Ponzi Schemes

Introduction

A Ponzi scheme is a fraudulent investment designed to defraud investors. It entails enticing the general public to invest in dubious yet lucrative schemes. With almost little real income, they rely on a steady stream of new money to stay afloat. The scheme collapses when there are no new investors or when existing investors cash out. Its absurdity is obvious on the surface. Nonetheless, the danger it poses to domestic society is apparent. The justification for investing in a Ponzi scheme is that it promises “above-average” returns. Typically, the anticipated rate performance is high enough to pique investor interest, but not to the point of creating investor distrust.

In India nowadays, we frequently read about different well-known entrepreneurs and companies gaining money through such “Ponzi schemes” and then abruptly disappearing after they have gained enough money from the deception.

Social Trade Scam, Qnet Scam, Sardha, and Rose Valley are some of the most well-known Ponzi schemes in India. To date, there is no explicit law or procedure in place by the government to stop and control these scams. According to the Indian penal law, anyone found guilty of such conduct will be penalized for deception, fraud, and other offenses. However, in view of the growing prevalence of Ponzi schemes, the Indian government has determined that it is now important to take the appropriate actions to combat these malicious organizations.

Laws in Place to deal with Ponzi Schemes

A number of laws have been enacted in India to address the problem of Ponzi schemes. It has a proclivity to turn into a complicated web of rules. To that end, the purpose of this article is to address a few of these laws.

^ The Chit Funds Act, 1982: Only schemes that have been registered and regulated by the state governments are allowed to operate under this Act. The Registrar of Chits, who is appointed under section 61 of the Chit Funds Act, is thereafter in charge of them. If a chit group gets off the ground, it must register with the Registrar and pay a security deposit, which is refunded once the group is finished. The Act also establishes an arbitration procedure before the Registrar, who has powers comparable to those of a civil court under the 1908 Code of Civil Procedure. If any party to the dispute fails to comply with the Act, the Registrar has the authority to attach their property and to wind up a registered chit.

^ Prize Chits and Money Circulation Schemes (Banning) Act, 1978 [PCMCS Act]: This statute, which predates the Chit Funds Act, was enacted in 1975 as a result of a report by the Reserve Bank of India Study Group, which was chaired by James S. Raj. Prize chit/benefit/savings systems, according to the organization, profit solely the promoters and serve no social purpose. The Group discovered these to be harmful to the public interest and have an impact on the country’s fiscal and monetary policy.

Section 3 of the Act bans prize chits and MCS and enrolment to these schemes. Sections 4 and 5 are penal provisions. Section 6 entails offenses committed by companies. Section 7 empowers a police officer, not below the rank of officer in charge of a police station, to exercise power to enter and search premises and to seize things used for such a scheme. Section 8 provides for the forfeiture of newspapers and publications containing a money circulation scheme. Certain exemptions are assured to state government-run bodies amongst others as per Section 11Section 13 of the PCMCS Act empowers the State governments to make rules on consultation with the RBI.

^ The Companies Act, 2013 & Companies (Acceptance of Deposits) Rules, 2014: From the perspective of corporate frauds, the Companies Act of 2013 is the key focus. A corporate fraud, according to Section 447, is any omission, concealment of the truth, or abuse of position presented by any individual with the intent to deceive, gain benefit from, or hurt the firm, its investors, or its shareholders, regardless of whether there is any unjust gain or loss.

This provision further states that the person who misrepresents himself or herself is subject to detention for a period of 6 months to 10 years, as well as a fine. If the fraud is in the public interest, the minimum sentence is three years in prison.

Section 73 and 76 of the Companies Act, 2013 concern deposits and are read with the Companies (Acceptance of Deposits) Rules, 2014.

^ Securities and Exchange Board of India (SEBI) Act, 1992 & SEBI (Collective Investment Scheme) Regulations, 1999: Hundreds of cases have been filed by SEBI against illicit investment programs that take public funds. Section 11AA of the SEBI Act of 1992 defines these Collective Investment Schemes. The Act and the SEBI (CIS) Regulations, 1999 have governed them.

In dealing with these issues, SEBI has found itself out of its depth. In August 2016, in response to a concern raised by a bench led by then-CJI, T.S. Thakur, in a PIL filed by NGO Humanity Salt Lake concerning unauthorized and illegal deposit schemes and Collective Investment Scheme, SEBI denied any regulatory authority over Ponzi schemes, delegating all investor protection to state governments. They stated that the PCMCS Act and the individual State government entities were responsible.

^ The Banning of Unregulated Deposit Schemes Act, 2019: The BUDS Act was introduced to prohibit illegal deposit-taking schemes. Initially enacted as an Ordinance on February 21, 2019, it was passed as an Act on July 31, 2019.

The purpose of the BUDS Act was to put an end to all fraudulent, unregulated deposit schemes. It does so by listing certain deposit schemes that are valid and regulated by MCA, SEBI, RBI, and others, such as certain collective investment schemes, alternative investment funds, portfolio management services, employee benefit schemes, mutual fund schemes, and so on, as well as deposits accepted by NBFCs, insurance contracts regulated by IRDAI, and schemes or arrangements made or offered by co-operative societies, chit funds, and so on.

^ The Banning of Unregulated Deposit Schemes Rules, 2020:  These Rules provide for:

  • Important information to be considered prior to issuing a notice of provisional attachment of deposit takers’ properties who contravene the Act. (Rule 3)
  • The procedure to be followed by the Competent Authority in relation to provisional attachment of property, its administration and application to the Designated Court to make such attachment absolute. (Rules 4 & 8)
  • Data in regard to deposit takers working in India to be maintained by the Central Online Repository in an online database. (Rule 6)
  • Full and fair retraction on the part of newspapers and other publications, withdrawing any prior promotion or inducement to any person to join an unregulated deposit scheme. (Rule 11)

Conclusion

While there are legislations in India to combat chit funds, the growing threat of uncontrolled and fraudulent chit funds necessitates a simple system, transparency, and strict enforcement of rules. The huge Saradha scam, masterminded by Sudipto Sen, defrauded over 10 million Indians. Even after that, in 2013, the Rose Valley chit fund Ponzi scheme came into the public light. According to sources, more than INR 17,000 crores of money was defrauded.

To effectively combat Ponzi schemes, the BUDS Rules must be clarified, particularly when it comes to the internet repository. The database was created with the goal of finding unregulated businesses, and this goal should be pursued rather than burdening the conforming, regulated businesses.

Given the various forms that Ponzi schemes take, it is somewhat unsurprising that there is a plethora of legislation. However, the primary legislation addressing the issue, the BUDS Act, has yet to be fully filled out in all of its subtleties, and it will be interesting to see how the statute is interpreted by the courts.

References

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