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Will New Laws Stop Chain-money Schemes?
The Parliamentary committee on Finance turns its spotlight on multi-state cooperative societies as a major conduit for illegal chain-money schemes
Ponzis, money circulation schemes, dubious chit funds, multi-level marketing (MLM) schemes or pyramid companies masquerading as direct selling companies, are the scourge of India. The problem is gigantic. In fact, it so big that the massive refunds ordered by the Securities & Exchange Board of India (SEBI) in the case of Sahara group companies (Rs25,000 crore plus interest) or PACL (Rs49,100 crore) do not even begin to scratch the surface of the money robbed from ordinary savers.
The parliamentary standing committee on finance, headed by Veerappa Moily, has done extensive work on Ponzis and presented some startling findings in its report submitted in October 2015; it also recommends new legislation to bring illegitimate money-raising companies to book. Unfortunately, the excellent analysis of issues has not translated into a workable set of recommendations to deal with this large-scale loot that exploits the greed and gullibility of people across the economic spectrum.
The standing committee’s discussions show that there is no shortage of regulators or statutes—both Central and at the state level—to curb money circulation schemes; but they have failed to deliver results. The Chit Funds Act, 1982, and the Prize Chits and Money Circulation Schemes (Banning) Act, 1978, are Central legislations implemented by the states which have not been deployed effectively. Then there are multiple regulators who do not bother to act until it is too late. Consequently, unscrupulous companies “take advantage of this regulatory vacuum/lacuna” between various statutes and regulators to plunder large sums of money.
The parliamentary committee has recommended a “model Central law that would be comprehensive and all-encompassing including in its ambit collective investment schemes, chit funds, Direct Selling Schemes and such other activities, which are permissible but are defined and regulated in a dispersed manner.” It wants the law to also spell out non-permissible schemes and prohibited activities and to ensure that legislative provisions are accompanied by “effective administrative and enforcement measures” to ensure that people’s hard-earned savings are duly protected.
Further, it recommends capital adequacy requirements for money-pooling companies, capping commissions for garnering deposits at 2%, a deposit-linked insurance cover, and extension of the scope of special courts provided for in the recently enacted Securities Laws (Amendment) Act, 2014, to deal with Ponzis and money circulation schemes.
Many of these suggestions appear to have emanated from SEBI, which has always been a reluctant regulator of collective investment schemes, although it received great kudos for bringing the Sahara group to its knees. The committee’s deliberations note that SEBI had proposed the creation of a new regulator for all money collection schemes. All this finds an echo in the model Central law suggested by the committee, except that it leaves the question of an independent regulator for money pooling schemes open for a ‘considered’ decision.
While a strong new statue and special courts sound good on paper, it is unclear how this will work in practice, unless various high courts and district courts agree not to entertain pleas by dubious Ponzi operators and grant a stay against regulators’ orders. PACL is a classic case where the company doubled the money collected from Rs25,000 crore to Rs49,100 crore precisely because it obtained stay-orders from multiple courts on the SEBI action, prohibiting it from raising further funds. No statute can work, unless the government finds a way to stop the misuse of judicial forums.
A shocking new element in the report is that “huge amount of money has been transferred out of Ponzi schemes to multi-state cooperatives, which has a weak regulatory regime at present.” These cooperatives, it says, have become “some kind of a shelter for illegitimate funds” and asks for a special audit to unearth ‘this scam’. The committee notes that such cooperatives, operating under the agriculture ministry, have increased 100-fold since 2010. The ministry was headed by Sharad Pawar, whose Nationalist Congress Party (NCP) was part of the ruling United Progressive Alliance in that period.
Unfortunately, the committee’s strong observations end with weak recommendations. It wants the department of economic affairs under the finance ministry to take charge of the enforcement aspect of financial schemes floated by multi-state cooperatives, since their present regulator, the Central registrar, does not have any financial regulatory infrastructure. The finance ministry’s track-record as a regulator is hardly encouraging and, given that the cooperative sector is controlled by powerful politicians, the recommendation has little meaning.
In fact, its department of financial services (DFS) has not only been lambasted by the committee but also asked to submit an explanation for its inaction. The committee says DFS ‘remained a reticent bystander’ and ‘singularly failed’ to prevent the rampant violation of the Prize Chits Act, nor made a push to plug loopholes in the legislation. The finance ministry also faces heat for its failure to act on recommendations to strengthen the regulation of chit funds, submitted in 2013. It has been asked to decide on these in the next three months. Ironically, it was during the decade of the UPA government, when Ponzis were allowed to cheat investors with impunity.
Given the multiplicity of hapless regulators, including RBI and SEBI, the parliamentary committee recommends Central legislation for depositor protection which respective states can amend in line with the Central Act. After tracking Ponzi scams for several years, it is unclear to us, at Moneylife, how this will be any more effective in preventing scams or catching them early enough. All it will do is aid some recovery and enforcement, provided there is a political will to do so.Every major money circulation scheme has had the active involvement and support of powerful politicians. This is true of Sahara, Saradha, Alchemist, City Limouzine, QNet or scams in Orissa, Rajasthan, Madhya Pradesh and the North East. So, state governments initiate action only when there is a default and people make a noise, by which time, the money is already spent or siphoned off. A strong depositor protection law only leads to a few well-publicised arrests, but rarely does it recover investors’ money.
In addition to these broad recommendations, the Direct Sellers Association of India (which has been lobbying hard to get away from enforcement action by the police), managed to get the committee’s attention through the Indian Institute of Corporate Affairs. The Institute has submitted a ‘research paper’, which suggests an objective ‘smell test’ for law enforcement agencies to apply at the time of investigation. This has found favour with the parliamentary committee which wants the ministry to create a regulatory framework and compulsory registration process for all direct selling businesses to provide an oversight mechanism and clarity on whether they are legitimate direct sellers or Ponzi/pyramid schemes.
Similarly, the All India Association of Chit funds (AIACF) also got an opportunity to complain about how it is maligned by unregistered chits or Ponzis claiming to be chit funds, and its business model hurt by the levy of service tax. The Association’s representatives told the Business Standard that there are 25,000 registered chit funds and five million investors. Amusingly, the Association seems to think that changing its name from chit funds to ‘fraternity funds’ will resolve its problem, says an article in the paper.
Finally, there is a string of suggestions, such as setting up dedicated help desks for lodging complaints, encouragement to whistleblowers and the need for market intelligence. Had the standing committee followed its own recommendation and sought a case study on the modus operandi of a few of the notorious schemes that robbed people on a large scale (PACL or Saradha, or even a SpeakAsia), it could have obtained a clearer picture of why regulators and law enforcement agencies hesitate to act against these dubious companies.
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