The recent amendment to the Securities Act falls short in its effort to give the Securities and Exchange Board of India (SEBI) more power to regulate illegal Collective Investment Schemes. The amendment seeks to bring all funds collected under investment contracts with corpuses exceeding Rs 100 crore under SEBI’s purview. But merely setting a limit may not serve this objective, as unscrupulous promoters could float multiple schemes just short of the Rs 100 crore mark. Further, only some schemes have been using regulatory gaps and overlaps to escape control; there are others that have been raising and deploying funds in innovative ways so that their business does not fall within the legal definition of a collective investment scheme. A better way to widen the regulatory net would have been to broaden the description of such schemes.
Collective investment schemes, interpreted broadly, are those where investors have a share in an asset that is nurtured for an extended period of time into something more valuable at the conclusion of the agreed period. Another feature of such schemes is that investors pool their resources to acquire indivisible shares in assets. A scheme involving investors coming together to own a teak plantation or a cattle farm are classic examples: One teak is like another, just as a head of cattle cannot be distinguished from another in the herd. Many unscrupulous promoters are exploiting this narrow definition to escape regulatory scrutiny by resorting to such devices. For instance, they could claim that funds mobilised from investors is just a financial transaction even as they would argue the very opposite before the Reserve Bank of India (RBI). Another tactic employed is to structure the transaction as sale of an asset along with a supplementary agreement for the sale of some other value-adding service (land development in the case of an initial transaction that involves the sale of a barren piece of land). To further escape regulatory scrutiny, the arrangement is structured as one involving the payment of an initial sum of money as an advance, with the final deal concluded after a period of time. If the definition of collective investment schemes in the legislation is widened to cover any transaction involving a physical asset where a relationship is created between an investor and another person for a period exceeding 180 days, then most of the fraudulent schemes currently in vogue could be brought under the regulatory ambit. Alternatively, it could be deemed as a deposit and thus be subjected to RBI regulations applicable for non-banking finance companies.
The other changes brought about through the ordinance, such as giving SEBI the power to attach the assets of companies that do not comply with the CIS rules and to search and seize documents, should go some way towards strengthening the regulator’s powers and make it more effective in checking ponzi schemes. It will also help in speeding up the process of returning investor money in such fraudulent schemes.