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According to the Chit Funds Act, 1982, a chit is an arrangement under which a person enters
into an agreement with a specified number of persons that every one of them shall subscribe a
certain sum of money by way of periodical instalments over a definite period and that each
such subscriber shall, in his turn, as determined by lot or by auction or by tender or in such
other manner as may be specified in the chit agreement, be entitled to the prize amount.
This can be complicated to understand so lets take a simple example:
A, B, C, D and E put in 10000 rupees each. They have an aggregate fund of rupees 50000
(10000 * 5). This fund is the chit fund. Now the fund will be auctioned to the person who is
willing to give maximum discount. B is willing to give a discount of 2000 rupees, i.e. he
wants 48000 rupees, c is willing to give a discount of 2500 rupees (he wants 50,000 2500
= 47,500 rupees) and D is willing to give a discount of 5000 rupees (he wants 50,000
5000 = 45,000 rupees), which is the maximum discount offered by any one of them. So, D
will get the amount left after deducting the discount and organisational charges say 1000
rupees]. Therefore D will get 50,000 5000[discount] 1000[organisational charges], that
is, 44,000 rupees. The remaining 6000 will be divided equally among A,B,C,D and E.
Benefit: D gets a larger sum of money in hand than what he could have afforded which can
be used for various purposes like taking a loan or buying a car, etc. This has been made
possible by pooling of funds of several other people. In another cycle, the same money will
be pooled for the benefit of another participant.
A chit fund does not have pre-determined return as in the case of corporate deposits and
MLM schemes. The return depends on various factors like discount and organisers charges.
What is a Collective Investment Scheme (CIS)?
According to Section 11 AA (2) of the SEBI Act, any scheme or arrangement made or
offered by any company under which the contributions, or payments made by the investors,
are pooled and utilised with a view to receive profits, income, produce or property, and is
managed on behalf of the investors is a CIS. Investors do not have day to day control over the
management and operation of such scheme or arrangement.
Difference between chit-fund, MLM company, corporate deposits and chit funds
Multi-level marketing or MLM schemes - An MLM company is one which is involved in
multi-level marketing. It is a plan for the distribution of products whereby participants earn
money by supplying products to other participants in the same plan. They, in turn, make their
money by supplying the same products to other participants. It is possible for multi-level
marketing businesses to generate funds by sale and distribution of genuine products or
services however, often MLM businesses generate money exclusively by charging
enrolment or subscription fees from new participants, and the fraction of revenues generated
from sale of products and services is nil or insignificant, in which case they become similar to
ponzi schemes (see below for a description of Ponzi schemes).
Most multi-level marketing schemes in India qualify as money circulation schemes under the
Prize Chits and Money Circulation Schemes (Banning) Act, 1978 Act and are hence illegal,
unless the schemes are carefully structured to be compliant with the law. The act defines
money-circulation schemes as schemes for the making of quick or easy money on any event
or contingency applicable to the enrolment of members into the scheme, irrespective of
whether the money paid out is derived from the entrance money of the members of the
scheme.
Note that even if a particular MLM scheme has been structured to be compliant with the law,
it does not prevent risk of investigative proceedings being initiated by the police against the
promoters of such schemes.
Ponzi schemes The expression ponzi scheme has been borrowed from US experiences,
but businesses have used similar models across the world. Lets refer to the definition given
by the Securities and Exchange Commission (SEC):
A ponzi scheme is a fraudulent investment operation that pays returns to its investors from
their own money or the money paid by subsequent investors, rather than from profit earned
by the individual or organization running the operation.
Corporate deposits Corporate deposits are very similar to fixed deposits, with the
difference that the deposit is made with a company instead of a bank. The company pays a
fixed rate of interest on the deposit according to the terms and conditions on which the
deposits were invited from the public. Note, in the case of deposits it is understood that the
company will repay depositors from the money generated from conducting its business.
Understanding the Saradha groups activities
Saradha group was running a wide variety of collective investment schemes. The group
appointed agents who were recruited from local rural communities these agents collected
money from the public by issuing secured debentures and redeemable preferential bonds on
commission basis. This money was raised by over 100 companies under the Saradha Group.
In India, raising money from the public (whether it is by equity, debentures or deposits)
attracts jurisdiction of a regulatory authority such as the Registrar of Companies (and the
Central Government) in case of deposits or SEBI (in case of debentures, etc.). Raising money
in the form of debentures or through collective investment schemes attracts SEBI regulations,
which have been issued to protect investors interest.
Usually, these regulations prescribe the duration, maturity period, return and other conditions
pertaining to these instruments, and a number of reporting obligations towards regulators and
stakeholders. Such provisions usually prevent businesses from defrauding the public to raise
money, and thus help in protecting investor interest.
