Carpio Villaraza Barza & Cruz

February 21, 1984 Carpio Villaraza Barza & Cruz Law Offices 5th Floor, LTA Building 118 Ferea St., Legaspi Village Makati, Metro Manila Gentlemen: This has reference to your letter dated November 19, 1983, requesting this Commission to render an opinion on behalf of your client, ARACATRADE CORPORATION, on the legality of its sales plan. It appears therein that Aracatrade Corporation, along with other institutional investors, plans to engage in multi-level marketing. Multi-level marketing is a popular and legally sanctioned method of retailing whereby consumer products are sold by independent distributors in customer's homes. The distributors who act as independent businessmen have the opportunity to set their own hours and earn money based on their efforts selling consumer products. cdlex You alleged that your client's sales plan is substantially patterned after the Amway Plan in the United States: The United States Federal Trade Commission In the Matter of Amway Corp. Inc . declared that Amway's multi-level marketing plan was "not an illegal pyramid scheme" nor an "investment contract" because of the fact that it has the following characteristics: a) The distributor will receive a commission upon actual sale of the products to consumers. A distributor will not be paid any commission for merely recruiting another distributor. b) The client will guarantee to buy back the products purchased by the distributor in case the distributor cannot sell them or in case he terminates the distributorship. The buy back price will be the purchase price, less freight and handling expenses, surcharges and related expenses normal in buy back arrangements of consumer products. c) The start-up cost for being a distributor will be minimal, and will primarily be intended to recover actual costs. Thus, the sales kit containing brochures and selected representative products, will be sold to a new distributor at cost plus expenses for administration, freight, handling, storage and allowance for spoilage. No investment or deposit will be required to be a distributor. d) Moreover, no fees will be charged by the client for orientation seminars. No finder's fees will be paid to anyone for recruiting a distributor. No franchise fees will be charged to distributors. And no investment, deposit, or fee will be required for moving to a higher level as such movement will be determined solely by actual sales of products by the distributor. You now request for the opinion of this Commission on the following: a) Whether or not the sales plan involves any sale of an "investment contract" under Section 2 of the Revised Securities Act, and b) Whether or not the Sales Plan is an illegal pyramid scheme. Section 2(a) of the Revised Securities Act refers to "similar contracts and investments where there is no tangible return on investments plus profits but an appreciation of capital as well as enjoyment of particular privileges and services". An "investment contract" within the regulatory jurisdiction of the Securities and Exchange Commission, consists of the intrusting of money or property to another with the expectation of profit or income therefrom through the efforts of such other person. (SEC v. Bourbon Sales Corp. D.C. Ky. 47 F Suppl. 70.72). The phrase "investment contract" within the Securities Act of 1933 defining a "security" as including investment contracts, includes as agreement where the purchasers look entirely to the efforts of the promoters to make their investment a profitable one. (Words and Phrases. Vol. 22 A p. 270 citing Securities Act of 1933, 2(1) 15 U.S.C.A. 77 b(1) Penfield Co. of Calif. v. SEC, C.C.A. Col. 143 F. 2d 746, 750, 154 A.L.R. 1027.) In case of SEC v. W. J. Howey Co. where the prospective customers were offered both land sales contracts, with the issuer, the service contracts, with a service company under common control and management, the Court held that these deeds were "investment contracts" within the meaning of Section 2(1) and emphasized the following factors: 1) the expectation of a profit, to be derived solely from the efforts of a promoter or a third party; 2. the element of a common enterprise; 3. the lack of economic feasibility and the purchaser's lack of skill and equipment; 4. the seller's retention of possession. (Business Organizations, Vol. II, the Federal Securities Act, citing SEC v. W. J. Howey Co. 328 U.S. 293, 66 S. Ct. 1100 [1946]). Basically, the sales plan as envisioned necessitates that the Aracatrade Corporation will sell consumer products to a buyer who in turn will sell the same to another buyer. The transaction entered into would therefore be a sale and not an investment considering that the buyer receives consumer products as consideration for his money, unlike in an investment contract where the seller retains possession of the products. It must be observed that the buyer did not merely receive a promise or a chance to earn something in the future, as in case of investment contracts where profits are expected to be derived solely from the efforts of a promoter or a third party. In this instance, the buyer of the consumer products has to look for another buyer whom to sell the consumer products. Profits will be given to the distributor and sub-distributors in the form of discounts and commissions. Considering the absence of the aforementioned four elements in the subject sales plan, the same, therefore does not involve the sale of an "investment contract" as this term is used in Section 2(1) * of the Revised Securities Act. cdll The remaining issue to be resolved is whether the Sales Plan is an illegal pyramid scheme. For a better understanding of the matter, distinctions between a pyramid scheme and multi-level marketing would be in order. Pyramid schemes are illegal schemes in which large numbers of people at the bottom of the pyramid pay money to a few people at the top while multi-level marketing is a popular method of retailing in which consumer products are sold, not in stores by sales clerk but by independent, businessmen and women (distributors) usually in customers' homes. It is our opinion that the Sales Plan is not an illegal pyramid scheme in view of the following reasons: 1. The start-up cost is minimal and intended merely to recover actual costs unlike in a pyramid scheme where the start-up cost is substantial or expensive as it makes virtually all of its profits on the signing up of new recruits. 2. The client will guarantee to buy back the products unlike pyramid schemes which do not buy back unsold inventory. 3. The distributor will receive a commission upon actual sale of the products to consumers. Pyramid schemes are not concerned with repeat sales to users of the products because their profits are made on volume sales to new recruits, who buy the products, not because they are useful but because they must buy them to participate in the schemes. 4. The distributors or sub-distributors do not earn any fee for merely recruiting sub-distributors. 5. The said sales plan is substantially patterned after the Amway Plan in the United States, and the United States Federal Trade Commission has ruled In the Matter of Amway Corporation, Inc . that "Amway's multi-level marketing plan was not an illegal pyramid scheme". In view of the foregoing and based on the actual facts as presented in your letter of November 19, 1983 and its enclosures, this Commission will not interpose any objection to the said sales plan. However, its actual operations shall be closely monitored by the Brokers and Exchanges Department of this Commission. Please be advised accordingly. cdlex Very truly yours, (SGD.) MANUEL G. ABELLO Chairman * Copied verbatim from documents obtained directly from the Securities and Exchange Commission .