Thursday, July 9, 2015

SEBI’s Action on Illegal Collective Investment Schemes

[The following guest post is contributed by Pavit Singh Kochar, a legal associate (corporate) with KNM & Partners Law Offices, New Delhi]

The Securities and Exchange Board of India (SEBI), the Indian market regulator has been taking significant steps over the last couple of years by protecting the interests of retail investors due to their inability to take a well-informed decision about investing in various securities. For this, SEBI has intensified its scrutiny over different companies. Right from initiating action against Sahara Group to the unfolding Saradha Scam, SEBI has acted for the benefit of such investors.

To regulate such behavior and clamp down on entities running illegal  schemes, the market regulator introduced the Securities and Exchange Board of India (Collective Investment Schemes), Regulations, 1999 (“Regulations”). These Regulations, among other things, deal with the registration and obligations of the Collective Investment Management Company. To begin with, it would be useful to examine the definition of “Collective Investment Scheme” and “Collective Investment Management Company”.

The term “Collective Investment Scheme” (“CIS”) is defined under section 11AA of the Securities and Exchange Board of India Act, 1992 (“SEBI Act”). As the name suggests, it is an investment scheme or arrangement where several individuals come together to pool their money for investing in a particular asset(s) and for sharing the returns arising from that investment as per the agreement reached between them. In order to be a CIS, it should satisfy the following conditions:

1. The contributions or payments made by the investors are pooled and utilized solely for the purpose of such scheme or arrangement.

2. The contribution or payments are made by the investors with a view to receive profits or income from such scheme or arrangement.

3. The property, contributions or payments forming part of such scheme or arrangement is managed on behalf of the investors.

4. Investors do not have day-to-day control over the management of such scheme or arrangement.

Moreover, by way of the Securities Laws (Amendment) Act, 2014 a proviso was inserted to section 11 AA stating that any pooling of funds under any scheme or arrangement, which is not registered with SEBI, involving a corpus of Rs. 100 crores or more, shall be deemed to be a CIS.   

Any scheme or arrangement made or offered by a Co-operative society or under which deposits are accepted by, non-banking financial companies (“NBFCs”), or being a contract of insurance, or under which deposits are accepted by a company declared as a Nidhi Company or falling within the meaning of Chit Business shall not be a CIS.

A Collective Investment Management Company (“Company”) has been defined under regulation 2 (h) of the Regulations as a company incorporated under the Companies Act, 1956 and registered with SEBI, whose object is to organize, operate and manage a collective investment scheme.

SEBI has made it mandatory for every entity that is running the CIS to register itself under section 12(1B) of the Act and Regulation 3 of the Regulations. However, if any person is operating a CIS before the commencement of the regulations, such person shall make an application to SEBI for the grant of registration certificate.[1]

A Company shall launch only close ended CIS for a minimum period of three years[2] in the form of a trust[3], appraised by an appraising agency[4] and obtain rating from a credit rating agency[5] with no guaranteed or assured returns[6]. The Company shall also obtain adequate insurance policy for the protection of the Scheme’s property.[7]

Case Law Dealing With Collective Investment Schemes

A large number of cases have come to light in the past where the investors have been defrauded through illegal CIS.

1.         Rose Valley Real Estate and Construction Limited Case (2011)

In this matter, SEBI had observed that Rose Valley Real Estate and Construction Ltd. (“Rose Valley”) was mobilizing funds under CIS without obtaining a certificate of registration as required under Section 11AA of the Act. Rose Valley in turn moved the High Court challenging the constitutional validity of the said Act. The Calcutta High Court dismissed the said Writ Petition filed by Rose Valley challenging the constitutional validity of SEBI’s power in regulating CIS. Dismissing the Writ Petition, the High Court observed that the Section 11AA of the Act is legal and the provisions provided in it were valid. The High Court also slapped a fine of Rs. 10 lakhs on Rose Valley.

