Are Fraudulent Collective Investment Schemes taking SEBI for a ride?

Pavit Kochhar

23 Jun 2015 8:18 PM GMT

  • Are Fraudulent Collective Investment Schemes taking SEBI for a ride?

    Over the years, the aam aadmi of the country has been drenched into a series of crisis arising either due to nature’s fury or the greed of few fellow human beings and is often found at the receiving end without the possibility of recovery of lost ground. Disaster Management groups have been brought into existence by the State to tackle natural calamities. However, disasters which are...

    Over the years, the aam aadmi of the country has been drenched into a series of crisis arising either due to nature’s fury or the greed of few fellow human beings and is often found at the receiving end without the possibility of recovery of lost ground. Disaster Management groups have been brought into existence by the State to tackle natural calamities. However, disasters which are man-made belong to the classes of their own. Investment companies had mushroomed in the last century comprising of people, having no scruples and sense of morality. They cashed on the opportunity to enrich themselves by luring the aam aadmi with a triumvir, i.e. wealth. These companies floated tempting advertisements to lure the aam aadmi to invest in such schemes with the promise of hefty returns. The credulous aam aadmi relied on such schemes without analyzing the risk factors attached to such schemes and the need to take informed decision on such ponzi schemes. Forget the minimal returns, the aam aadmi did not even receive a penny.

    The Securities and Exchange Board of India (SEBI), the Indian market regulator has been on a roll for last couple of years by protecting the interests of such aam aadmi being swindled because of their inability to take a well informed decision and intensifying its scrutiny over different companies. Right from initiating acting against Sahara Group to unfolding Saradha Scam, SEBI has acted as a savior for such investors.

    As usual, companies keep playing with the loopholes in the system and even if an assumption is made that the companies do not intend to cheat, they do not comply with the statutory/regulatory compliances. The easiest targets for the companies are the hapless investors (mostly illiterate about the securities market). One of the modes of tricking the investors but not the regulator is by launching a mala fide Collective Investment Scheme.

    You must have heard this term in Saradha Scam. Yes, you are right!! The Collective Investment Scheme is one of the modes of raising capital which involves contribution or payments by the investors, which are pooled and utilized with a view to receive profits and is managed by the manager on behalf of the investors. The investors do not have day-to-day control over the affairs of the scheme. So, technically investors have no clue about where there hard-owned income is parked in a scheme as in the case of Sahara where millions of investors were defrauded. A Collective Investment Scheme being a security, SEBI automatically becomes the regulatory body who can regulate such schemes.

    Law dealing with Collective Investment Scheme

    To regulate the behavior and clamping down on entities running illegal Collective Investment Schemes, the market regulator introduced the Securities and Exchange Board of India (Collective Investment Schemes), Regulations, 1999 (“Regulations”). These Regulations deal with the registration and obligations of the Collective Investment Management Company among other things. To begin with let’s first understand the definition of ‘Collective Investment Scheme’ and ‘Collective Investment Management Company’.

    “Any scheme or arrangement which satisfies the conditions referred to in sub-section (2) or sub-section (2A) shall be a collective investment scheme.

    Provided that any pooling of funds under any scheme or arrangement, which is not registered with the Board or is not covered under sub-section (3), involving a corpus amount of one hundred crore rupees or more shall be deemed to be a collective investment scheme.”

    Sub-section (2) states that any scheme or arrangement made or offered by any person under which:

    • The contributions, or payments made by the investors, by whatever name called, are pooled and utilized for the purposes of the scheme or arrangement;
    • The contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement;
    • The property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;
    • The investors do not have day-to-day control over the management and operation of the scheme or arrangement.”

    Sub-section (2A) states that any scheme or arrangement made or offered by any person satisfying the conditions as may be specified in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992.

