Collective Investment Scheme: Still a Hard nut to crack for the Regulator

Introduction

Investment is one of the major political planks of the present political regime which helped them to attain the throne. The Government is also striving hard to meet their promises by taking different investment-friendly steps. It also raises potential regulatory challenges which may arise in near future. Already, the country has witnessed big scams like Harshad S. Mehta v. CBI[1] which lead to the formation of the regulatory bodies like SEBI in 1992. After the formation of SEBI, proper registration method is followed aimed at curbing such scams in future. It is noteworthy mentioning that SEBI has been successful in achieving its objective until now.

But, with the development of time different new schemes were floated in the financial market giving rise to new challenges. CIS i.e. collective investment scheme has been seen (probably acting) as a potential danger for the country’s economy. Through this scheme, the companies are extorting money from the poor people of the society who has very minimum knowledge about investor’s rights and general rule of investment. The Dave Committee which was formed by SEBI for making recommendations on CIS made various recommendations like making it mandatory for the CIS firm to get registered themselves under the provisions of the Companies Act, 1956 and also under SEBI as collective investment schemes. It has been decided by SEBI that the CIS should be constituted as a two-tired structure i.e. comprising of a trust and the Collective Investment Management Committee. Some kind of security must also be there so that in case of any loss the SEBI authority can repay back the same.

Majority of these recommendations became the part of “SEBI (Collective Investment Scheme) Regulations, 1999” in order to tighten the grip on these business honchos. The regulation made it mandatory for every CIS to be registered[2] and must be launched by CIMC i.e. collective investment management company[3] through a registered trust.[4] SEBI through this regulation took further futuristic steps such as rating by a credit agency[5], disclosures to the investors,[6] the Company starting such scheme must have net worth of at least 5 crores.[7] The regulation also made it mandatory for the appointment of at least one Director being the representative of the trustee who shall not be subject to any retirement. The regulation further deepened the trust control by mandating that no appointment of Director of CIMC shall be made without the prior approval of the trustee. Further the trust deed shall not have any clause limiting or extinguishing the liability of the CIMC or any indemnification clause.[8] To curb these companies from fooling the innocent masses, it has been made strictly prohibited for these companies to provide guaranteed or assured returns.[9]

SEBI have also insisted that the duration of the CIS schemes shall be for a minimum period of three years while no scheme shall be kept open for subscription for a period of more than 90 days. The schemes should be closed-ended in nature. The initial issue expenses for schemes of duration of up to eight years shall not exceed seven per cent of the corpus mobilised and for schemes of duration exceeding eight years shall not exceed nine per cent of the corpus mobilised.[10] The most important of all the recommendations is that there must be compulsory insurance cover for the assets of the scheme and personal indemnity cover for the CIMC. There are also penalty clauses as well as criminal prosecution for violating the regulation.[11]

According to the SEBI Ordinance dated 18-7-2013, which subsequently became an Act of Parliament in 2014 i.e. the Securities Laws (Amendment) Act, 2014 says that any pooling of funds under any scheme or arrangement, which is not registered with SEBI, involving a corpus amount of one hundred crore rupees or more shall be deemed to be a collective investment scheme.

To sum up, these Regulations as well the amendments somewhat restricted the unrelenting power of these companies in exercise of these schemes. It is noteworthy mentioning that SEBI has done commendable job by passing orders against huge number of companies which are running these schemes in violation of mandatory registration provision.[12]

But still large number of such scheme was launched in the country which proved to bring misfortune for the poor investors. In all these kinds of cases it is seen that the companies make investment in such kind of long-term plans which are having totally uncertain base.

There are about six hundred fifty-four CIS firms which responded to SEBI inquiries and submitted reports related to their activities including collection of about Rs 25.89 billion through such schemes.[13] The instruction was given by SEBI that they should start their business with a minimum capital of Rs 10 million for the first year which would have to be raised to Rs 50 million over a period of five years. The management fees payable to CIMC shall consist of basic fee and incentive fee. Therefore, it is necessary that some kind of improvement must be made in the existing regulation and rules so that efficient control can be made over such kind of schemes.