SEBI, in its January 2011 order, held that Rose Valley was raising funds through sale of plots of land and pooling the same to develop the land and providing investors a return on the amount invested at the end of the scheme in the form of credit value. Investors could utilize the credit value to either adjust partly against the cost of land or to get refund for the investments made. “These activities were akin to the features of CISs, specified under the Section 11AA of the Act”. SEBI had further directed Rose Valley not to collect any money from investors or to launch any scheme and not to dispose of any of the properties of the scheme. SEBI had also  in another case imposed a penalty of Rs. 1 crore on Rose Valley for not providing details sought by the market regulator in a case charging the company with issuing debentures illegally.

SEBI had also barred Rose Valley Hotels and Entertainment from collecting money from investors under its ‘holiday membership’ schemes alleging that such schemes were CIS in nature and required a certificate of registration. SEBI had begun the investigation of the case after it received a letter in June, 2012 from the Additional Director-General of Police, Guwahati, Assam, alleging that Rose Valley Hotels and Rose Valley Real Estates Constructions Ltd. had collectively raised Rs. 1,006.70 crores until February 2012. It was pointed out that Rose Valley Hotels had launched a scheme called Rose Valley Holiday Membership Plan in 2010. Under the scheme, an investor can book a holiday package by paying monthly installments. Upon maturity or the completion of the installment tenure, the investor can either opt for a holiday, which includes hotel accommodation and services, or a return on the investment with annualized interest.

The market regulator had sought various details on the scheme that included the number of individuals who had subscribed to the plan and the total amount refunded by the Company towards principal investment and interest. Rose Valley Hotels, however, contended that it was in the time share business, which did not fall under SEBI’s purview. S. Raman, whole-time member of SEBI, in his order stated that the scheme had all the ingredients of a CIS. He added that the contribution made in the form of monthly installments by investors were pooled and utilised for the purpose of the holiday membership plan. Moreover, such contributions are made by the investors with a view to receiving profits or income in the form of returns with annualized interest. He had also directed Rose Valley Hotels not to collect any more money from investors either through existing schemes or via new ones.

2.         Maitreya Services Pvt. Ltd. Case (2013)

SEBI began the probe against Maitreya Services Pvt. Ltd. (“Maitreya”) after a reference from the Income Tax department in September 2010 alleging violation of SEBI regulations by Maitreya. During the inquiry, Maitreya submitted that it carries out the business of real estate and its business includes buying and selling of land, development of the land, construction and other land related activities. SEBI found that Maitreya had launched various schemes under which money was collected from the public. These schemes differed on the basis of the periodic payment to be made by the investor, and the time period for which such investments were to be made. In the course of its inquiry, the SEBI found that the Company had launched and operated CIS without obtaining registration in terms of section 12(1B) of the Act and regulation 3 of the Regulations and an amount of Rs. 804 crores was outstanding with it was to be repaid to investors. In view of the same, a show cause notice was issued to Maitreya and its directors asking them to show cause as to why suitable action should not be initiated against them for the violation of regulation 3 of the Regulations read with section 11AA of Act.

In reply to the show-cause notice by SEBI, Maitreya denied being in CIS operations and refuted all charges leveled against it and requested that the proceedings be terminated and discharged from the show-cause notice. In 2012, Maitreya sought to settle the proceedings through a consent procedure but that was rejected by SEBI. SEBI’s probe found that Maitreya had mobilized Rs. 1,332 crores from the public as “advances” as on March 31, 2011 and had repaid Rs. 538 crores as “repayment” to investors, resulting in an amount of Rs. 794 crores as outstanding to be repaid as on that date. SEBI also found that the assets were insufficient to meet the liabilities and its repayment obligations were almost double the value of its total movable and immovable assets.

In view of the foregoing, SEBI ordered for winding up of CIS being run in the garb of real estate business, asking the entity concerned to refund the money to investors within three months. SEBI also barred Maitreya, and its directors from accessing the securities market till the time all its CIS are wound up and decided to initiate prosecution proceedings against them. SEBI also made a reference to the police to register a civil/criminal case against Maitreya and their Directors and persons in charge of the CIS business for “offences of fraud, cheating, criminal breach of trust and misappropriation of public funds”.

