Is Network Marketing Legal? Understanding the Legal Issues of Multi-Level Marketing and Pyramid Schemes

You may have heard news stories about people who were persuaded by close acquaintances with promises of “easy money” and “guaranteed profits”, only to end up in debt after paying for a contract that didn’t yield the promised returns.

While these are cases of network marketing being misused, it’s also true that there are many companies that operate within the law and conduct their business legally.

In this article, we will clearly explain the legal definition and prohibitions of “network marketing”, as well as the meaning and differences of similar terms like “multi-level marketing” and “pyramid schemes”.

What is Network Marketing?

The term “Network Marketing” is broadly used in two different contexts:

A. A business model known as Multi-Level Marketing (MLM)

B. Businesses that utilize networks such as the internet

For B, it is well-known that various business models, such as “online shops” like Amazon, “online auctions” like Yahoo Auctions, “cloud services” for software, and advertising businesses using blogs and YouTube, have deeply permeated our lives.

A’s “Multi-Level Marketing (MLM)” is a commercial transaction that expands the sales organization in a pyramid shape by recruiting individuals as salespeople and further encouraging those individuals to recruit the next salespeople. It is also referred to as “Multi-Level Marketing (MLM)”, “Multi-Business”, or “Network Business”.

In Network Marketing, by utilizing the network of people, it is fundamentally possible to significantly reduce sales expenses that do not depend on advertising or stores, and the profit can be allocated to rewards for salespeople and product development costs.

Also, a portion of the sales made by the salespeople you recruited is distributed to you, so as the number of salespeople you recruit, i.e., the salespeople under you, increases, your rewards will also increase.

Companies that are globally expanding in Network Business include well-known names such as Amway, Natura Cosmeticos, Herbalife, and Avon Products. In Japan, there are also companies like Pola Cosmetics, Menard, and Noevir.

Definition/Requirements of Multi-Level Marketing

Under the Japanese Act on Specified Commercial Transactions (特定商取引に関する法律), network marketing is defined as “multi-level marketing transactions” as follows:

• A business that involves the sale of goods (or providing services, etc.)
• Attracts individuals to resell, consignment sale, or broker the sale (or providing services or brokering thereof)
• Entices with the promise of specific benefits
• Engages in transactions that involve specific obligations (including changes to transaction conditions)

The Consumer Affairs Agency provides the following examples of multi-level marketing transactions:

“If you join this club, you can buy products at a 30% discount, so you can make a profit by selling them to others,” or “If you invite others to join, you can receive a referral fee (specific benefit) of 10,000 yen.” If there is any financial burden of 1 yen or more for conducting transactions, it falls under “multi-level marketing transactions.”

While the actual situation is more complex and many take various contract forms, any transaction that involves some form of financial burden, regardless of whether it is for membership fees, security deposits, sample products, or products, falls under “multi-level marketing transactions.”

(Source: Consumer Affairs Agency Guide to Specified Commercial Transactions.jn)

Regulations on Multi-Level Marketing Transactions

Under the Act on Specified Commercial Transactions, the following obligations are imposed on those who conduct multi-level marketing transactions to protect consumer safety:

Obligation to disclose name, etc. (Article 33-2)

When conducting multi-level marketing transactions, the following matters must be disclosed to consumers prior to solicitation:

• The name (or company name) of the person in control (the person who effectively controls the multi-level marketing business), or the person who actually solicits consumers (including the person in control)
• The purpose is to solicit the conclusion of a contract involving a financial burden
• The type of goods or services involved in the solicitation

Obligation to display information when advertising (Article 35)

When advertising for multi-level marketing transactions, the following matters must be displayed:

• Type of goods (services)
• Matters concerning the consumer’s burden associated with the transaction
• When advertising the rewards obtained by soliciting others, the calculation method of the rewards
• Name (company name), address, and telephone number of the person in control, etc.
• If the person in control, etc. is a corporation and advertises using an electronic information processing organization, the name of the representative or the person in charge of the multi-level marketing business
• Product name
• If sending commercial advertisements by email, the email address of the person in control, etc.

Obligation to provide written documents (Article 37)

When a person conducting a multi-level marketing business contracts for a multi-level marketing transaction, the following two types of documents must be provided to the consumer:

• Before entering into the contract: An outline document (a document describing the outline of the multi-level marketing business)
• After entering into the contract: A contract document (a document clearly stating the contract details)

In addition, the contract document must include a description of the “cooling-off period (contract cancellation)” in red letters within a red frame, and the font size must be at least 8 points.