Condition required for a scheme to be collective investment scheme

Some criteria are required to be fulfilled as per Section 11-AA[14] of the SEBI Act, 1992 for considering a scheme to be collective investment scheme. This section was inserted in the SEBI in 1999 by seeing the increasing misuse of these kinds of scheme for exploiting poor investors. The insertion of this section was for the benefit from the point of investor’s right protection. The criteria are as follows:

(a) The contributions, or payments made by the investors, by whatever name called, are pooled and utilised solely for the purposes of the scheme or arrangement[15].—This provision means that the money which will be invested by the investors in any such scheme of the company will be for pooling out money and will be utilised in a particular arrangement. The money is generally invested in a company for many reasons by the way of several schemes. If the main aim of the scheme is for utilising the money received from the investors for any future plan such as harvesting policy, then in that condition it will be regarded as a type of collective investment scheme.

(b) The contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable from such scheme or arrangement[16].—If there is any condition in the agreement of the scheme that the investors would get their money that they have invested back along with substantial profit after a span of long years such as ten years or more then it is said to be a collective investment scheme. The return of money from such agreement is based upon some kind of unsecured results. So, the payment made under this scheme by the investors should be with a view to receive profits. Profits promised under such schemes are such that cannot be acquired by investing in any kind of other scheme in normal course.

(c) The property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors[17].—In such schemes, the investors are promised that the money would be invested in some kind of plantation scheme or any such kind of plan which is uncertain and is dependent on some kind of uncontrollable factors like environmental factor. So, the result of such schemes is that the property in which the money is invested becomes the property of the investors in form of future goods after a particular time span and is managed by the company in the behalf of the investors for that time span.

(d) The investors do not have day-to-day control over the management and operation of the scheme or arrangement[18].—The most important element of such scheme is that the investors don’t have day-to-day control over the scheme. Therefore, due to this reason the uncertainty attached to such schemes is very high. The investors are having no right over the examination of the development of the project or not having any control over the day-to-day control over the management and operation of the scheme.

CIS schemes cover all investment in the nature of equity, debt, deposit or advance. Schemes that seek to manage property or investments and also distribute the surplus to the investors come under the purview collective investment schemes and it also includes agricultural, plantations or livestock. Schemes that seek to pool the subscription amount of investors and utilise them for specified purposes and those that manage property or subscription on behalf of the investors are also covered.

Plantation companies and CIS

It is estimated that agro-plantation companies in recent past have collected more than Rs 12,000 crores from over 25 lakhs investors. Plantation companies through attractive investment schemes assures high return, maximum security, disinvestment option, assured buy back and easy instalment plans to suit all investors. These kinds of investment plans range from five to twenty-five years. Most of these schemes are of teakwood in which it is claimed that 2000 trees will grow per acre and returns are based on future market price twenty years hence. In this case also the company promised to pay surplus amount of profit to the investors.

The risk is high as plantation mainly depends on monsoon which is dependent upon nature. Also, realistic calculation and business losses should have been kept in mind by the company. Risk of flood, drought and fire cannot be ignored. Trees may die their natural death and there is no security for investment. So, the company before floating such a huge scheme must have examined these aspects of the scheme so that innocent investors would not have been penalised out of the scheme.

These plantation companies collected billions from the masses under various scheme and vanished with the money. These incidents prompted Union Government to empower SEBI to deal with the growing numbers of plantation companies floating various collective investment schemes.[19] The decision was taken after fraudulent companies collected billions of rupees under various schemes and vanished with public money.

In all probability, all plantation schemes, may, ultimately, offer investors only a harvest of misfortune and losses. In a business where the risk is high, rewards are tempting, accounting schemes are opaque, regulation is weak, forest yield are difficult to determine, and investors are ignorant, there is always a scam in the making.[20] The reason for floating such schemes can only be attributed to the regulatory anarchy coupled with the greed of high returns. It is of common knowledge that the investors for these kinds of schemes belongs to lower strata of the society i.e. fourth grade employees who posses very minimum knowledge about investment. They fall easy prey to such schemes because of their human greed of doubling their money without understanding the nuances of such schemes.

