Analysis of the basic characteristics of the crime of organizing and leading pyramid schemes and the main points of innocent defense
Authors | Mak Cheuk-lam and Cheung Yuk-wai, Zhuosheng Criminal Law Team
PART 01
Introduction
In the wake of globalization and information technology, the diversity and complexity of economic activities have been steadily increasing. However, this diversity and complexity also create opportunities for certain illegal activities, one of which is pyramid selling. Due to their highly concealed nature, tight organizational structure, and wide-ranging impact, pyramid schemes not only severely disrupt the order of the market economy but also pose a significant threat to individuals’ property security and social stability.
Pyramid schemes are, by their very nature, illegal profit-making activities that rely on recruiting downlines and collecting entry fees. It typically lures people into joining with the promise of high returns, then expands the organization by continuously recruiting new members, thereby creating a pyramid‑shaped structure. This type of scheme often results in substantial losses for a large number of participants, with some even losing their entire fortunes. Meanwhile, the organizers can reap huge illegal profits from it.
This article will, from a legal perspective, conduct an in-depth analysis of the fundamental characteristics of pyramid schemes, with the aim of helping readers gain a more comprehensive understanding of the crime of organizing and leading pyramid schemes. After gaining a basic understanding of pyramid-scheme activities, this article will further examine the key points for mounting a defense of innocence in cases involving the crime of organizing and leading pyramid-scheme activities.
PART 02
The basic characteristics of the crime of organizing and leading pyramid schemes
According to Article 224-1 of the Criminal Law of the People's Republic of China and the “Opinions on Several Issues Concerning the Application of Law in Handling Criminal Cases Involving Organizing and Leading Pyramid Schemes” issued by the Supreme People's Court, the Supreme People's Procuratorate, and the Ministry of Public Security (hereinafter referred to as the “Opinions”), the main characteristics of the crime of organizing and leading pyramid schemes include four aspects: first, using a hierarchical structure as the organizational form; second, using the collection of “entry fees” as a means of profit; third, basing remuneration on the number of recruited personnel; and fourth, having the essence of defrauding property.
Only when all four of these characteristics are present can the crime of organizing and leading pyramid-scheme activities be established. Below, we will analyze each of the four features separately:
(I) The organizational form is a hierarchical structure.
In a pyramid scheme organization, the organizers and leaders recruit new members, who are then required to recruit additional members, thereby continuously expanding the size of the organization. Pyramid schemes feature a broad-base, narrow-top organizational structure. The higher one climbs in the pyramid, the higher the rank and the fewer the members; the lower one descends, the lower the rank and the more numerous the members. The expansion of pyramid schemes primarily relies on the downward extension of their vertical hierarchical structure.
The “Opinions” contain specific provisions regarding the determination of the hierarchical structure and the number of participants in pyramid‑scheme organizations constituting this crime. First, where an organization’s members engaged in pyramid scheme activities number thirty or more and the hierarchy comprises three or more levels, the organizers and leaders shall be held criminally liable. When calculating the number of participants and the hierarchical levels within a pyramid scheme organization, the starting point for the calculation shall be the individuals at the lowest level engaged in the scheme; the organizers, leaders, and their respective hierarchical levels must also be included.
“Hierarchy” and “level” refer to the hierarchical relationships between organizers, leaders, and participants in pyramid‑selling activities, rather than the ranks or grades held by organizers and leaders within the pyramid‑selling organization. Second, where an individual organizes or leads multiple pyramid schemes, and the hierarchical levels in one or more of such organizations have reached three or more tiers, the number of persons recruited across all organizations may be aggregated for calculation purposes.
Third, if an organizer or leader formally separates from the original pyramid scheme organization but continues to receive remuneration or rebates from it, the number of levels and the number of participants developed by the original pyramid scheme organization after such separation shall be counted as part of the levels and participants they have developed.
(II) The profit model involves charging an "entry fee."
The source of profit for this crime’s pyramid scheme organization is the “entry fee” paid by its members. Prospective members must pay an “entry fee” by paying a certain amount or purchasing goods or services before they can join the organization and qualify to recruit downline members and receive rebates. It is worth noting that, in cases where one obtains “membership eligibility” by purchasing goods or services, the goods or services are often merely nominal or virtual; alternatively, while genuine goods or services may exist, they do not offer value commensurate with their price.
The individuals recruited purchase the product or service not to obtain the product or service itself, but solely to qualify for membership in the pyramid scheme.
At the same time, because pyramid schemes rely on continuously attracting new members who pay fees to sustain the profits of their upper-level participants. Therefore, in order to sustain its operations, a pyramid scheme must continuously expand its membership base. Once new members join, they are often induced or pressured by the organization to recruit additional newcomers, thereby establishing a self-reinforcing “recruitment” cycle.
(III) The basis for remuneration is the number of downline members developed.