SEBI has acted against the Saradha group because the group companies would have been
required to comply with its regulations pertaining to collective investment schemes while
raising bonds and debentures, which has not been done.
Earlier, the Sahara group had run into trouble with the SEBI, as some companies within its
group had raised funds from the public without getting listed on stock exchanges (see here for
a brief discussion of the Sahara incident).
stock exchange (or even from a private investor), companies are required to disclose to
investors the manner in which the money will be used in the prospectus as per the Companies
Act, and SEBI Regulations.
In the Saradha group case, investors were rarely informed about the true nature of how their
investment was used by the group although this will require to be established in a court.
Instead, many investors were assured that they would get high returns after a fixed period,
which leaves the possibility of initiating criminal proceedings under Section 68(b) open.
How can proceedings be initiated for defrauding creditors under the Companies Act?
Under the Companies Act, criminal proceedings can be initiated by the Central Government
if a company has tried to defraud its investors or creditors for this, the Registrar of
Companies (ROC) must submit a report to the government. Alternately, the shareholders
have the power to call a meeting of the company if 75 percent of the shareholders present
pass a resolution in favour of the investigation, such an investigation can be initiated. In
reality, it is likely that the promoters of these companies have a dominant shareholding. It
may also be extremely difficult at a practical level for shareholders of the 100 companies to
coordinate and call meetings, hence initiation of proceedings by the ROC is the only feasible
option for proceeding under the Companies Act.
(written by Abhyudaya Agarwal and Satyaditya Singh Dhakare)
Harshad Shantilal Mehta was born in a Gujarati Jain family of modest means. His early childhood
was spent in Mumbai where his father was a small-time businessman. Later, the family moved to
Raipur in Madhya Pradesh after doctors advised his father to move to a drier place on account of his
indifferent health. But Raipur could not hold back Mehta for long and he was back in the city after
completing his schooling, much against his fathers wishes.
Mehta first started working as a dispatch clerk in the New India Assurance Company. Over the years,
he got interested in the stock markets and along with brother Ashwin, who by then had left his job
with the Industrial Credit and Investment Corporation of India, started investing heavily in the stock
market.
Mehta gradually rose to become a stock broker on the Bombay Stock Exchange, who did very well
for himself. At his peak, he lived almost like a movie star in a 15,000 square feet house, which had a
swimming pool as well as a golf patch. He also had a taste for flashy cars, which ultimately led to his
downfall.
RISE OF MEHTA
The year was 1990. Years had gone by and the driving ambitions of a young man in the faceless
crowd had been realised. Harshad Mehta was making waves in the stock market. He had been
buying shares heavily since the beginning of 1990. The shares which attracted attention were those
of Associated Cement Company (ACC), write the authors. The price of ACC was bid up to Rs 10,000.
For those who asked, Mehta had the replacement cost theory as an explanation. The theory basically
argues that old companies should be valued on the basis of the amount of money which would be
required to create another such company.
Mehta was the darling of the business media and earned the sobriquet of the Big Bull, who was
said to have started the bull run. But, where was Mehta getting his endless supply of money from?
Nobody had a clue.
FRAUD COMMITTED
The crucial mechanism through which the scam was effected was the ready forward (RF) deal. The
RF is in essence a secured short-term (typically 15-day) loan from one bank to another. Crudely put,
the bank lends against government securities just as a pawnbroker lends against jewellery.The
borrowing bank actually sells the securities to the lending bank and buys them back at the end of the
period of the loan, typically at a slightly higher price.
It was this ready forward deal that Harshad Mehta and his cronies used with great success to
channel money from the banking system.
A typical ready forward deal involved two banks brought together by a broker in lieu of a
commission. The broker handles neither the cash nor the securities, though that wasnt the case in
the lead-up to the scam.
In this settlement process, deliveries of securities and payments were made through the broker.
That is, the seller handed over the securities to the broker, who passed them to the buyer, while the
buyer gave the cheque to the broker, who then made the payment to the seller.
In this settlement process, the buyer and the seller might not even know whom they had traded
with, either being know only to the broker.
This the brokers could manage primarily because by now they had become market makers and had
started trading on their account. To keep up a semblance of legality, they pretended to be
as a pawnbroker lends against jewelers. The borrowing bank actually sells the securities to
the lending bank and buys them back at the end of the period of the loan, typically at a
slightly higher price. In a ready-forward deal, a broker usually brings together two banks for
which he is paid a commission. Although the broker does not handle the cash or the
securities, this was not the case in the prelude to the Mehta scam. Mehta and his associates
used this RF deal with great success to channel money through banks.