Rights of the investors investing in collective investment scheme

It is the duty of company floating such schemes that the investors shall not be attracted by unreasonable rates of returns or interest. Similarly, it is the duty of an investor to take well-informed decision based on the track record and credentials of the promoter along with the viability of the project. It is always wise to look in facts and fundamentals before taking any decision of investment.[21] But, looking at the masses actively taking part in these small investments, it is unwise on our part to expect that much awareness in a country which is suffering from a double cancer of poverty and illiteracy? The scams related to such kind of collective investment schemes are not new and steps have been taken by SEBI since November 1997 against such CIS.

There is prohibition on part of companies to launch such new schemes till the time such schemes are notified by any regulations. In May 1998 SEBI decided to launch action against Association of Agro-Plantation Companies of India (Aapci) and its office-bearers. SEBI directed that no existing scheme shall mobilise any money from the public or from the investors under their existing scheme unless the instrument of such schemes carry a rating from any of the recognised credit rating agencies. The rating describes the authenticity of the schemes and the details of the company floating such scheme.

Time to time advisories are also issued by SEBI urging investors to take informed decisions basing upon the collective credit points. In SEBI v. Libra Plantation Ltd.[22] the main point of contention was that such investment schemes offered by the agro and plantation compa­nies were associated with high risks and that the high rates of return offered are not consistent with the normal rate of returns. In this case the Tribunal ordered the defaulting Company to return the amount taken and had frozen the accounts of the respondent Company and attached the properties of the Company.

The return of money once the purpose for which money has been invested is fulfilled has always been a contentious issue. These schemes when associated with some plantation schemes then it is seen that the investors don’t get their money when the crops or the tress get spoiled due to adverse environmental factors. This is unacceptable as the company should be held liable for paying at least the principal amount invested by the investor. The investors must have all right to compel the company to return their invested money as it was the fault on part of the company that they invest the money in such kind of very unsecured project which are solely dependent on environmental factors. The role of Director appointed by the trust while making such investment decision is very crucial.

Need for separate laws for investor’s protection

There is need for protecting the rights of the innocent investors investing in such schemes which only bring misfortune for them. Penalising the defaulting companies will certainly act as deterrence for them in future. Various committees have been formed for giving their view on this issue. The committees[23] formed a collective view that it is essential to safeguard the interest of investors through proper articulation of corporate governance in a manner that ensures transparency and accountability. The Report on Investor Education and Protection given by Ministry of Corporate Affairs records on record that the protection of investors right is an integral part of corporate process. As like all other sectors, legal framework already exists to deal with the criminal offences. But, the requirement is to provide a suitable orientation to corporate law so that the investor, irrespective of size, is recognised as a stakeholder in the corporate processes. It doesn’t imply vouching for a separate Act which would require special enforcement mechanism with attendant coordination issues. Therefore, a separate Act for investor protection is not considered necessary. This aspect may be dealt comprehensively and effectively in the company law itself.

Same position was maintained by Ministry of Corporate Affairs, it said that the interface between the companies and its stakeholders including investors should be regulated through the legislative framework of the Companies Act and other civil and criminal laws of the country as well as by different regulators such as SEBI, RBI, etc. as well as institutions such as the stock exchanges through their rules of operation. In the Report it was clearly enumerated that various agencies pursue action in their respective domain without regard to the comprehensive picture. This results in overlap of jurisdiction or regulatory gaps. There is a need to bring about coordination in the role and action of various regulatory agencies to enable effective investor protection.

