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This is an extract from 2006 from Warren Pengilly

By Warren Pengilly

Pyramid selling is illegal. But what is pyramid selling? It is covered by Division 1AAA of Part V of the Trade Practices Act and akin State and Territory legislation. This Division is a re-write and a considerable simplification of, the prior s.61 of the Act but still contains a number of somewhat difficult concepts. Prime amongst these concepts is the difference between an illegal pyramid selling scheme and a legal multi-level marketing scheme.

The October 2005 decision of the Full Federal Court in Australian Communications Network Pty Ltd v Australian Competition and Consumer Commission (ACCC)1 is a beacon in illuminating the statutory provisions as to what constitutes a pyramid selling scheme. It is a joint judgment of all three members of the Full Federal Court and thus has the virtue of not requiring reconciliation of subtle and often not readily apparent differences between the views of court members. Further the judgment has the great merit of looking at commercial realities and at academic and other commentaries² in order to determine what the legislature really meant to ban.

The decision, for reasons which will later be apparent, depended upon the interpretation of the somewhat elastic words “in relation to”. The Court, in interpreting what the legislature meant to ban by use of these words, strongly relied upon commentaries referred to,³ embracing the views of Justice Dawson in the High Court decision of O’Grady v Northern Queensland Pastoral Company Ltd.⁴His Honour there held that the relevant statutory words “in relation to” were wide enough to cover every conceivable context but, in their interpretation in specific cases, should not be read out of context. They had, therefore, to be interpreted with the relevant legislation in mind and seek the purpose such legislation aimed to achieve.

Given the above, the Full Court noted that none of the commentaries referred to by it had found any intention to illegalise multi-level marketing schemes and that such schemes were able to be differentiated from pyramid selling schemes. The court cited the differences between the two as set out in all the commentaries referred to.⁵ This difference is that multi-level marketing schemes involve the earning of money pursuant to the sale of products. Pyramid selling on the other hand essentially involves “payments when new participants are recruited into the scheme”. ⁶

The view of the plaintiff Australian Competition and Consumer Commission (ACCC) itself (as set out on its website) was cited by the court in its judgment. This view was:

“Pyramid selling schemes rarely include the legitimate and regular retailing of products. Instead, they provide rewards for introducing new participants. Saturation point is very quickly reached and later recruits have little chance of recovering their money. Legitimate marketing schemes only provide rewards based on genuine product sales. Pyramid sales promoters may attempt to disguise their schemes by selling goods and services that are overpriced, of poor quality, difficult to sell or of little value.…

There are two questions that may help consumers identify legitimate multi-level marketing schemes:

• Are the rewards for participants in the scheme purely based on product sales (by either themselves or others they introduce to the scheme)?
• Are the products genuine products of real value, and of a type that normally will be used and purchased time and time again by a consumer, and not at a grossly inflated price?

“If you answer yes to both questions, it is likely that the scheme is a legitimate multi-level marketing scheme.” ⁷

The facts of the case

Australian Communications Network Pty Ltd (ACN) was a provider of retail telephone services and marketed these services through a structure involving multi-level marketing and elaborate commission arrangements

In essence independent representatives signed up customers for ACN’s services. ACN billed customers direct and paid independent representatives a commission on billings. To become appointed as an independent representative, a payment of $499.00 (plus GST) was made to ACN. An annual renewal fee of $163.70 was also payable to ACN. It was accepted that these fees were expected to meet most of the costs of ACN in producing marketing brochures, the cost of customer service and so on.

Independent representatives introduced other independent representatives, who introduced other independent representatives downstream and so on. All downstream representatives paid their participation and annual renewal fees to ACN and not to the independent representative who introduced them. Commission arrangements were complex. They are set out in detail in the judgment but will not be detailed here. In essence, however, independent representatives received commissions not only for billings to customers they had signed up but also for ACN’s billings to customers signed up by their downstream independent representatives. However, no commission or other reward was earned simply by recruiting downstream independent representatives. There had to be a billing by ACN to a customer for telephone services before any commission was payable. The amount of commission was calculated by reference to actual billed revenue but an amount of override commission depended upon the number and level of downstream independent representatives.