3.         Alchemist Infra Realty Ltd Case (2013)

SEBI received an anonymous letter which alleged that Alchemist Infra Realty Ltd. (“Alchemist”) was mobilizing money from its investors. In order to ascertain whether Alchemist was operating CIS, SEBI initiated an inquiry against it. On perusal of various documents provided by Alchemist and inquiring into its affairs, SEBI found that the scheme/arrangement is in the nature of CIS and issued a show cause notice to Alchemist and its Directors advising them to show cause as to why appropriate action including directions under section 11 and 11B of the Act read with regulation 65 of Regulations should not be issued against all of them for the alleged violations.

The charge against Alchemist, as per show cause notice, is that its scheme/ arrangement are in the nature of CIS and that it is offering/launching them without obtaining registration from SEBI for carrying on such CIS in contravention of section 12(1B) of the Act and regulation 3 of Regulations. Meanwhile, Alchemist had filed an application for a consent order which was rejected by SEBI. To stop the illegal business, SEBI issued following directions to safeguard the interests of the investors:

(a) Alchemist shall not collect any money from investors or launch or carry out any scheme which has been identified as a CIS in the order.

(b) Alchemist and its Directors shall wind up the existing CIS and refund the money collected by it under the schemes with returns which are due to its investors as per the terms of offer within a period of three months from the date of the order and submit a winding up report to SEBI.

(c) Alchemist and its Directors are restrained from accessing the securities market till all the CIS are wound up by it and all the monies mobilized though such schemes are refunded to its investors with returns.

SEBI also found that the Investment Application Forms of Alchemist mentioned that it was a part of ‘Alchemist Group’, which was engaged in diverse activities such as steel, food and beverages, IT, healthcare, media, aviation, realty, hospitality, education and tea estate, among others, with asset base of over Rs 5,000 crores. Thus, an Investor/Applicant was misled to believe that the company, Alchemist Infra Realty Ltd, is part of the Alchemist Group, whereas the company had contended that it was not associated with the Alchemist Group.

Alchemist and its Directors filed an appeal before the Securities Appellate Tribunal (SAT) challenging the order. The SAT disposed of the appeal by way of common order and granted 18 months to refund the money (estimated Rs. 1000 crores) in view of the “long and tedious process of implementing the scheme of repayment” to 1.5 million investors.

4.         Rich Infra Developers India Ltd. Case (2015)

SEBI received a complaint alleging that Rich Infra Developers India Ltd. (“Rich Infra”) was giving huge returns to investors towards the investments in the company. As a matter of preliminary examination into whether or not Rich Infra is carrying on the activities of CIS, SEBI sought certain information from the company.

Meanwhile, SEBI received another complaint by email from a person who had invested Rs. 6.2 lakhs in Rich Infra alleging that the company failed to repay the amount on maturity. The complainant also stated there are several other investors from Odisha who had deposited Rs. 12 lakhs in the company and they did not receive repayment.

SEBI informed Rich Infra and its Directors that the information provided by the company did not include schemes seeking deposits from public for farming and development of agricultural land. Meanwhile, SEBI received a complaint alleging that Rich Infra is promising huge returns or an option to take land. The money invested is for the development of the land however, the land could be located anywhere in India. Rich Infra allotted a plot of 4000 sq. ft for a consideration of Rs. 2,00,000/- and at the end of the term, that is, six years, the investor is entitled to an amount of Rs. 4,05,457/- as ‘Consideration value at the time of maturity’. However, there are no specifications as to the plot/the details to identify the property.

The main contention raised by Rich Infra was: “……We are not involved in the activities of collecting money from general public. We are dealing in real estate activities i.e., selling of plots/flats/farm houses/commercial shops/agriculture land/residential properties, etc., which are being sold to prospective customers/buyers.” In this context, Rich Infra has been inviting applications for advance against plot/ land, for agricultural/residential/commercial purpose. As already mentioned in the preceding paragraph, no plot/land is identified or distinguished by company. Hence, it is apparent that that the schemes offered by Rich Infra are nothing but a 'collective investment scheme' clothed in the guise of a real estate scheme. It is pertinent to note that the most essential feature of a real estate transaction which is a clearly distinguishable immovable property say, a flat or plot which is identifiable by its description, etc. is absent in the schemes offered by Rich Infra.

