Tort liability of senior members involved in massive fraud by L & G similar to multilevel marketing
After investing in financial instruments planned and solicited by L & G Co., Ltd. (hereinafter called "L & G"), consumers claimed damages against solicitors who were L & G senior members, L & G group company's executive officers and employees, alleging that solicitation for investment in the financial instruments violated the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates and constituted organization-wide multilevel marketing fraud.
L & G group company's executive officers and senior members who had been able to foresee L & G bankruptcy were ordered by the court to pay compensation. On the other hand, the court construed that victims had been also at fault in jumping at the extremely high yield financial products, and apportioned negligence between solicitors and victims in the ratio of 50:50 under the rule of comparative negligence. The court did not adopt the rule of comparative negligence with regard to liability of executive officers including CEO. (Judgment by the Tokyo District Court on March 30, 2015; published on LEX/DB)
Summary of the case
- X, etc. (62 consumers at the time of judgment)
- Y1 (CEO of L & G)
Y2, etc. (executive officers and solicitors of L & G group company: 38 persons at the time of judgment)
- Party concerned:
- L & G Co., Ltd. (L & G)
L & G used to sell health foods, heath appliances, etc. since its foundation in 1987. In 2000, the company started to raise investments with annual interest rate of 12%, and in 2001 began to deal deposits with annual interest rate of 23%. In 2003, L & G started to sell principal-guaranteed financial instruments with annual interest rate of 36%, and further launched new financial instruments one after another. Those financial products were sold applying a conventional multilevel marketing scheme. Sales figures were vanishingly small as of November 2002. Later, L & G completely ceased product sales and then focused on selling financial instruments.
In April 2007, the media started to point out problems arising from the L & G marketing scheme. In October 2007, the Metropolitan Police Department conducted a criminal investigation into the L & G head office. On November 26, a decision was made on commencement of bankruptcy proceedings. According to bankruptcy trustee's investigation, the total money collected by the L & G group amounted to 240,300,000,000 yen.
X, etc. who had invested in financial instruments sold by L & G alleged that solicitation for investment in the financial instruments by L & G and its affiliate companies including subsidiaries (hereinafter called "L & G group") had been against the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates as well as public order and morals and that the solicitation had been organization-wide and headed by Y1 with use of multilevel marketing scheme, which constituted organization-wide fraud. The victims claimed damages against L & G group's executive officers, employees and L & G senior members, alleging that they had directly or indirectly solicited X, etc. to invest in the financial instruments, sharing roles necessary for solicitation, although they had recognized or had been able to recognize that sooner or later it would be unable to return money invested in L & G financial instruments.
L & G marketing method
L & G induced many and unspecified L & G members to invest certain money in L & G and promised to pay them high-yield dividends and to return money equal to the principal. Collecting money in this way constitutes receipt of deposits. Therefore, the L & G marketing method is against Article 2 (1) of the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates.
The L & G solicitation method entails elements of a pyramid scheme as follows, so it is against public order and morals.
- High-yield dividend resource under the L & G investment scheme entirely came from contributions by new members. Under this mechanism, it was obvious that unless new members increased exponentially, L & G had to cease payment of dividends and a huge debt would be left, as a result of which L & G would go bankrupt.
- L & G advertised high annual interest rates such as 23% and 36%. In case of Enten (See "Explanation" below), a refundable deposit of 100% was guaranteed. These kinds of advertisements unjustly stimulate the speculative spirit of consumers.
- L & G dividend resource entirely came from contributions by new members. Under this mechanism, senior members got big profits in the name of referral fees, but it was clear that once the company went bankrupt, many members, particularly new members would not be able to recover the principal (i.e. a substantial portion of members would be victimized).
Moreover, L & G concealed the inevitable future failure of the investment business and pretended to be a reliable company to keep soliciting and selling financial instruments. L & G should have considered these conducts as organization-wide fraud. Accordingly, the L & G investment scheme was obviously illegal.
Solicitors' liability for damages
Those who directly solicited X, etc. shall be liable for tort if they intentionally or negligently performed the conducts and adequate causal relation between the conducts and the damage incurred by X, etc. was recognized. Even in the case where a senior member did not directly solicited investment, the senior member shall be liable for tort if the senior member intentionally or negligently used a subordinate member to solicit investment.