    Sub-section (3) states any scheme or arrangement made or offered by a Co-operative society or under which deposits are accepted by NBFC’s, or being a contract of insurance, or under which deposits are accepted by a company declared as a Nidhi Company or falling within the meaning of Chit Business shall not be a Collective Investment Scheme (Section 11AA of SEBI Act).

    A Collective Investment Management Company (“Company”) has been defined under regulation 2 (h) of the Regulations as a company incorporated under the Companies Act, 1956 and registered with Securities and Exchange Board of India (“Board”), whose object is to organize, operate and manage a collective investment scheme.

    SEBI has made it mandatory for every entity who is running the Collective Investment Scheme to register themselves under section 12(1B) of the Securities and Exchange Board of India Act, 1992 (“Act”) and Regulation 3 of the Regulations. However, if any person is operating a Collective Investment Scheme before the commencement of the regulations, such person shall make an application to the Board for the grant of registration certificate within a period of two months from the date of commencement of these Regulations (Regulations 5).

    A Company shall launch only close ended Collective Investment Scheme for a minimum period of three years in the form of a trust, appraised by an appraising agency [Regulation 24(3)] and obtain rating from a credit rating agency with no guaranteed or assured returns. The Company shall also obtain adequate insurance policy for the protection of the Scheme’s property.

    Case laws dealing with proliferation of fraudulent Collective Investment Scheme

    A large number of cases have come to light in past where the investors have been defrauded though illegal Collective Investment Schemes. The managers of such schemes claim to be innocent, having returned the money to the investors. But such is not a case.

    1. Rose Valley Real Estate and Construction Limited Case

    In this matter, SEBI had, in January 2011, observed that Rose Valley Real Estate and Construction Ltd. was mobilising funds under Collective Investment Schemes (“CIS”) without obtaining a certificate of registration as required under Section 11AA of Act. Rose Valley in turn moved the High Court challenging the constitutional validity of the said Act, 1992. The Calcutta High Court dismissed the said Writ Petition filed by Rose Valley challenging the constitutional validity of SEBI in regulating Collective Investment Schemes. Dismissing the Writ Petition, the High Court observed that the Section 11AA of the Act is legal and the provisions provided in it were valid. The High Court also slapped a Rs. 10 lakhs fine on Rose Valley.

    The SEBI, in its January 2011 order, held that Rose Valley was raising funds through sale of plots of land and pooling the same to develop the land and providing investors the return on the amount invested at the end of the scheme in the form of credit value. Investors could utilise the credit value to either adjust partly against the cost of land or to get refund for the investments made. “These activities were akin to the features of a CIS, specified under the Section 11AA of the Act”. The SEBI had further directed Rose Valley not to collect any money from investors or to launch any scheme and not to dispose of any of the properties of the scheme. The SEBI previously had also imposed a penalty of Rs. 1 crore on Rose Valley for not providing details sought by the market regulator in a case charging the company of issuing debentures illegally.

    The SEBI had also barred Rose Valley Hotels and Entertainment from collecting money from investors under its ‘holiday membership’ schemes alleging that such schemes were CIS in nature and required a certificate of registration. The SEBI had begun the investigation of the case after it received a letter in June last year from the Additional Director-General of Police, Guwahati, Assam, alleging that Rose Valley Hotels and Rose Valley Real Estates Constructions Ltd. had collectively raised Rs. 1,006.70 crores till February 2012. It was pointed out that Rose Valley Hotels had launched a scheme called Rose Valley Holiday Membership Plan in 2010. Under the scheme, an investor can book a holiday package by paying monthly instalments. Upon maturity or the completion of the instalment tenure, the investor can either opt for a holiday, which includes hotel accommodation and services, or a return on the investment with annualised interest. The market regulator had sought various details on the scheme that included the number of individuals who had subscribed to the plan and the total amount refunded by the Company towards principal investment and interest. Rose Valley Hotels, however, contended that it was in the time share business, which did not fall under SEBI’s purview.  S. Raman, whole-time member of SEBI, in his order stated that the scheme had all the ingredients of a CIS. He added that the contribution made in the form of monthly instalments by investors were pooled and utilised for the purpose of the holiday membership plan. Moreover, such contributions are made by the investors with a view to receiving profits or income in the form of returns with annualised interest. He had also directed Rose Valley Hotels not to collect any more money from investors either through existing schemes or via new ones.

