Background
The operation of pyramid schemes in Hong Kong is governed by the Pyramid Schemes Prohibition Ordinance (Cap.617)  (the “Ordinance”), which came into force on 1 January 2012. The Ordinance replaced the Pyramid Selling Prohibition Ordinance (Cap. 355) (the “Old Ordinance”), which contained loopholes and was not effective in combating the different forms of pyramid selling in recent years.

What is a pyramid scheme?
Generally speaking, a pyramid scheme is a scheme whereby new participants are required to pay a “participation fee” at the time of joining the scheme (which would be shared among the introducing participants, other participants at the higher tiers of the hierarchy or the establishers of the schemes), in return for the right to receive a “recruitment fee” when they recruit or introduce further new participants into the scheme.

The major features of a pyramid scheme are that the rewards are closely linked to the introduction of new participants and that there is no genuine underlying business. As such, a pyramid scheme serves no economic purpose. When the recruitment runs out and there is insufficient profits to pay to its participants, the whole pyramid scheme would collapse and become unsustainable, resulting in a loss down the line.

Limitation of the Old Ordinance
Under the Old Ordinance, a pyramid selling scheme was defined to be a scheme whereby:

1.          a participant in the scheme is granted a licence or right to introduce another participant into the scheme who is also granted such licence or right, and who may further extend the chain of persons; and

2.          a participant receives a reward on, or at any time after, the introduction into the scheme by him of another participant which reward is based, whether wholly or in part, otherwise than on the fair market value of goods or services actually sold by him or by or through that other participant.

In the cases of HKSAR v Yau Mee Kwan CACC 96/2003 and HKSAR v Li Chi Yung CACC 55/2004 where the defendants were acquitted of the charges of conspiracy to promote a pyramid selling scheme, the Court identified two loopholes in the definition of “pyramid selling scheme” under the Old Ordinance:

1.          there must be selling of goods or services in the operation of a pyramid selling scheme. Therefore, if there is no sale of goods or services, the Old Ordinance would not apply; and

2.          there must be sale of goods and services by or through participants. Therefore, if the goods or services are sold in other ways, for example, by the company directly to the new participants, the Old Ordinance would not apply.

The Ordinance

The definition of pyramid scheme
With the view to close the loopholes in the Old Ordinance, the Ordinance provides a new definition to “pyramid scheme” to mean a scheme in which:

1.          new participants must make a participation payment (or other consideration) to other participants and/or establishers;

2.          such participation payment or consideration is entirely or substantially induced by the prospect held out to the new participants that they will be entitled to receive a recruitment payment (financial or other otherwise); and

3.          the recruitment payment is derived entirely or substantially from the introduction of further new participants.

The new definition of “pyramid scheme” is based on the fundamental characteristics of a pyramid scheme (i.e. the incentives for participants to join the scheme come from the benefits which are primarily derived from the recruitment of new participants). The scope of the new definition is wider and whether sale of goods and services is involved has become immaterial.

However, when a scheme involves the marketing of goods or services, in determining whether such a scheme is a pyramid scheme, the Court must consider whether the participation payments are comparable to the value of the goods or services and whether the return is linked to the recruitment of new members or sales of goods or services.

Criminal liability
Under the Old Ordinance, only the promoters of a pyramid selling schemes would be held criminally liable. However, under the Ordinance, participants who induce other persons to join a pyramid scheme, with the knowledge that the benefits they may get would be entirely or substantially derived from the introduction of new members, would also attract criminal liability. This provision is intended to deter people from participating in and inducing others to join pyramid schemes, which can only be sustained by the introduction of new members by existing members.

The maximum penalty for an offence in relation to pyramid scheme has been increased from a fine of HK$100,000 and imprisonment for three years to a fine of HK$1,000,000 and imprisonment for seven years.

Conclusion
Sometimes a pyramid scheme maybe disguised to be a multi-level marketing scheme and the participation fee may be packaged as a payment for goods or services acquired by the participants for their own use or onward sale. However, since participants of a pyramid scheme may also attract criminal liability under the Ordinance, the general public should always be cautious about the structure of the scheme.

Since the commencement of the Ordinance in January 2012, there appears to be no reported cases on the charges in relation to pyramid schemes under the Ordinance yet. It remains to be seen whether the Ordinance can serve the purpose of eradicating pyramid schemes in Hong Kong.

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: criminal@onc.hk

W: www.onc.hk

T: (852) 2810 1212

F: (852) 2804 6311

IMPORTANT: The law and procedure on this subject are very specialized and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.