There was no evidence that ACN did not operate viably in the telecommunications market. There was no suggestion that its marketing strategies were a sham or that its financial projections, based on such strategies could not be realised.

Legislation

The question for decision was whether the arrangements set out above constituted an illegal pyramid selling scheme. Section 65AAD(1) of the Trade Practices Act defines the term “pyramid selling scheme” as a scheme with both of the following characteristics:

“(a) to take part in the scheme, some or all new participants must make a payment (a ‘participation payment’) to another participant or participants in the scheme; and

(b) the participation payments are entirely or substantially induced by the prospect held out to new participants that they will be entitled to a payment (a ‘recruitment payment’) in relation to the introduction to the scheme of further new participants.”[Emphasis added]

Section 65AAD(3) provides that a scheme may be a pyramid selling scheme even if it has any or all of certain characteristics, including if: “(e) the scheme involves the marketing of goods or services (or both).”

Section 65AAE(1) provides for certain matters which a court may have regard to in working out whether participation payments are entirely or substantially induced by the prospect of entitlement to recruitment payments. These are:

“(a) the extent to which the participation payments bear a reasonable relationship to the value of the goods or services that participants are entitled to be supplied under the scheme (as assessed, if appropriate, by reference to the price of comparable goods or services available elsewhere); and

(b) the emphasis given in the promotion of the scheme to the entitlement of participants to the supply of goods and services by comparison with the emphasis given to their entitlement to recruitment payments.”

Trial judgment

The ACCC was successful at trial in that the trial judge held that amounts paid to the independent representatives for assisting downstream independent representatives to introduce customers to ACN; and commissions payable to independent representatives depending upon the level of the downstream independent representatives constituted payments in relation to the introduction to the scheme of new participants. The scheme was thus an illegal pyramid selling scheme.8 It was not denied that there was a “scheme” involved.

The Full Federal Court decision and its reasoning

Given the approach of the Full Federal Court previously set out, the Full Court had little difficulty in finding that the payments held illegal by the trial judgment were not made in relation to the introduction to the scheme of further new participants. It so found for the following reasons:

• The recruitment and introduction of new members to the scheme had to be at a particular point of time. This time was when a participant arranges for a new participant to join the scheme. The relationship must be directed to that between a prospective entitlement and the introduction involved;⁹
• Any payment must be “in relation to” the introduction of new participants. The vice aimed at is the payment for the introduction of new participants. But the payments here were as a result of post-introduction activities of members;¹⁰
• The ACCC was unable to point to any social or economic vice or mischief involved in the arrangements which would warrant the arrangements being deemed illegal;¹¹
• Of course, the statutory provisions had to be applied case by case to infinitely variable fact situations but the statutory purpose would not be served by illegalising an introduction no matter what had to be done subsequently to earn a reward and no matter how genuine or competitive the goods being sold;¹²
• In this case, the rewards were earned by the independent representatives themselves, remuneration depended upon volume sales and nothing was earned in the event that an independent representative did nothing but introduce. The participation fee payable by a new independent representative did not go to the introducing representative but to ACN;¹³ and
• The real vice in pyramid selling schemes is that rewards held out are substantially for recruitment others, who in turn get their rewards substantially for recruiting more members and so on. Ultimately the scheme collapses and many will have been induced to pay money for nothing. This situation is to be contrasted with the present case where rewards were derived for genuine sales of goods or services. The benefits an independent representative received came not from new recruits but from customers and ACN in that the reward was based on ACN’s services to customers of the downstream independent representatives who form part of the upstream independent representative’s organisation.¹⁴

The appeal was thus upheld and no illegal pyramid selling scheme was found.