Moreover, it is inferable that solicitors could predict on May 11, 2004 when L & G began to sell new fraudulent financial instruments that L & G investment business would fail sooner or later and it would be unable or highly unable for new investors to recover money invested, unless the circumstances were exceptional for certain solicitors and it was unable for them to recognize that sooner or later the hand-to-mouth operation would get worse and L & G would go bankrupt. If a solicitor solicited or made other members to solicit investment while knowing the future circumstances and adequate causal relation between the conducts and the damage incurred by X, etc. was recognized, the solicitor shall be liable for tort. Considering that the time when solicitors could recognize the dead-end conditions was around and after May 11, 2004, it is reasonable to construe that those solicitors are liable for tort concerning damage caused by investment in and after June 2004.
X, etc. incurred financial detriment as a result of investment in abnormally high-yield financial instruments sold by L & G, so they should recognize their fault in jumping at the financial products. It is reasonable to apportion negligence between solicitors and X, etc. under the rule of comparative negligence (in the ratio of 50:50). On the other hand, it is not reasonable to apportion negligence between executive officers including CEO and X, etc. because executive officers played a key role in L & G investment scheme (Y1 consistently headed the business).
It is a civil case related to "Enten". L & G purported that they were doing a mail-order business with use of a virtual currency called "Enten" (actually the mail-order business did not exist) and solicited investment in financial instruments which they said are principal-guaranteed and high-yield with a mechanism by which investors can gain larger profits if they induce their acquaintances, etc. to invest in the financial instruments. It was a fraudulent business. L & G business with use of a multilevel marketing scheme expanded for some years, but failed in the end. L & G was accused of breaching the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates, and later their conviction of organization-wide fraud was decided. After L & G was accused, a legal team organized a victims group and filed a petition for commencement of bankruptcy proceedings. It was found out that the company did not have any valuable asset, so victims claimed damages in joint tort against L & G group executive officers including CEO as well as a hundred and several tens of senior members.
The court construed the sales scheme as follows: "L & G sales scheme entails elements of a pyramid scheme, so it is against public order and morals. L & G hided that the L & G investment business would inevitably fail and pretended to be a reliable company to continue soliciting and selling financial instruments, which should be rated as organization-wide fraud".
Concerning liability of solicitors, whether or not solicitors could predict future failure of the L & G business was determined based on the time when they engaged in the business. Those who could predict it were regarded to satisfy subjective requirements for being liable for tort, and were ordered to pay damages to victims concerned. The court construed that solicitors could predict bankruptcy in and after June 2004 based on the L & G history with transition. L & G used to sell health foods with use of a multilevel marketing method in early time (L & G did not use a pyramid scheme at first.), but gradually started to sell high-yield financial instruments, and then ceased sales of goods in 2003 and in May 2004 started to sell fictitious high-yield financial instruments. Those who solicited by themselves and those who made subordinate members to solicit the investment in and after June 2004 were judged to have committed a tort and were ordered to pay damages to victims concerned. The court construed that victims had been at fault in believing the abnormally high dividend (annual interest of 23% or 36%) and apportioned negligence between solicitors and victims in the ratio of 50:50 under the rule of comparative negligence. The court did not adopt the rule of comparative negligence with regard to tort liability of executive officers including CEO.
With regard to fraudulent gold sales scheme*, there was a case related to Toyota Shoji incident where victims claimed damages against employees including female part-time workers who were telephone appointment makers and the court affirmed the claim. All of those who were ordered to pay damages were Toyota Shoji employees (Reference precedent (2)). The case was characterized by the fact that solicitors concerned were not Toyota Shoji employees, but were persons who had entered into a contract, paid contributions to become members and solicited subordinate members.
- *It is a scheme by which a salesperson purports to sell gold or other spot goods and receives payment for such goods, and just gives a piece of paper as a receipt, but never deliver actual goods.
- Judgment by the Supreme Court on August 30, 1956 (Page 1292 of Keishu Vol.10, No.8,) - the court judged whether or not a conduct constituted receipt of deposits under Article 7 of the former Moneylending Control Act (corresponding to Article 2 of the Act Regulating the Receipt of Contributions, Receipt of Deposits and Interest Rates)
- Judgment by the Osaka High Court on March 31, 1989 (Page 40 of Hanrei Jiho No.1327) - the court affirmed tort liability of Toyota Shoji employees