Collective Investment Schemes: The pervasive frauds

Background

Concept of Collective Investment Schemes is not new in India. In the pre-independence era it was widely practised but in an unorganised, scattered and non-uniform manner, where money was collected and invested largely in agriculture related activities. Post independence this practice greatly and allowed scope for mischief and frauds by misappropriation and misutilisation of the money.

By a press release dated 18th November 1997, the Government of India pronounced that a regulatory framework needed to be put into place for companies issuing instruments such as Agro Bonds, Plantation Bonds, etc. The Government decided that bonds like these would be issued through schemes known as Collective Investment Schemes (CIS), which have been defined under section 11AA of the Securities and Exchange Board of India Act, 1992. The Collective Investment Schemes are regulated by the Securities and Exchange Board of India (Collective Investment Schemes) Regulation, 1999 which came into force on 15th October 1999. The establishment, operations and winding-up are all regulated by the market regulator through the CIS Regulations 1999.

What is a Collective Investment Scheme?

According to section 11AA of the Securities and Exchange Board of India Act, 1992 Collective Investment Schemes are schemes offered by any person under which contributions made by investors are pooled and used for the purposes of the scheme. It is done with a view of receiving profits, income, produce or property which may either be movable or immovable. The contributions made are managed by Collective Investment Management Companies on behalf of the investors, and the investors do not have day to day control over the management and operation of the schemes. Sub-section (3) of section 11AA lists the schemes that are expressly exempted from the purview of being Collective Investment Schemes under the Act. Schemes falling under this purview include the following:

1. schemes offered by a co-operative society registered with the Co-operative Societies Act 1912

2. schemes by Non-banking Financial Institutions as defined under the Reserve Bank of India Act 1934

3. scheme being an insurance contract under the Insurance Act 1938

4. schemes, including pension schemes or insurance schemes formulated under the Employees Provident Fund and Miscellaneous Provisions Act 1952

5. schemes for which deposits are accepted under section 58A of the Companies Act 1956

6. schemes for which deposits are accepted by Nidhi Companies or a mutual benefit society falling under section 620A of the Companies Act 1956

7. schemes by Chit businesses under the Chit Fund Act 1982

8. schemes under which contributions are made in the nature of a mutual fund

9. any other scheme which the Central Government may notify as not being a Collective Investment Scheme.

Registration and Regulation

The minimum requirements for the establishment, running and winding-up of a Collective Investment Scheme are laid down under the Securities and Exchange Board of India (Collective Investment Schemes) Regulations.

The Collective Investment Management Company should be registered under the Companies Act, 1956 and also be registered with the Securities and Exchange Board of India under the Securities and Exchange Board of India (Collective Investment Schemes) Regulations 1999. Their objective is to organise, operate and manage this Collective Investment Schemes. This registered company must specify management of collective investment schemes are its main object in its Memorandum of Association. It must have a net worth of not less than three crore rupees at the time of application, which should be increased to at least five crore rupees at the time of registration. The applicant should have adequate infrastructure in order to operate the collective investment scheme.

The Collective Investment Management Company is under obligation to essential information to its investors and maintain transparency in its operations. The Collective Investment Management Company is not allowed to undertake activities other than the management of the Collective Investment Scheme or acting as a trustee for any other Scheme. The trustee company ought to hold assets of the Collective Investment Scheme for the unit holders’ benefit.

Difference between Collective Investment Schemes and Mutual Funds

Mutual funds are investment schemes wherein investors pool in their money into a type of scheme based on their financial goals. A professional mutual fund manager handles each such scheme and further invests the investors money into the share market. People invest in mutual to collectively earn the highest possible returns on their investment.

Whereas in Collective Investment Schemes people meet up and collectively invest their money into assets like land, livestock and farms etc. Depending upon the agreement between them, they share the profits earned from such investment.

Mutual funds are expressly excluded from the ambit of being Collective Investment Schemes under clause (viii) of sub-section (3) of section 11AA of the Securities and Exchange Board of India Act 1992.

Hurdles and Frauds

The Securities and Exchange Board of India does not seem to have the infrastructure to effectively regulate the Collective Investment Schemes. It has limited number of staff and offices. Companies find loop holes to escape regulation from SEBI by contesting that it is beyond SEBI’s powers to ask them to refund the money to their investors. Companies running Collective Investment Schemes do not realise the need to be transparent and this goes unchecked even by the banking system.

Owing to the Sharada scam in 2013, the Securities and Exchange Board of India issued the Securities Laws (Amendment) Act, 2014 which inserted a proviso in sub-section (1) of section 11AA of the Securities and Exchange Board of India Act, 1992. This proviso stated that pooling of funds under any scheme which is not registered with SEBI or not covered under sub-section (3) of section 11AA shall be deemed to be a Collective Investment Scheme if the corpus amount involved is one hundred crore rupees or more.

The market regulator also notified norms to classify certain activities as frauds and impose penalties on them which can extend to up to three times the profits earned buy them or twenty five crore rupees, whichever is higher. The Securities and Exchange Board of India (Prevention of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations 2003 was amended with effect from 6th September 2013 which enlists practices that would classify illegal Collective Investment Schemes as fraud. The SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market) (Amendment) Regulations, 2013 inserted clause (t) in regulation 4 which states that “illegal mobilization of funds by sponsoring or causing to be sponsored or carrying on or causing to be carried on any collective investment scheme by any person” will classify as an illegal and fraudulent activity. The amendment regulation also inserted an Explanation at the end of regulation 4 to clarify that the acts and omissions listed therein are not exhaustive and will include any such act or omission which falls within the purview of regulation 3, although it may not be listed. With the enforcements of these amendments SEBI increased its powers to declare illegal any CIS activity that it found to be fraudulent in nature. SEBI can also issue orders with respect to stoppage of fund collection by these CIS.

A lot of Collective Investment Schemes with fraudulent intentions thrive on people’s greed and desire to make quick money with high returns. They gain investors’ trust by promising abnormally high returns. They trap then into taking more risks and eventually vanish with all their hard earned savings.

Precautions

Humans are gullible. They are so blinded by greed that they can’t see through the facts that a scheme which is not even linked with the market economy cannot give the returns they are promising.

In the current time, the “pachhees din mein paisa double” schemes are very common. Irrespective of whether you live in urban areas, suburban areas or villages areas, you will find defrauders all around you.

Money doesn’t grow on trees and the earlier you realise that, the safer your money will be. Our savings should be invested with great precaution. It is our responsibility to check whether the scheme we have been approached is registered with the Securities and Exchange Board of India or not.

There are a large number of investments options in the market which are well regulated by the Reserve Bank of India, Securities and Exchange Board of India, Insurance Regulatory and Development Authority of India etc. Investing in reliable schemes is safer than chasing unrealistic investment returns with high risks.

Currently there is only one Collective Investment Scheme registered with the Securities and Exchange board of India, and that is the Gift Collective Investment. If you still wish to invest in a collective investment scheme, it is advisable to invest in this one that’s registered, because most likely all the others you’re looking at could be illegal and will give you a run for your own money. Legal experts say clarity will develop gradually when the Securities and Exchange Board of India’s cases will be tested in the courts.

Remember what J. Bridges once said “A fool and his money are quickly parted”

Sonam Chandwani is the Managing Partner at KS Legal & associates and heads the firm’s Corporate Litigation Practice.