The securities and payments were delivered through the broker in the settlement process. The
broker functioned as an intermediary who received the securities from the seller and handed
them over to the buyer; and he received the check from the buyer and subsequently made the
payment to the seller. Such a settlement process meant that both the buyer and the seller may
not even know the identity of the other as only the broker knew both of them. The brokers
could manage this method expertly as they had already become market makers by then and
had started trading on their account. They pretended to be undertaking the transactions on
behalf of a bank to maintain a faade of legality.
Mehta and his associates used another instrument called the bank receipt (BR). Securities
were not traded in reality in a ready forward deal but the seller gave the buyer a BR which is
a confirmation of the sale of securities. A BR is a receipt for the money received by the
selling bank and pledges to deliver the securities to the buyer. In the meantime, the securities
are held in the sellers trust by the buyer.
Complicit lenders
Armed with these schemes, all Mehta needed now were banks which would readily issue fake
BRs, or ones without the guarantee of any government securities. His search ended when he
found that the Bank of Karad (BOK), Mumbai and the Metropolitan Co-operative Bank
(MCB) two small and little known lenders, were willing to comply. The two banks agreed to
issue BRs as and when required. Once they issued the fake BRs, Mehta passed them on to
other banks who in turn lent him money, under the false assumption that they were lending
against government securities. Mehta used the money thus secured to enhance share prices in
the stock market. The shares were then sold for significant profits and the BR retired when it
was time to return the money to the bank.
Outcome
Mehta continued with his manipulative tactics, triggering a massive rise in the prices of stock
and thereby creating a feel-good market trajectory. However, upon the exposure of the scam,
several banks found they were holding BRs of no value at all. Mehta had by then swindled
the banks of a staggering Rs 4,000 crore. The scam came under scathing criticism in the
Indian Parliament, leading to Mehta's eventual imprisonment. The scams exposure led to the
death of the Chairman of the Vijaya Bank who reportedly committed suicide over the
exposure. He was guilty of having issued checks to Mehta and knew the backlash of
accusations he would have to face from the public.
A few years later, Mehta made a brief comeback as a stock market expert and started
providing investment tips on his website and in a weekly newspaper column. He worked with
the owners of a few companies and recommended the shares of those companies only. When
he died in 2002, Mehta had been convicted in only one of the 27 cases filed against him.
What attracted the taxmans attention was Mehta's advance tax payment of Rs 28-crore for
the financial year 1991-92. Another eye-catcher was his extravagant lifestyle.
I-T, PSBs recover dues nine years after Mehta's death
Nine years after Harsad Mehta died, the I-T department and public sector banks (PSBs) have
successfully recovered a significant portion of their claims emerging out of the securities
scam from his liquidated assets. The Supreme Court directed the Custodian of the attached
properties and assets of the Harshad Mehta Group (HMG) in March 2011 to make payments
of Rs1,995.66-crore to the I-T department and Rs 199.25-crore to the State Bank of India
(SBI), making the two institutions two of the earliest claimants to recover their dues.
While the SBIs total principal amount claim of Rs 1,000-crore have been largely settled,
financial institutions have also received some money. However, Standard Chartered Bank,
which had claimed Rs 500-crore, has yet to recover its dues it was one of the late claimants.
Although the total claim over the HMG is of more than Rs 20,000-crore, the apex court has
said that for the present, it would only consider claims towards the principal amount.
Who is Ketan Parekh
Ketan Parekh is a former stockbroker based in Mumbai who was convicted in 2008 for being
involved in engineering the technology stocks scam in Indias stock market in 1999-2001. A
chartered accountant by training, Parekh comes from a family of brokers and is currently
serving a period of disqualification from trading in the Indian bourses till 2017.
Ketan Parekh has been accorded with sobriquets such as the Pentafour Bull and the One Man
Army by the countrys national business newspapers, while the market simply refers to him
as KP or associates him with his firm NH Securities. Parekh is known to have no reluctance
in meeting the press. He is also known to have razor-sharp forecasts on market developments.
What distinguishes Ketan Parekh from the 'Big Bull' late Harshad Mehta
The two have been compared by people to have operated their scams using similar means and
that their backgrounds were similar as well. But the differences are very conspicuous.
At the outset, Mehta came from a lower middle-class and modest background, while KPs
family has been engaged as stockbrokers for a significant time. He is also related to many
prominent brokers. Secondly, when Mehta was operating, the market was still a closed one
and was just beginning to liberalize. It was revealed later that Mehta operated using the
money of other people as his last recourse. Further, Mehta is known to have resorted to
aggressive publicity campaigns whereas KP operates almost clandestinely. The latter has also
been successful at creating stories and selling them aggressively to institutional investors.
