Ponzi schemes: Protecting investors

Investor protection attracted the attention of the policy makers rather late when the Harshad Mehta scandal rocked the nation. By then, crores of rupees belonging to the gullible investors had vanished. The legacy continues. Neither the people nor the government has learnt lessons.

Thousands of people, including so called celebrities, are losing money by investing in chit funds, multilevel marketing schemes and such other Ponzi schemes. Thanks to the Parliamentary Standing Committee on Finance under the chairmanship of Veerappa Moily, a slew of measures have been suggested with a view to regulate public collection of deposits, which need immediate action.

The committee has rightly pointed out that much of the problem is due to the involvement of multiple agencies in collecting deposits. The Committee has recommended measures with effective administrative and enforcement powers. It has suggested unification and harmonisation of regulation of all entities engaged in acceptance of deposits from public, whether it is a NBFC or a non-NBFC.

Financial frauds are peculiar. They come in different forms with different features. Experience shows that by the time they are exposed, it would be too late. The committee is perfectly right when it says that time factor is of great significance not only to prevent a fraud from snowballing but also to ensure that the deposited money is not siphoned off. It has called for a mechanism to gather market information and prompt dissemination to investors.

Many states have laws to protect the interests of depositors which envisage preventive action and investigation into deposit schemes with abnormal returns and extraordinary commission to the agents. But there are not many instances of this law being used. The Committee, therefore, was of the view that in the light of such a dismal situation, there is an urgent need to galvanise and strengthen the enforcement and vigilance mechanism at the state level so that scamsters are severely punished and small investors duly protected. An effective whistle blower mechanism should also be developed for this purpose.

At present, there is a State Level Coordination Committee (SLCC) constituted under the RBI which shares information about public deposits etc. However, this mechanism has not been able to either protect investor interest or regulate deposit schemes. Hence, the committee favoured that the state chief secretary should invariably chair the meetings of this body and Central agencies like the Registrar of Companies, Income Tax, and Enforcement Directorate etc should also be made part of this committee.

Designated courts
It is suggested that information from neighbouring states where Ponzi schemes are reported are to be involved. The Economic Offences Wing of the state police should report to the SLCC in regard to investigation and prosecution of cases relating to unauthorised deposits, money collection schemes and other such activities banned under the Prize Chits and Money Circulation Schemes (Banning) Act. The Committee has also suggested setting up of designated courts under the Securities Law (Amendment) Act, 2014.

It is observed that high commission paid to agents is another reason for dubious deposit schemes. A 2% cap on commission has been suggested, besides deposit-linked insurance for all collective investment schemes. The Committee has made serious remarks about the failure of the Ministry of Finance (Department of Financial Services) in implementing the Prize Chits Act and the recommendations of the Key Advisory Group on Chit Funds/Nidhi companies. Observing the increase in the number of multi-state cooperatives, it recommended that financial schemes of these institutions be shifted o Department of Economic Affairs. Similarly, in the background of the delay of SEBI in taking action against Ponzi schemes the Committee wants it to be more transparent, vigilant and accountable in their regulatory action.

One of the important suggestions is to frame a separate law to deal with deposits, chit funds and Ponzi schemes. It says that such a law should also have provisions such as attachment of property, recovery and distribution of proceeds in a stipulated time-frame, deterrent penalties with imprisonment, time-bound repayments/compensation and provision for class action suits/litigation. These offences should be treated as “offences committed against the state” analogous to the Indian Penal Code and accordingly made non-bailable and cognisable.
(The writer is Member, Central Consumer Protection Council)