Direct selling companies, at various industry forums, have been reiterating their demand for a ‘separate regulatory framework’ to govern direct selling in India that will bring in clarity and certainty to their nature of operations.
Direct selling is an alternate form of selling without the involvement of conventionalretail outlets[#_ftn1][1]–sales happen face-to-face at home, work place, parties or other group events. Companies engaged in direct selling reach out to the consumer through a chain of independent sales representatives or distributors. Various indigenous and multinational direct selling companies are active in India with the industry clocking a sales turnover over INR 60 billion in the last year.
In this fifth edition of BMR point of view on Retail, we take up issues surrounding direct selling companies - their operating structure and the regulatory gaps in the system - that need to be addressed sooner than later. Read further as we decode what is direct selling and the controversies surrounding it.
Genesis of the debate – Genuine direct selling vs illegitimate pyramid schemes
The genesis of the debate lies in the operating structure adopted by direct selling companies. These companies typically adopt a multi-layered marketing (MLM) structure whereby company distributors sponsor new distributors, and each second level distributor may identify and sponsor further (the sponsoring distributor may be referred as upline and the new distributor joining the program, as downline).
Recruitment and sponsorship of new distributors is not mandatory– instead the distributor at each level is responsible for making product sales to end consumers. The sales incentive program in such an MLM structure is based on product sales where an upline distributor earns sales credit on account of products and services sold by him and his downline distributors. This MLM structure of a genuine direct selling company is unfortunately tagged alongwith pyramid based financial and money circulation schemes banned under the Prize Chits and Money Circulation Scheme (Banning) Act, 1978 (“PCMCSB Act”).
The PCMCSB Act was legislated in 1978 to regulate and ban fraudulent pyramid and ponzi[#_ftn2][2]schemes prevailing in the country. Such predatory schemes manifest in various sectors including real estate, agriculture, on the internet and e-mail and spread rapidly causing significant financial loss to the public at large. With a view to make quick money, the promoter typically mandates participants to deposit significant money to join in the business opportunity, and financial rewards are highly dependent on further recruitment of members. Some schemes may purport to sell products to camouflage the financial fraud but the moneys collected are never commensurate to the product market value.
With this overarching objective of protection of public interest, the PCMCSB Act prohibits promotion, conduct of or participation in any ‘prize chit’ or ‘money circulation scheme’. A‘money circulation scheme’ is widely defined under the PCMCSB Act as “any scheme 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 Supreme Court[#_ftn3][3]has interpreted the above definition and held that for a scheme to be viewed as an illegal money circulation scheme, two conditions must be satisfied (1) it must be proved that a scheme is being promoted or conducted for the making of quick or easy money; and (2) the chance or opportunity of making quick or easy money must be shown to depend upon an event or contingency relative or applicable to the enrollment of members into that scheme.
The PCMCSB Act does not explicitly exclude or deal with schemes which involve genuine sale of products or services. Accordingly, depending on the terms and conditions of the MLM structure adopted by a direct selling company, where it is found that a new joiner directly or indirectly pays an enrolment fee- part of which is credited to the account of the sponsoring upline distributor, such a scheme may be perceived as a 'money circulation scheme'[#_ftn4][4]. Differences in interpretation regarding the applicability of the PCMCSB Act to genuine MLM structures leads to business uncertainty for a direct selling company in India, with an added risk of harassment and business disruption. It is in this backdrop that the need to confer regulatory clarity and certainty to direct selling companies with legitimate MLM structures, arises.
To summarise our perspective, mere implementation of a multi-tier distributor incentive program by direct selling companies should not be viewed suspiciously – infact various conventional retail companies also adopt similar schemes to incentivise distributors. The real issues are whether individuals are ‘fraudulently lured’ or ‘unduly influenced’ to become a distributor on the hope and expectation of making easy money through enrolment of new members. There exists judicial precedence in the international context[#_ftn5][5]where various facets of an MLM structure have been factually tested and principles laid down to distinguish a valid MLM scheme.
Thecriterion used to distinguish an MLM scheme from an illegal money circulation scheme would be to objectively assess whether the sales incentive under a compensation plan is based primarily on recruitment of members or on product sales to end consumers. In our view, an MLM scheme where products are sold more to the public than to other distributors and where sales incentives are based on actual sales volume generated and not on recruitment, should be outside the purview of a money circulation scheme as defined under the PCMCSB Act.