Admittedly, Rich Infra had mobilized funds from public in lieu of allotment of property and also claimed repayments made to some of the investors. However, the company has failed to submit the relevant details of amount mobilized from these investors or a list of all its investors, despite being given several opportunities to do so.

Hence, SEBI directed Rich Infra and its Directors:

(a) not to collect any fresh money from investors under its existing schemes;

(b) not to launch any new schemes or plans or float any new companies to raise fresh moneys;

(c) to immediately submit the full inventory of the assets including land obtained through money raised by Rich Infra;

(d) not to dispose of or alienate any of the properties/assets obtained directly or indirectly through money raised by Rich Infra; and

(e) not to divert any funds raised from public at large which are kept in bank account(s) and/or in the custody of Rich Infra.

Analysis

Considering the above clamp down on illegal money pooling activities, SEBI has played a significant role in protecting investors against such schemes and tightened the noose around entities running illegal CIS. Two years ago, SEBI had notified new norms to classify such activities as fraud and impose penalties of up to three times their profits. Besides, the new rules have expanded the list of activities to be covered under fraudulent and unfair trade practices to hold individuals as well as companies equally guilty for manipulations.

The norms were amended to plug the loopholes prevailing in the existing laws which were blatantly misused by the companies. SEBI has come across many cases where it has been claimed that the norms do not explicitly permit penal action against individuals for certain ‘fraudulent and unfair trade practices’ like front running, withholding of key information from the investor and making false promises.

SEBI has already accelerated action against such so called CIS that are in violation of regulatory norms. In 2011, SEBI ordered Sahara group entities to refund Rs. 24,030 crores along with 15% interest to nearly 30 million investors in so called optionally fully convertible debentures and in April 2013, SEBI ordered Kolkata based Saradha to close all its collective schemes and refund the money collected from investors within three months.

At the same time, it is equally important for investors to be vigilant of such schemes and protect their investment funds. Hence, investors would do well to conduct a proper due diligence and taken an informed decision before investing in such schemes.

- Pavit Singh Kochar



[1] Regulation 5.
[2]Regulation 24(4).
[3]Regulation 16.
[4]Regulation 24(3).
[5]Regulation 24(2).
[6]Regulation 25.
[7]Regulation 24(5).

4 comments:

Anonymous said...

If you look at the definition of CIS and the conditions to be satisfied for a scheme to be CIS as given above, it appears that even a venture capital fund could be regarded as a CIS. But is that really the case?

pavit kochar said...

According to me, there is a difference between CIS and VCF. A VCF will collect money from,may be, 4 or 5 institutional investors and CIS will raise fund from million of investors, like in the case of Sahara. Also, in CIS, funds are mostly raised from public but such is not a case in VCF.

Bharath said...

Well the SEBI CIS Regulations do not make the regulations applicabe only if a particular number of investors are involved (however it is required to have at least two investors, failing which the requirement of 'investors' (plural) is lost and there would not be any 'pooling of funds'). Therefore there is a risk that VCFs may also be held as 'CIS'. However, Regulation 4A of the SEBI CIS Regulations provides that "Provided that any scheme or arrangement which is otherwise regulated or prohibited under any other law shall not be deemed to be a collective investment scheme". Thereore if its a SEBI registered VCF, then it is specifically carved out and is not CIS.

Anonymous said...

It is very much interesting and surprising when a cheater company looted crores of rupees during long journey of years then SEBI ED RBI ROC and several government agencies active for steps, but how long days they are able to raise fund without any notice. Shall I hope some thing wrong during the operation and given opportunity for bulk size of corpus? If Govt and Regulator is not serious or transparent nothing can be improved for cheaters and dishonest entity in India. Strict punish and fines which has already imposed (is not worry) for them can not change activity, so stringent action only remedy for fraudster.