countries?
Around the world, MLM programmes are generally legal if participants earn their commissions mostly from actual product sales rather than recruitment fees or mandatory purchases, said Ms Chin.
In China, the MLM model is banned and only single-level direct selling is permitted, she added.
Gathering commission or bonuses based on a downline hierarchy or recruitment structure is not allowed in such businesses.
Direct selling is regulated in China and licences are issued to legitimate businesses, said Mr Edward Lehman, foreign counsel at law firm Lehman, Lee & Xu based in Beijing.
To be licensed, a business must submit a written “compensation plan” showing the income that it generates without the inclusion of any payments for recruiting members, he said.
These legal direct selling schemes (“zhixiao”) are distinct from illegal pyramid schemes (“chuanxiao”).
What are the risks of getting involved in MLM in Singapore?
Ms Chin said participants may feel pressured to buy high monthly quotas of products to maintain an “active tier status”, potentially leaving them with a large amount of unsellable stock.
“Social capital bankruptcy is also an issue when one feels pressured to recruit from your immediate social circle, which may burn bridges and strain family ties and friendships,” she said.
I am thinking of joining an MLM programme. How do I know if it is legal?
Since the MLM label carries a stigma, businesses will not advertise themselves as such to prospective joiners, said Mr Yeo.
Individuals will have to do their own checks to ensure it is not an illegal pyramid scheme.
The first step is to check the regulatory status of the business. This can be done by looking at the Direct Selling Association of Singapore Member list.
“If they are not registered or fail to meet certain criteria, they may be operating an illicit pyramid scheme,” said Ms Chin.
Investment vehicles can also be checked against the Monetary Authority of Singapore’s Investor Alert List.
The next step is to understand the MLM programme’s business model and how the organisers benefit.
A prospective participant should not delegate away their due diligence just because a “very savvy investor” or others who appear to be doing well have put their own money in, said Mr Yeo.
“That’s how we make mistakes, when we choose not to do (due diligence) and we delegate this responsibility, without even checking whether the people whom we actually trust have themselves done their homework.”
Pyramid schemes usually promise “incredible” returns to attract “get rich quick” investors, and this in itself is a red flag, he said.
Mapping out the flow of money in the business – to see who is holding the funds, what the funds are being used for and whether there is an actual product – is also important, said Mr Yeo.
“Ask yourself whether you are able to make a viable income just by selling this product to others without recruiting anyone into the company. If the answer is no, it is likely a recruitment trap,” said Ms Chin.
Want an issue or topic explained? Email us at digitalnews [at] mediacorp.com.sg (digitalnews[at]mediacorp[dot]com[dot]sg). Your question might become a story on our site.
Source: CNA/dv
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