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Ponzi schemes thrive on loopholes

Barely a fortnight ago, the Rose Valley group’s Joint Forum of all Registered Field Trade Unions organised a meeting of 1.5 million agents at Eco Park, a 480-acre plot on the northeast fringes of Kolkata. Such a show of strength by a company accused of money-pooling by the Securities and Exchange Board of India (Sebi) points to the fact that deposit-raising companies are still flourishing, owing to loopholes in regulations.

In the past five years, West Bengal, Odisha, Assam and Tripura have seen a major surge in the number of private companies raising deposits. But last year, the model crashed after West Bengal-based Saradha went bust.

Recently, the Supreme Court ordered the Central Bureau of Investigation to probe the Saradha scam. It also pulled up regulators for failing to check financial scams by deposit-taking companies.

Regulators have, however, expressed inability to prevent scams of this nature on the grounds of jurisdiction. In the aftermath of the Saradha episode, there were two regulatory changes in this regard – the Companies Act, 2013, was passed; and Sebi was vested with new powers (for search, seizure and attachment of properties, among other things). But that didn’t stop money-pooling activities.

From debentures to bonds, companies have dabbled in a range of instruments to raise public money. Amid a clampdown and more stringent laws, what has stood out is an instrument seldom heard of in financial markets – time share.

The business of time share

Time share is a common scheme in the tourism sector, through which hotels and resorts give long-term membership, or use rights, against a lump sum amount.

However, the scheme is, in many cases, being used to raise crores of funds as advances for real estate and hospitality projects, on the promise of hefty returns, against cancellation of bookings. “Time share is a long-term holiday membership plan, and plans are purely meant for investment in a holiday scheme,” said R S Rathor, chairman, All India Resort Development Association.

Sebi: No firepower?

Many new laws are aimed at making it easy for regulators to bring Saradha-like companies to light. Among the most important provisions in the Securities Laws (Amendment) Ordinance, 2014, is it allows Sebi to conduct search-and-seizure operations. Further, it also brings all money-pooling schemes worth at least Rs 100 crore under the market regulator’s jurisdiction. Broadly, Sebi considers time share a collective investment scheme (CIS). Though CIS is a recognised financial tool, in the past decade, Sebi hasn’t renewed CIS certificates. But companies have been operating through old certificates, claiming time share isn’t within Sebi’s purview.

Companies Act, 2013

Under the Companies (Acceptance of Deposits) Rules, 1975, companies could raise deposits to meet any short-term fund requirements. However, the Companies Act 2013, has made raising deposits more stringent. “The new law makes raising deposits extremely difficult. Companies have to go for credit-rating, pass a special resolution at a general meeting and have credit insurance for raising deposits,” said Mamata Binani, former chairman, Institute of Company Secretaries of India (eastern region). At the same time, the Act gives relaxation to real estate projects. Therefore, the law allows deposits, which are taken as advances, to be adjusted against property, says Binani. Yet, money-raising companies don’t agree they fall under the new law. “Basically, we are registered with the Registrar of Companies and doing time share business, according to the usual Companies Act, like others. There is no specific code of conduct to regulate time share in India,” says Amit Banerjee general-secretary of Rose Valley union. Considering the complexity of the situation, regulators need to come together to fight possible Saradha-like scams.

NEW LAWS FOR CURBING ILLEGAL MONEY POOLING

Key provisions in Companies (Acceptance of Deposits) Rules, 2014

* Deposits to be repayable on demand, within 36 months

* Only public company with net worth not less than Rs 100 cr or turnover not less than Rs 500 cr can accept deposits from non-members

* Eligible company can accept deposit up to a maximum of 10% (from members) and 25% (from non-members) of paid-up capital and free reserves, including outstanding deposits, if any

* Separate regulations for NBFCs prescribed by RBI

Key Provisions in Securities Laws (Amendment) Ordinance, 2014

* Empowers Sebi with authority for search and seizure

* Recall and enhance the penalty imposed by the adjudicating officer. Allows the SEBI to supersede an order issued by an adjudicating officer, if it feels that the order is erroneous

* It also empowers the market regulator’s board to recall and enhance the penalty imposed by the adjudicating officer

* Seeks to empower Sebi to regulate all money pooling scheme worth Rs 100 crore or more and also attach assets in cases of non-compliance

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