Ponzi Schemes in India –The Legal and Regulatory Landscape

Introduction

In 1920s USA, an Italian immigrant named Charles Ponzi ran a fraudulent scheme that promised a 50 per cent return on investment within a few months. While the scheme lured investors with the claim that investments were in international mail coupons, it was actually a fund embezzlement cycle wherein monies were rotated from new investors to pay “returns” to older investors[1]. After Charles Ponzi’s arrest, his name became synonymous with similar fraudulent schemes that drew beguiled investors, and the term “Ponzi scheme” took off.

India is no stranger to Ponzi schemes, numbers of which have surged in the recent times. While central legislations and regulations are in force to regulate and/or ban certain deposit collecting activities, several unscrupulous schemes continue to operate outside the purview of any regulatory body.[2] The presence of several sector-specific regulators has resulted in contemporaneous jurisdiction of many regulatory bodies and as a paradox, several gaps in their operation. In addition, the legislations have differing enforcement mechanisms and penal provisions in case of default. Banning of Unregulated Deposit Schemes Act, 2019 (BUDS Act) was enacted in July 2019, and Banning of Unregulated Deposit Schemes Rules, 2020 (Rules) were notified in February 2020, as there was a necessity for a uniform comprehensive legislation to regulate deposit-taking and provide an effective investor protection mechanism.

This article is divided into two parts. The first part attempts to examine provisions, powers, and enforcement mechanisms in certain central legislations that govern deposit-taking activities and analyse whether their shortcomings have been addressed by the BUDS Act. The second part of this article discusses the regulatory obstacles faced in the investigation, enforcement, and recovery of monies under a few Ponzi schemes in India.

What is a Ponzi scheme?

A Ponzi scheme, in essence, refers to any investment scheme which has no legitimate source of revenue or profits to pay “returns” to investors. Returns are paid to old investors by new investments made on a rolling basis. When the Ponzi scheme does not generate new investments anymore, it collapses and, in most cases, the principal investment is compromised too. Some common features of a Ponzi scheme include false assurance of “guaranteed” high returns or “guaranteed” consistent returns, vague or no business activities, seldom having a commission on referrals, involvement of shell companies, etc.

Jurisdiction, powers and enforcement under legislations/regulations

Apart from BUDS Act, the following legislations/regulations govern and regulate deposit collecting activities:

(a) Chit Funds Act, 1982 (Chit Funds Act).

(b) Prize Chits and Money Circulation Schemes (Banning) Act, 1978.

(c) Companies Act, 2013 and Companies (Acceptance of Deposits) Rules, 2014.

(d) Securities and Exchange Board of India Act, 1992 (SEBI Act) and Securities and Exchange Board of India (Collective Investment Scheme) Regulations, 1999 (CIS Regulations).

In this article, we will be analysing the Chit Funds Act and CIS Regulations (hereinafter collectively referred to as “Regulating Law”).

Penal provisions under the Regulating Law

The Regulating Law prescribes penalties for violation of its provisions and for operation of deposit-taking activity without adequate registration or in contravention of the respective Regulating Law. However, it is pertinent to note that each of the Regulating Law only operates and penalises the deposit-taking activity within the scope of its ambit. For instance, Securities and Exchange Board of India (SEBI) exercises jurisdiction only over collective investment scheme management companies. There is not a comprehensive penal provision, which penalises any other deposit collecting operation that is not regulated by the Regulating Law.

Power to take any urgent measures

The Chit Funds Act provides for statutory arbitration before the Registrar of Chits, who has the same powers as a civil court under the Code of Civil Procedure, 1908 and may attach properties of any party to the dispute upon satisfaction that the party may defeat or obstruct the execution of an award. In addition, the Registrar of Chits may wind up chit funds in case of inter alia contravention of the provisions of the Chit Funds Act. The SEBI Act and CIS Regulations empower SEBI to cancel or suspend registration of the collective investment management company, in addition to issuing in some cases ex parte directions to secure the investors. It is to be noted that there is an inconsistency in the powers conferred upon the regulatory bodies to order urgent interim measures to secure the interests of the defrauded investors.