Conclusion and Suggestion

The various recommendations made by different expert committees formed by SEBI and other regulatory bodies for regulating such CIS unanimously recommend for the protection of less educated investors. Some attempts have also been made towards achieving the same. But, unfortunately we are the citizen of such a country where the polity as well as bureaucracy (as both are interconnected) runs with its own pace without competing with the fast changing world in almost each and every matter. So, it is highly advisable that the system of investment should be strengthened in the country contrary to our trade mark culture of working. Further, the ranking system of these schemes should be made accessible to the common people so that they can be easily aware about the upcoming schemes. While these mandatory ratings are required for each collective investment scheme, it must be given by a recognised credit rating agency. The rules made by SEBI are highly beneficial like they (CIS proposals) need to be registered with SEBI within a period of two months from the date of notification. If the required rules are followed in a letter and spirit then the occurrence of such failure of CIS will reduce and the scheme that result into misfortune for the investors can turn out to be a great profit for them and will in turn reduce the risk to the country’s economy. But, the current regulatory regime is still largely dependent upon the established legal principal of caveat emptor which needs to be relooked considering the masses which fall prey to these schemes. Because, it is one thing to argue that the investor must take a well?informed decision. But, it is other thing to realise the same in our socio?legal condition.

*   4th Year BA LLB (Hons.) student of National University of Study and Research in Law, Ranchi, Jharkhand, e-mail: shivalimishra005@gmail.com.

**  4th Year BA LLB (Hons.) student of National University of Study and Research in Law, Ranchi, Jharkhand, e-mail: Nilotpalshyam007@gmail.com.

[1]   1992 SCC OnLine Del 461 : ILR (1993) 1 Del 274.

[2]   Chapter II of the SEBI (Collective Investment Schemes) Regulations, 1999.

[3]   Chapter III of the SEBI (Collective Investment Schemes) Regulations, 1999.

[4]   Regn. 16, SEBI (Collective Investment Schemes) Regulations, 1999.

[5]   Regn. 24(3), SEBI (Collective Investment Schemes) Regulations, 1999.

[6]   Regn. 50, SEBI (Collective Investment Schemes) Regulations, 1999.

[7]   Regn. 9, SEBI (Collective Investment Schemes) Regulations, 1999.

[8]   Regn. 17, SEBI (Collective Investment Schemes) Regulations, 1999.

[9]   Regn. 25, SEBI (Collective Investment Schemes) Regulations, 1999.

[10]  Statement of Additional Information (SAI) of LIC Nomura Mutual Fund Asset Management Company Ltd. by SEBI, available at <http://www.sebi.gov.in/mfsid/licsai.pdf>, last accessed on 2-8-2015.

[11]  Regn. 65, SEBI (Collective Investment Schemes) Regulations, 1999 read with S. 24 of the SEBI Act, 1992.

[12]  Pavit Kochhar, Are fraudulent Collective Investment Schemes taking SEBI for a ride?, available at <http://www.livelaw.in/are-fraudulent-collective-investment-schemes-taking-sebi-for-a-ride/>, last accessed 11-8-2015.

[13]  Ministry of Commerce and Industry, Department of Industrial Policy and Promotion (FC Division), has issued a Circular No. 2 of 2010, updating all instructions and clarifications relating to FDI Policy.

[14]  Inserted by the Securities Laws (Amendment) Act, 1999.

[15]  KBCL (India) Ltd. v. SEBI, PR No. 11 of 2014, 15-1-2014.

[16]  JSV Developers (India) Limited v. SEBI, PR 81 of 2014, 31-7-2014.

[17]  Sunmangal Industries Ltd. v. SEBI, PR No. 13 of 2013, 27-7-2013.

[18]  PGF Ltd. v. Union of India, 2004 SCC OnLine P&H 676 : (2004) 55 SCL 165.

[19]  Securities and Exchange Board of India directions under Ss. 11(4) and 11(b) of the Securities and Exchange Board of India Act, 1992 read with Regns. 65 and 73 of the SEBI (Collective Investment Schemes) Regulations, 1999. [(WTM/RKA/CIS/07/2013)].

[20]  SUMPL v. SEBI, PR No. 59 of 2014, 2-8-2014.

[21]  Statement from The Guidelines for the Investors Investing under CIS issued by SEBI in the year 2012.

[22]  (1998) 17 SCL 345.

[23]  Ministry of Corporate Affairs, Government of India, “Report on Investor Education and Protection.”

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