In pyramid-scheme activities, basing rebates and profits on the number of recruits is one of the essential characteristics of the crime of organizing or leading pyramid schemes. Pyramid schemes typically use the number of recruits, either directly or indirectly, as the basis for compensation and rebates, effectively employing a “referral-based compensation” model. This is distinctly different from “team-based compensation”–style pyramid schemes.
With respect to the former, the income of an upline within the organization is determined by the number of downlines they have recruited; thus, their earnings depend entirely on how many downlines they recruit. In contrast, in the latter case, the upline’s income is tied to the sales performance of their downlines rather than to the number of recruits, constituting a purely “team-based compensation” arrangement, which does not constitute the crime of organizing or leading pyramid‑scheme activities.
The “Opinions” contain specific provisions regarding the handling of “team-based remuneration” practices. Organizers or leaders of pyramid schemes recruit new members who are then required to recruit additional members, thereby establishing a hierarchical structure with upstream and downstream relationships. Compensation for those in the upper tiers is calculated and paid based on the sales performance of their downline, enabling them to amass illegal profits. This constitutes a “team-based compensation” type of pyramid scheme.
Purely “team-based compensation”–style pyramid schemes that are conducted for the purpose of selling goods and whose remuneration is based solely on sales performance shall not be treated as criminal offenses. If the activity formally adopts a “team-based compensation” structure but, in substance, constitutes pyramid selling by basing remuneration or rebates on the number of recruits, it shall be prosecuted and punished as the crime of organizing or leading pyramid selling activities.
(IV) The essence is to defraud property.
In the crime of organizing and leading pyramid schemes, the pyramid‑scheme organization does not actually engage in any business activities; rather, it lures others into joining by employing fraudulent means such as fabricating or exaggerating business operations, investment opportunities, service projects, and profit prospects. At the same time, the goods or services that pyramid schemes claim to sell often do not actually exist; even if they do exist, they are either worthless or of very little value. The goods and services merely serve as a facade to conceal the scheme’s reliance on “recruiting new members” as the basis for payouts, making such practices clearly deceptive.
Therefore, a pyramid scheme activity must have the characteristic of defrauding others of their property in order to constitute the crime of organizing or leading a pyramid scheme.
PART 03
Defence Strategies for Acquittal in Cases of the Crime of Organizing and Leading Pyramid-Scheme Activities
(I) Analyze the case in light of the four basic characteristics.
The preceding discussion has examined the four essential characteristics of the crime of organizing and leading pyramid schemes: the organizational structure, the profit‑making model, the basis for remuneration, and the deceptive nature of the scheme. When mounting a defense of innocence, defense counsel should first consider the defense strategy from the perspective of the fundamental characteristics of the case.
1. In terms of organizational structure:
In general, the determination of the hierarchical structure and the number of participants in a pyramid scheme should be based on whether there is a system of rebates between superiors and subordinates. Suppose a pyramid scheme has the hierarchy A → B → C → D; then B is A’s downline, C is B’s downline, and D is C’s downline, with each subsequent level’s enrollment generating commissions for the preceding level.
At the same time, if the recruitment of personnel at levels B and C entitles A to a rebate, but the recruitment of D does not entitle A to a rebate, then D naturally cannot be considered A’s downline. At this time, A has only two subordinates: B and C. Defense counsel should pay attention to the client’s profit‑earning status within the pyramid scheme organization and exclude any tiers that did not generate profits for the client.
Secondly, in practice there is another scenario: in order to expand their downline network, individuals use the names of their relatives and friends to register accounts themselves, thereby recruiting them as their own downline. Alternatively, one may develop a downline through a fictitious account—where the account’s registrant and owner remain the individual in question—thereby making the number of people they have recruited appear to be substantial.
However, at its core, in the aforementioned situations, the actual number of individuals who have withdrawn is zero; there has always been only one perpetrator. In such cases, the defense counsel should ascertain how many of the downline accounts developed by the client are owned by the client himself or are fictitious.
According to Article 224-1 of China’s Criminal Law, the crime of organizing or leading pyramid schemes requires a large number of participants and the establishment of a hierarchical structure. Specifically, the requirement is that there must be more than thirty participants in the pyramid scheme activity, and the hierarchical levels must be three or more (“or more” includes the specified number). If the existing evidence is insufficient to prove that the number of participants or the hierarchical structure in a pyramid scheme meets the statutory requirements, then, in accordance with the principle of “in dubio pro reo,” such conduct cannot be deemed criminal.
The defense counsel needs to analyze whether the number of downline members developed by the perpetrator meets the statutory threshold for prosecution, and whether the calculation of hierarchical levels is accurate. To illustrate this issue, the author has cited the following case:
Judgment in the case of Li Moujia for organizing and leading pyramid‑selling activities and provoking trouble: This Court finds that, under the “xx Mall” platform’s “Matching Bonus” scheme, 118 member accounts affiliated with Li Moujia’s account were automatically assigned to his downline by the platform from among those developed by others; not all of these accounts were directly developed by him.