The Midas touch
Parekh attracted the attention of market players and they kept track of every move of Parekh
as everything he was laying his hands on was virtually turning into gold. But the Pentafour
Bull still kept a low profile, except when he hosted a millennium party that was attended by
politicians, business magnates and film stars. And by 1999-2000, as the technology industry
began embracing the entire world, Indias stock markets started showing signs of hyperactivity as well and this was when KP struck.
Almost everyone, from investment firms which were mostly controlled by promoters of listed
companies to foreign corporate bodies and cooperative banks were eager to entrust their
money with Parekh, which, he in turn used to inflate stock prices by making his interest
obvious. Almost immediately, stocks of firms such as Visual soft witnessed meteoric rises,
from Rs 625 to Rs 8,448 per unit, while those of Sonata Software were up from Rs 90 to Rs
2,150. However, this fraudulent scheme did not end with price rigging. The rigged-up stocks
needed dumping onto someone in the end and KP used financial institutions such as the UTI
for this.
When companies seek to raise money from the stock market, they take the help of brokers to
back them in raising share prices. KP formed a network of brokers from smaller bourses such
as the Allahabad Stock Exchange and the Calcutta Stock Exchange. He also used BENAMI
or share purchase in the names of poor people living in Mumbais shanties. KP also had large
borrowings from Global Trust Bank and he rigged up its shares in order to profit significantly
at the time of its merger with UTI Bank. While the actual amount that came into Parekh's
kitty as loan from Global Trust Bank was reportedly Rs 250 crore, its chairman Ramesh Gelli
is known to have repeatedly asserted that Parekh had received less than Rs 100 crore in
keeping with RBI norms.
Parekh and his associates also secured Rs 1,000-crore as loan from the Madhavpura
Mercantile Co-operative Bank despite RBI regulations that the maximum amount a broker
could get as a loan was Rs15-crore. Hence, it was clear that KPs mode of operation was to
inflate shares of select companies in collusion with their promoters.
Lady luck disfavours Parekh!
Notably, a day after the presentation of the Union Budget in February 2001, Parekh appeared
to have run out of luck. A team of traders, Shankar Sharma, Anand Rathi and Nirmal Bang,
known as the bear cartel, placed sell orders on KPs favorite stocks, the so called K-10
stocks, and crushed their inflated prices. Even the borrowings of KP put together could not
rescue his scrips. The Global Trust Bank and the Madhavpura Cooperative were driven to
bankruptcy as the money they had lent Parekh went into an abyss with his reportedly
favourite K-10 stocks.
The exposure of the dupe
As with the Harshad Mehta scam, Ketan Parekh's fraudulent practices were first exposed by
veteran columnist Sucheta Dalal. Sucheta's column read, It was yet another black Friday for
the capital market. The BSE sensitive index crashed another 147 points and the Central
Bureau of Investigation (CBI) finally ended Ketan Parekhs two-year dominance of the
market by arresting him in connection with the Bank of India (BoI) complaint. Many people
in the market are not surprised with Parekhs downfall because his speculative operations
were too large, he was keeping dubious company, and he was dealing in too many shady
scrips.
When the prices of select shares started constantly rising, innocent investors who had bought
such shares believing that the market was genuine were about to stare at huge losses. Soon
after the scam was exposed, the prices of these stocks came down to the fraction of the values
at which they had been bought. When the scam did actually burst, the rigged shares lost their
values so heavily that quite a few people lost their savings. Some banks including Bank of
India also lost significant amounts of money.
Dalal goes on to state that Parekh's scheme was not visible to a layman given the positive
deflection that media had made him a hero while some of the biggest national dailies had
even quoted him profusely on that years Union Budget. Dalal added that KPs arrest and the
uncanny similarity of his operations to the Harshad Mehta securities scam of 1992 vindicated
the miserable inadequacy of the countrys regulatory system. The Securities Exchange Board
of India (SEBI) and the Reserve Bank of India (RBI) had remained complacent when the
stock bubble was created during the latter half of 1999 and through 2000 while it had not
bothered to take any action through 2001 when it was ready to burst.
SEBIs damage control measures
SEBI investigations into Parekh's money laundering affairs revealed that KP had used bank
and promoter funds to manipulate the markets. It then proceeded with plugging the many
loopholes in the market. The trading cycle was cut short from a week to a day. The carryforward system in stock trading called BADLA was banned and operators could trade using
this method. SEBI formally introduced forward trading in the form of exchange-traded
derivatives to ensure a well-regulated futures market. It also did away with broker control
over stock exchanges. In KPs case, the SEBI found prima facie evidence that he had rigged
prices in the scrips of Global Trust Bank, Zee Telefilms, HFCL, Lupin Laboratories, Aftek
Infosys and Padmini Polymer.