The lesson from the case

The case serves as an important precedent in distinguishing illegal pyramid selling from legal multi-level marketing. The relevant applicable principles in the establishment of a legal multi-level marketing scheme are:

• commissions and rewards should be paid to participants by the seller of the goods and services involved and not by a party introducing a new scheme participant;
• any participation fees should be paid by a new participant to the seller of the goods and services involved and not to a party introducing a new scheme participant;
• any rewards must relate to the genuine sale of goods and services and not to “introductions”;
• the court warns against sham transactions whereby recruitment payments may be disguised as post recruitment commercial activities.¹⁵ In assessing any payments, it is clear that the provisions of s.65AAD and s.65AAE set out earlier will loom large.

The case gives the relevant principles and demarcation lines. It is not a green light to set up and implement sham activities. The writer suggests that all payments and receipts be clearly demarcated in order to avoid potential pyramid selling scheme illegality. A crucial aspect to ensure the legality of any arrangement is that nothing be paid to a scheme participant by virtue of the introduction of a new scheme member and that there be no payments which the court may otherwise characterise as being of this nature.

High Court Appeal

The ACCC sought special leave to appeal the Full Federal Court’s decision to the High Court of Australia. The special leave application was heard before Justices Hayne and Crennan on 2 June 2006. Special leave to appeal was denied. Justice Hayne, in denying special leave, stated: “An appeal, in our opinion, would enjoy insufficient prospect of success in this matter to warrant a grant of special leave.”¹⁶

End Notes

¹ Australian Communications Network Pty Ltd v Australian Competition and Consumer Commission [2005] FCAFC 221 (25 October 2005) [Joint judgment of Heerey, Merkel and Siopis JJ].
² In reaching its conclusions the court cited, in addition to case law, the following commentaries: Myers, Wedding and Maertin – “Non-Egyptian Pyramids – U.S. Style” (1974) 2 Australian Business Law Review 84; M Head “Pyramid Legislation Effective”? (1974) 2 Australian Business Law Review 167; Donald & Heydon “Trade Practices Law” (at [14.40 and 14.50]); A Fels ACCC Update11 June 2002; the ACCC Website under the heading “Differences
between pyramid selling and multi-level marketing”; W Hudson & K Hubert “An Incredible Business Opportunity” (August 1999) New Zealand Law Journal 270; and Bills Digest 66 2002-03 (published by the Parliamentary Library for distribution to Senators and Members of Parliament in relation to debate on Division 1AAA of Part V of the Trade Practices Act).
³ n.2.
⁴ O’Grady v Northern Queensland Pastoral Company Ltd (1990) 169 CLR 356 at 367. To similar effect see PMT Partners Pty Ltd v Australian National Parks and Wildlife Services (1995) 184 CLR 301 (Brennan CJ, Gaudron and McHugh JJ) and J & G Knowles & Associates Pty Ltd v Commissioner of Taxation (2000) 96 FCR 402, 408.
⁵ n.2.
⁶ Bills Digest 66 2002-03 (n.2 above). Cited by the Full Federal Court [n.1] at [42].
⁷ See ACCC Website reference at n.2. Cited by the Full Federal Court [n.1] at [40].
⁸ ACCC v Australian Communications Network Pty Ltd [2005] FCA 267 (Selway J).
⁹ n.1 at [30].
¹⁰ n.1 at [33] and [43].
¹¹ n.1 at [43].
¹² n.1 at [45]. Likewise, said the court, the statutory purpose would not be served by an interpretation which required that the recruitment payment must be made solely for the introduction no matter how worthless the prospect of selling goods and services under the scheme. This would open the door to artificial evasion and could not be reconciled with s.65AAD(3)(e).
¹³ n.1 at [47].
¹⁴ n.1 at [46] and [47].
¹⁵ See 12 and related text.
¹⁶ ACCC v Australian Communications Network Pty Ltd & Anor [2006] HCA Trans 265 (2 June 2006): High Court Special Leave Application heard before Hayne and Crennan JJ.

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