What is a Pyramid Scheme (Definition and Requirements)

One concept often confused with multi-level marketing is the “pyramid scheme” (also known as an endless chain scheme). The “Japanese Law on the Prevention of Pyramid Schemes” defines it as follows:

• A system that assumes an infinite increase in participants who contribute money or goods
• Those who join first are considered higher-ranking members, and those who join later, increasing at least twofold in a chain-like manner, are considered lower-ranking members
• A “dividend organization of money or goods” where the higher-ranking members receive goods or money from the lower-ranking members that exceed the value or quantity of what they themselves contributed

For example, a person who first joins a pyramid scheme recruits two lower-ranking members. These two members then each recruit two more lower-ranking members, and this process repeats, continually expanding the number of participants.

Then, at a certain point, the higher-ranking members receive a predetermined amount of money or goods and leave the organization. The lower-ranking members do the same at a later point, gradually leaving the organization.

While the above example may seem unproblematic, endless chain schemes are based on the premise of an infinite increase in participants. It is clear that at some point, the recruitment of lower-ranking members will reach a dead end, leading to the collapse of the scheme. This is why such schemes are prohibited by law.

Difference Between the Two

The difference between Multi-Level Marketing (Japanese: 連鎖販売取引) and Pyramid Schemes (Japanese: 無限連鎖講) can be clearly distinguished from their definitions.

• Multi-Level Marketing: A business that sells goods (or provides services, etc.)
• Pyramid Schemes: An organization that distributes money

In other words, ‘Multi-Level Marketing’ earns and distributes rewards through commercial activities such as selling goods or providing services, while ‘Pyramid Schemes’ earn and distribute rewards under the guise of membership fees and the like.

When does multi-level marketing become illegal?

Multi-level marketing becomes illegal when it violates the obligations outlined in the previously mentioned “Regulations on Multi-Level Marketing”, such as ① the obligation to disclose names and other information, ② the obligation to display certain information when advertising, and ③ the obligation to provide written documents. It also becomes illegal when the following prohibited acts, which are banned under the Japanese Act on Specified Commercial Transactions, are committed.

Prohibited Acts (Article 34)

When conducting multi-level marketing, the following acts are prohibited when soliciting:

1. Not disclosing, or providing false information about, the quality and performance of the product, specific benefits, specific burdens, conditions for contract cancellation, and other important matters, in order to prevent cancellation of the contract during or after solicitation.
2. Intimidating and confusing the other party in order to prevent cancellation of the contract during or after solicitation.
3. Soliciting the conclusion of a transaction involving specific burdens at a place other than where the public has access, to consumers lured by a method of attraction without disclosing the purpose of solicitation (similar to so-called catch sales or appointment sales).

Prohibition of Exaggerated Advertising (Article 36)

When advertising for multi-level marketing, it is prohibited to make “displays significantly different from the facts” or “displays that mislead people into believing that it is significantly superior or advantageous than the actual product”.

Prohibition of Providing Email Advertising to Non-Consenting Parties (Article 36-3)

The Japanese Act on Specified Commercial Transactions prohibits sending multi-level marketing email advertisements to consumers who have not consented to receive emails. However, the following cases are not subject to this regulation:

• Advertisements accompanying “contract formation”, “order confirmation”, “shipping notification”, etc.
• Advertisements accompanying newsletters
• Advertisements accompanying free emails, etc.

If you want to know more about the provisions of the Japanese Act on Specified Commercial Transactions related to online shops, please see the detailed article below in addition to this article.

Summary: Network marketing can Lead to Penalties; Consult a Lawyer Before Conducting Multi-level Marketing

While network marketing itself is a legal business, distinct from pyramid schemes, there is no end to consumer damage caused by malicious operators.

Therefore, injunctions are recognized against operators who engage in illegal activities or are likely to do so. In addition, there are administrative penalties and punishments for violators, such as orders for business improvement, suspension of business, and prohibition of business.

When conducting chain sales transactions as a business, it is important not to violate the regulations and prohibitions stipulated by law. Therefore, rather than making judgments on your own, we recommend consulting with a lawyer who has extensive knowledge and experience in advance.

Introduction to Our Firm’s Measures

Monolith Law Office is a legal office with high expertise in both IT, particularly the Internet, and law. Troubles surrounding network businesses have become a significant issue, and the need for legal checks is increasingly growing. Our firm analyzes the legal risks associated with businesses that have already started or are about to start, based on various legal regulations. We aim to legalize the business as much as possible without stopping it. Details are described in the article below.