Enforcement and recovery mechanism

The Chit Funds Act provides that any interlocutory order or statutory arbitral award passed by the Registrar of Chits for payment of money would be deemed to be a decree of a civil court and enforced accordingly. The SEBI Act confers broad adjudicatory powers upon the SEBI to issue summons, and make such orders for penalty as are in the best interest of investors.

BUDS Act and Rules

In the backdrop of Ponzi schemes having defrauded many Indians, the BUDS Act was enacted with a view to address the lacunae in the present legal and regulatory framework for deposit collecting activities.

The BUDS Act provides for “regulated deposit schemes” and prohibits and penalises the acceptance of deposits under any scheme or arrangement which is not regulated, thereby characterised as “unregulated deposit schemes”, and therefore, addresses the gaps created by the spherical jurisdictions under each of the Regulating Law. In addition, penalty is prescribed for failure to return monies that are accepted by way of regulated deposit schemes on maturity or in rendering any promised service in lieu of the deposits.

The BUDS Act identified another major impediment in the successful enforcement of the Regulating Law. The Act noted that there was no central database of all deposit collecting activities in India and accordingly provides for constitution of an online database for information on all deposit takers PAN India. Further, it necessitates a deposit taker to provide information about its business in the form and manner prescribed in the BUDS Rules, including subsequent changes in operations/business.

The BUDS Act and BUDS Rules decentralise its operation and implementation and empower the State Government to appoint a competent authority and designated court within the State. To secure the interests of the investors in the interim, the competent authority, empowered as a civil court, may order provisional attachment of the deposits or properties of the deposit taker who is soliciting deposits in contravention of Section 3 of the BUDS Act. Further, the designated court has been granted exclusive jurisdiction for matters under the BUDS Act, which entails that no other civil court shall have the jurisdiction to entertain any matters arising out of the BUDS Act.[3] With a view to secure the interests of investors, Section 18 of the BUDS Act confers extensive powers upon the designated court.

In our view, one of the significant lacuna addressed by the BUDS Act is that the competent authority may refer the investigation to the Central Bureau of Investigation (CBI) via the Central Government, if it has reason to believe that the offence relates to a deposit scheme in which (a) the depositors, deposit takers or properties involved are located in more than one State or Union Territory in India or outside India; and (b) the total value of the amount involved is of such magnitude as to significantly affect the public interest. Such unanimity in action is of paramount importance in severe cases involving multi-State scams as India has seen over the last two decades. In fact, seeking transfer to the CBI required a separate procedure and resulted in further delays at the nascent investigation stage.

The BUDS Act provides for a mechanism for restitution to depositors whose claims, and orders of provisional attachment, to the extent of depositors’ claims passed by the competent authority, have been given priority save as otherwise provided in Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 or the Insolvency and Bankruptcy Code, 2016.

Conclusion

The BUDS Act addresses several lacunae in the legal and regulatory framework and works to successfully bar illicit investment schemes from mushrooming and functioning. It further allows the regulatory bodies to govern the “regulated deposit schemes”. Taking cue from the CIS Regulations, it would be helpful if the bodies regulating deposit-taking activities could impose uniform conditions for filing of annual statements and annual returns of the regulated deposit schemes, periodic disclosures by the person accepting or soliciting deposits and periodic disclosures of the scheme itself. This would enable the regulatory bodies to undertake routine inspections and ensure prompt investigation into any irregularities or non-compliance of the regulating law or BUDS Act.

While the BUDS Act is a welcome legislation that has brought all deposit-taking activities in India under its umbrella, its effective implementation in the States is awaited.

† Partner, Cyril Amarchand, Mangaldas.

†† Associate, Cyril Amarchand, Mangaldas.

[1] Ponzi Schemes, US Securities and Exchange Commission. Available <HERE> (last visited 6-8-2021)

[2] Observations and Recommendations, Twenty-First Report of the Parliamentary Related Standing Committee on Finance (Sixteenth Lok Sabha) titled as “Efficacy of Regulation of Collective Investment Schemes, Chit Funds, etc.” Available <HERE> (last visited 10-5-2021)

[3] S.  8(2) of BUDS Act provides that no court other than the designated court shall have jurisdiction in respect of any matter to which the provisions of the BUDS Act apply.