Furthermore, the information provided by the RBI to the Joint Parliamentary Committee
(JPC) during the investigation revealed that financial institutions such as Industrial
Development Bank of India (IDBI Bank) and Industrial Finance Corporation of India (IFCI)
had given loans of Rs 1,400 crore to companies known to be close to Parekh.
Criticism of SEBI
Some of the regulatory actions SEBI undertook came under scathing criticism from some
quarters who accused it of still being clueless about its supervisory duties. Observers said the
regulator still continued believing that its only priority was to prevent a fall in stock prices.
It was rumored that SEBI banned short sales and increased margins creating a virtual cash
market in the process and squeezed turnover to a sixth of the normal level. It also fired all
broker directors from the Bombay Stock Exchange and Calcutta Stock Exchange and
declared the completion of three controversial settlements of the Kolkata bourse by retaining
a sizeable proportion of the payout of operators who had allegedly tied-up for collusive deals.
Furthermore, SEBI rounded up the bear operators and launched an inquiry into their alleged
short sales.
Stringent regulatory measures follow Parekh episode
Parekh's fraudulent operations motivated the authorities to take necessary steps that have
made made India's stock markets relatively safer in present times. He can also be credited for
having forced indolent policy-makers to bring about reforms in the financial system.
An active trader
According to an Intelligence Bureau report, though disbarred from trading in the countrys
bourses until 2017, is still operating in the markets through conduits, vindicating Dalal
Streets belief that he has never left the market. The report says that as recently as December
2010, KP has been rallying behind different stocks and placing some of them at rigged up
prices to large institutions such as the LIC. He is operating through little-known investment
firms, market operators and a following of loyal brokers. KP, who was at the forefront during
the technology shares-led bull run in 1999-2000, is apparently using front entities such as
Orchid Chemicals , GMR Infrastructure, Cairn India, Deccan Chronicles Holdings, Reliance
Industries, Punj Lloyd, Indiabulls Real Estate, Pipavav Shipyard, Amtek Auto, Hindustan Oil
Exploration, UCO Bank, State Bank of India, EIH and JSW Steel, among others, to trade in
shares.
The report further states that KP has been instrumental in inflating the share price of SKS
Microfinance from Rs850 to Rs1,100 following its listing in August 2010. He has also rigged
IPOs of little known companies by buying out 50% of the issue in collusion with his Kolkatabased associates. KP and his associates have also acquired very large positions in petroleum
companies such as ONGC and HPCL, according to the report. An IB official has further said
that KP and his team have revealed to their close associates that they have insider information
on the government's proposal to decontrol the sale of gas which is expected to raise profit
margins of these companies by about 20%.
- See more at: http://flame.org.in/knowledgecenter/scam.aspx#sthash.k0Q5ycHV.dpuf
The Centre may use this argument, of coal being a nationalised resource, to counter the
allegation that it deprived the nation of substantial revenues that could have been generated
through auction.
The underlying argument is: to auction the blocks the government needed to amend Mines
and Minerals (Regulation and Development) Act. And, given the track record of the coalition
politics, any such amendment could have been inordinately delayed.
Even if we accept this argument, Jaiswals contention that the process of allotting blocks has
been transparent is false. It is true that the process adopted post-2004 was better than the
practices followed during 1993 and 2004, when 60 blocks were doled out without any nonperformance clause or earnest money. The broad-basing of the screening committee also
helped to reduce the element of ad hoc selection.
But, why did the government not restrict such allotment only for commercial power
generation, ensuring that such electricity be available to the nation either at a regulated price
or through PPA with designated distribution utilities? This simple measure could have
ensured power for all at an affordable price.
On the contrary, captive blocks were granted to steel, cement, merchant power and even
downstream industries such as ferroalloys. They pocketed the benefit of getting coal free of
cost. Some fly-by-night operators even monetised the benefit by selling their project plans to
serious players.
DELIBERATE OMISSION?
And, going by the chain of events, one may argue that some omissions were deliberate.
Whats worse, only one of the 57 blocks allotted to private sector is developed and is in
operation (the figures are just a shade better for the public sector).
The bottom line: the nation was not merely deprived of revenues against allotment but also of
the required coal production (which was the cornerstone of the argument in favour of such ad
hoc distribution of assets free of cost) and is now paying for imports.
-Edited version an article in Business Line.