Government's response
The Government has been deliberating on these vexed issues in a much wider context as it seeks to balance diverse objectives and challenges that include ensuring adequate consumer protection, prevention of unfair trade practices and operation of fly-by-night operators.
The PCMCSB Act is a central legislation administered by the Department of Financial Services – however the enforcement and rule making powers are delegated to the State governments. Due to this bifurcation, regulatory gaps arise as individual State governments are open to take different action within their jurisdiction. For instance, Kerala[#_ftn6][6]and Rajasthan[#_ftn7][7]have legislated direct selling guidelines to specifically permit conduct of direct selling operations provided conditions stipulated therein are complied with. The States appear to have aligned partly to the MLM structure as the rules permit sales incentive which is based on profits on sales of products and is not related to joining of members. The rules prohibit the direct seller from charging a membership fee or mandating compulsory purchase of a product as a condition precedent for enrolment of new members. Further, both notifications lay emphasis on basic safeguards both for the consumer and the downline distributors, and impose extensive reporting and disclosure requirements on the company.
To bring in uniformity in rules across all States and to deal with the diverse objectives and priorities, an Inter-ministerial Committee comprising the RBI, SEBI and ministries of consumer affairs, corporate affairs, finance and law was formed by the government. The Committee formulated draft model rules titled Money Circulation Scheme (Banning) Rules, 2012 that could be adopted by various State governments. These rules do not provide desired clarity to genuine product selling companies in India. The draft rules sought to enlarge the definition of money circulation schemes to include schemes disguised as a scheme for a sale of product or providing a service and categorically reiterated the ban on formation and conduct of pyramid/multi-level marketing schemes and incentive programs, without any exclusions.
On the positive side, the draft rules acknowledge the need forestablishment of a nodal police authority, which inter alia has the responsibility to coordinate and share information and complaints across States and concerned regulatory bodies so that timely action can be taken against companies seeking to perpetuate prohibited schemes across different states. The draft rules are in the process of being re-worked with inputs from industry associations and the various government bodies involved.
International view on direct selling
This issue is not peculiar to India as many of the multinational direct selling companies have operations in various countries. Many countries including China, Japan, Malaysia, US, Singapore, Vietnam, and UK have either implemented new laws or made revisions to existing laws on direct selling in the last decade. These countries too have enacted specific anti-pyramid laws to deal with frauds and abusive schemes, however, through specific regulations, they distinguish permissible MLM operations by direct selling companies. To illustrate, the Direct Sales Act, 1993 of Malaysia, provides that no licence shall be granted for a direct selling scheme for sale of goods or services where the applicant for a consideration, acquires the opportunity to receive a pecuniary benefit which is not dependent on sales volume but which is based, to any extent, upon the inducement of additional persons to participate in such scheme or arrangement.
Fundamentally, this provision is founded on the same principles as the definition of money circulation scheme under the PCMCSB Act, however, the Malaysian law licenses direct selling and validates a genuine MLM scheme. Similar clarity would be beneficial in the Indian context. Considering all facts, India should also consider incorporating a similar legislation where under companies desirous of conducting direct selling operations in India need to obtain some sort of a licence – a mandatory registration process would help identify legitimate operators in the sector.
Presently, legitimate direct selling companies in different countries including India have joined hands to form direct selling associations, which promote ethical business practices and prescribe a detailed code of ethics for the members, its sales representatives and customers. The code seeks to capture various aspects of a direct selling business which need to be regulated including use of misleading testimonials, misrepresentation of actual or potential earning claims or use of any exploitative and deceptive recruitment practices. To ensure legal compliance, the code provides that new memberships should not be subject to significant monetary commitment either by way of entrance fee, training fee, purchase of sales kits or inventory loading. The companies take responsibility for consumer protection through provision of accurate information, product warranty and buyback offers. The industry associations ensure that member companies implement adequate mechanisms to address customer complaints with respect to their products and/or its sales representatives. International best practices on all such important issues may be incorporated by India to draft a holistic regulatory policy framework to govern direct selling.
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