On the “xx Mall” platform, Li Moujia directly or indirectly developed a total of eight offline members, with two levels in the downline structure. The number of participants in the pyramid‑selling activity did not meet the prosecution threshold of more than thirty persons and three or more hierarchical levels required for the crime of organizing or leading pyramid‑selling activities; the circumstances are clearly minor and the harm is slight, and therefore do not constitute the crime of organizing or leading pyramid‑selling activities.
Li Moujia convened members to petition for their rights in Pingguo City, Guangxi Province; however, no serious disruption of public order occurred, and the circumstances were clearly minor with limited harm, thus not constituting the crime of provoking trouble. In accordance with Article 16, Item (I), and Article 177, Paragraph 1 of the Criminal Procedure Law of the People's Republic of China, it has been decided not to prosecute Li Moujia.
2. Regarding the profit model:
The crime of organizing and leading pyramid schemes requires that the organizers and leaders of the scheme derive their profits from the “entry fees” paid by participants in order to qualify for membership. At each level, the compensation or rebates of higher-level participants are derived from the fees paid by lower-level participants. If the existing evidence cannot prove that the perpetrator’s profits derive from the “entry fees” paid by lower-level participants, then this crime is not established.
3. Regarding the basis for remuneration:
This offense requires that the pyramid‑selling organization base its remuneration or rebates on the number of persons it recruits. Under such a scheme, there is no genuine sale of goods or provision of services, and the pyramid‑selling activity does not generate or create any real value. However, according to Article 5 of the “Opinions,” so‑called “team‑compensation”–style pyramid schemes, although they also involve multiple tiers, compensate participants based on the actual sale of goods and the provision of genuine services. Such activities constitute legitimate business operations that generate or create real value. Therefore, if the pyramid scheme activity carried out by the perpetrator falls under this category, it does not constitute the crime of organizing or leading a pyramid scheme.
4. The deceptive nature:
According to the provisions of the “Opinions,” the establishment of this crime requires that the perpetrator has engaged in conduct involving the “fraudulent obtaining of property.” Therefore, in the defense, the defense counsel must focus on whether the perpetrator had the intent to unlawfully appropriate the property.
In summary, a pyramid scheme should be characterized by a large number of participants organized in a pyramidal hierarchical structure, with profits derived from the “entry fees” paid by newly recruited members upon joining the organization, and by the inducement of higher-level members to recruit additional downline members, all with the purpose of defrauding such members of their entry fees. Therefore, during the defense process, lawyers must carefully analyze whether the client truly meets the definition and essential characteristics of a pyramid scheme organization.
(II) Key points of defense from the perspective of roles and functions
During the defense, it is necessary to distinguish between organizers and leaders and ordinary participants. This crime only holds the organizers and leaders of pyramid-scheme activities criminally liable. Therefore, when reviewing the case files and formulating a defense strategy, defense counsel must first accurately determine whether the client is a mere participant or an organizer or leader.
Secondly, analyze its role and responsibilities within the organization. If the individual’s role within the organization is limited, or if their conduct does not possess the characteristics of organization or leadership, then such conduct may not constitute this crime. To illustrate with a case:
Case of Lan et al. for organizing and leading pyramid‑scheme activities: The Heping County Public Security Bureau, in its referral for review and prosecution, determined that the TRX Super Community constitutes a new type of pyramid scheme. Unlike traditional pyramid schemes that rely on “recruiting people” and indoctrination, TRX leverages the internet, requiring members to register and activate their accounts to qualify for membership. It establishes various rewards, including node dividends, operational bonuses, performance bonuses, and core bonuses, and uses the number of members recruited as the basis for compensation or incentives, thereby inducing members to recruit others to purchase TRX tokens.
According to the electronic data examination record provided by the Anqiu City Public Security Bureau of Shandong Province: the suspect, surnamed Lan, has an ID of 20***, is at Level 3 of the organizational structure, registered under the mobile phone number 188********, with a resident identity card number of 4416241986********, and a bank card number of 62122620180********; he has 8
27downline members.
The Heping County People’s Procuratorate believes that, with regard to the determination by the Heping County Public Security Bureau that Lan Moumou played a key role in expanding the pyramid‑selling organization—specifically in terms of developing downline members, recruiting new participants, and generating profits—it is unclear whether such a role was indeed pivotal. Consequently, there is insufficient evidence to establish that Lan Moumou should be classified as an organizer or leader, and the case does not meet the conditions for prosecution.
In accordance with Article 175, paragraph 4, of the Criminal Procedure Law of the People's Republic of China, it has been decided not to prosecute Lan [surname].
The foregoing outlines the common grounds for asserting innocence in cases involving the crime of organizing and leading pyramid‑scheme activities. Defense attorneys may use these as a reference for their defense strategy in such cases, striving to secure an acquittal or a reduction or mitigation of the sentence for their clients.
Zhuosheng Criminal
Team Introduction
Zhiheng · Introduction