    1. Maitreya Services Pvt. Limited Case

    The SEBI began the probe against Maitreya after a reference from the Income Tax department in September 2010 alleging violation of SEBI regulations by Maitreya. During the inquiry, the Company submitted that it carries out the business of real estate and its business includes buying and selling of land, development of the land, construction and other land related activities. The SEBI found that the Company had launched various schemes under which money was collected from the public. These schemes differed on the basis of the periodic payment to be made by the investor, and the time period for which such investments were to be made. In the course of its inquiry, the SEBI found that the Company had launched and operated ‘Collective Investment Schemes’ without registering the same. SEBI ordered for winding up of Collective Investment Schemes being run in the garb of real estate business, asking the entity concerned to refund the money to investors within three months. SEBI also barred the Company, and its directors from the securities market till the time all its Collective Investment Schemes are wound up and decided to initiate prosecution proceedings against them.

    1. Alchemist Infra Realty Ltd:

    During the initial probe, the company refused to provide details sought by the SEBI, saying the regulator did not have jurisdiction and the company is not running any Collective Investment Scheme (CIS). Alchemist Infra later on provided some details to SEBI after repeated reminders and show cause notices issued to the Company and its directors. In the meantime, the company sought to settle the case through SEBI's consent mechanism, but the plea was rejected by the regulator. The regulator later found that the company was running Collective Investment Schemes in the name of real estate business and had generated Rs 1,087 crores as on March 31, 2011 from the public. The SEBI probe also found that the Investment Application Forms of the company also mentioned that it was part of 'Alchemist Group', which was engaged in diverse activities such as steel, food and beverages, IT, healthcare, media, aviation, realty, hospitality, education and tea estate, among others, with asset base of over Rs 5,000 crores. Thus, an Investor/Applicant was misled to believe that the company, Alchemist Infra Realty Ltd, is part of the Alchemist Group, whereas the company had contended that it was not associated with the Alchemist Group. SEBI by its order dated 23.07.2013 asked Alchemist to wind up all such activities and refund the money collected from public investors, within three months. The SEBI also warned the company and its directors of initiating prosecution proceedings and a criminal case for "offences of fraud, cheating, and criminal breach of trust and misappropriation of public funds", if its orders are not complied with.

    1. Rich Infra Developers India:

    SEBI found that Rajasthan- based firm were running Collective Investment Schemes without obtaining certification from the market regulator. To safeguard investor interests, SEBI in its Order directed Rich Infra and its four directors “not to collect any fresh money from investors under its existing schemes” and “not to launch any new schemes or plans or float any new companies to raise fresh moneys.” Additionally, the company and its directors were directed not to dispose any assets obtained from the funds collected, while the entities also cannot divert money raised from the public.

    Further, the entities were asked “to immediately submit the full inventory of the assets including land obtained through money raised by Rich Infra Developers India. The company also had to furnish all information sought by SEBI including details of amount mobilised by the firm till date, within next 15 days.

    Considering the above clamp down on illegal money pooling activities, SEBI has played the role of rescuer against such schemes and tightened the noose around entities running illegal Collective Investment Schemes. From January, 2015 to May, 2015, SEBI has passed orders against huge number of companies which were running schemes without obtaining prior registration.

    As an investor it is really important to be vigilant of such schemes and protect our hard-owned money from getting drained overnight. The principle of “caveat emptor”, that is, buyer beware is the golden rule for investments. Hence, before investing do a proper due diligence and take a well informed decision.

    Pavit Kochhar

    Pavit Singh Kochar is a transactional lawyer with KNM & Partners Law Offices.
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