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).

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

6 comments

  • 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?

  • 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.

  • 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.

  • 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.

  • after reading about CIS, im afraid of such scheme in which im investing money on monthly basis towards a developer who is telling to return double the amount i invested for plot. They have not given any legal documents which clearly tells that we are the owener of this land/plot. Is there any chances of fraud?

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Recent Posts

Topics

Recent Comments

Archives

web analytics