For Avon and Amway, this year may bode well. China plans to legitimize direct-sales marketing on condition that it does not involve notorious pyramid schemes.

　　The Ministry of Commerce confirmed it is considering passage of a law regulating direct selling, or one-on-one sales not relying on a fixed location, within this year.

　　When it joined the World Trade Organization in 2001, China agreed to liberalize direct sales three years later.

　　While China should be applauded for honoring its WTO promises, the question is whether it is fully prepared to fight possible vices associated with distorted direct selling after the outright ban is lifted.

　　The problems that existed in 1998 when China banned all sorts of direct selling, linger on today. Cunning people still sell pyramid schemes in the name of direct-sales marketing.

　　In a classic pyramid scheme, participants attempt to make money solely or mainly by recruiting new participants into the program. According to the explanation of the US Securities and Exchange Commission, the hallmark of these schemes is the promise of sky-high returns in a short period of time for doing nothing other than handing over your money and getting others to do the same.

　　As in the past, some people who purport to sell lipsticks are not really selling products for a living. They earn their bread mainly by selling memberships. As the following chart shows, the scheme of selling memberships will eventually collapse, and the seller's promise is merely lip service.

　　Three young Chinese people, who wished to get rich overnight, killed their six bosses in January after getting nothing from buying the membership.

　　China now takes pyramid schemes as a crime, but the criminal law does not have a category for such schemes. Even if the law can be stretched to cover the schemes, punishment is ex post.

　　A better way is to find measures to prevent naive participants in a direct selling network from being hijacked into de facto pyramid schemes.

　　Unfortunately, Chinese lawmakers may not have understood the economic nature of pyramid schemes.

　　Pyramid schemes actually involve the sale of a security, as the US Court of Appeals found in a landmark case in 1974. This is quite a novel concept to most Chinese, who take only stocks and bonds as securities.

　　In the United States, an investment contract becomes a security if it involves expectation of profits arising from a common enterprise that depends predominantly for its success on the efforts of others. Investors in pyramid schemes typically rely on the sensational but empty get-rich-quick promises of promoters.

　　In SEC v. Koscot Interplanetary Inc, decided in 1974, promoters drove Cadillacs, dressed expensively and flaunted large amounts of money. A naive prospect was thus galvanized into signing a contract by these ostentations.

　　Classification of membership sales in the case of Koscot as a security was a wonderful development of US case law. As such, membership sales must be registered with the SEC to meet strict information disclosure and anti-fraud requirements.

　　The philosophy of registration and transparency is that sunlight is the best disinfectant.

　　Had the three young Chinese people who killed their bosses read a "prospectus" screened by China Securities Regulatory Commission, they would not have been cheated in the very beginning.

　　Direct selling is not faring well in the US nowadays. Companies tend to have incentives to sell memberships on top of selling lipsticks to get residual income.

　　Some membership sales are legal, such as in the case of franchise. But watch out for red flags.

　　What China needs to do most is to let CSRC to handle distorted direct selling to nip these rob-Peter-to-pay-Paul games in the bud.