SEBI (Collective Investment Scheme) Regulations, 1999: An Anachronistic Law

– Parth Tyagi

Introduction

To a certain extent, the health of an economy, depends upon the ability of its securities market to mobilize the household savings into investments. One such method to channelize the household savings into investments is the formation of Collective Investment Scheme (CIS).  CIS is an investment scheme under which numerous investors club their savings for investing in a particular asset, and for sharing the profits coming out of such investments. Such schemes were on a rise in the early 1990s, as these schemes attracted small investors by assuring them high return for their investments. However, a number of such schemes turned out to be nothing more than a pool of bogus promises. Taking cognizance of the situation and in order to keep a check on such schemes, SEBI formulated the SEBI (CIS) regulations, which came into force on the 15th October, 1999.

 In the initial years of its formation, the SEBI (CIS) regulation proved effective in curbing the malpractices related to such schemes, however, with the passage of time these regulations proved inefficient and are in an urgent need for appropriate amendments. The article briefly discusses the current SEBI (CIS) regulations, following up with a discussion on the loopholes in these regulations. The author deliberately refrains from commenting on the ‘possible reforms’ for the current regulation, due to the complex nature of the issue.

SEBI (Collective Investment Scheme) Regulations

Formulated with a view to protect the investors from fraudulent collective investment schemes, the SEBI (CIS) regulations, mandates that no other company, other than those incorporated under the Companies Act, 2013 and registered with SEBI under these regulations, can establish or manage a CIS. The company organizing a CIS must have the necessary infrastructure to manage the CIS apart from having a net worth of not less than five crore rupees at the time of registration. These regulations also lay down the obligations of the investment companies, the obligations of trustees, general obligations and procedure for audit and inspection. Though it seems as if the regulations comprehensively regulate the CIS, however, time and again there have been instances which accentuate the loopholes present in these regulations, the next section briefly discusses them.

Loopholes in the Regulations

  • Lack of clear definition of CIS

Section 11AA of the SEBI Act 1992 defines a CIS. The section further mentions that ‘pooling of funds’ is the primary element of CIS, however ‘pooling of funds’ is nowhere properly defined.  Moreover, the section does not lay down a clear and precise definition of CIS and leaves it too open-ended, which provides a window for entities to defraud the investors, by passing their investment scheme under the garb of other business activities.  A good example of this loophole is the Saradha Group financial scam, this scheme was floated as a chit fund scheme and duped over 1.5 million investors. It was in the following years that it was realized that the scheme was a CIS, passed under the garb of a chit fund scheme in order to escape the regulatory norms.

A comparison of this definition with the definition of CIS in other jurisdiction, points to the urgent need for its reformation. For example, in USA the definition of CIS covers mutual funds and unit investment trusts, and in Hong Kong real estate investment trusts are also covered under the definition of CIS. However, in India, the definition of CIS does not cover such activities, even though the primary function of all these activities are the same, that is pooling of funds.

  • Complex and excessive regulations

The complex and excessive nature of the SEBI (CIS) regulations, is evident from the fact that even after more than two decades of its implementation, only one company had registered itself with the SEBI under these regulations. The regulations mandate that the minimum net worth of the company planning to get itself registered must be 5 crores. Also, the company has to compulsorily list its unit on the stock exchange, thereby going through the additional burden of complying with the listing and disclosure requirement. Moreover, the company must also get its assets appraised in specific time intervals, apart from getting rated from a credit rating agency for every scheme it propagates. The cumulative cost of complying with theses regulation takes a heavy toll on the wallets of such schemes. Thus, leading to a conscious derogation from these mandatory regulations.

  • Unreasonable threshold for deeming unregulated schemes as CIS

Following the Securities (Amendment) Act, 2014, any unregistered scheme involving a corpus amount of one hundred crore rupees or more shall be deemed to be a collective investment scheme’. Though, the amendment was made in order to protect the interest of the investors, however, it turns out that it has a number of negative implications. There is no logical basis for pegging the threshold at hundred crores as such a threshold provides a window for smaller schemes to flourish, and exploit the investors. Moreover, any scheme having a corpus of more than hundred crore, whether it is a CIS or not, can now be regulated by the SEBI. Consequently, there have been reported instances where a number of unrelated individuals were mistakenly identified as illegal CIS, whereas in actuality ‘they were raising money solely for the purpose of building or redeveloping certain legitimate projects or properties and housing societies.’

  • Lack of provisions dealing with Hybrid Schemes

For overcoming the regulatory norms, often a scheme is floated as a hybrid scheme, which will come under the overlapping jurisdictions of different regulators. Due to this, there is an excessive delay in deciding the jurisdiction of the regulator under which such schemes would fall. For example, in the AgriGold scam, the SEBI initially decided not to take up jurisdiction and passed it onto other regulators, since the scheme had a nature of deposits. After few years, it was declared that the scheme was a CIS, and it was under SEBI’s jurisdiction. This resulted in extremely delayed investigations, giving time for the offenders to escape.

  • Absence of timely orders

In majority of the cases, even after the commencement of investigation, the SEBI has taken more than a year to pass even the interim orders against the offenders, and the final orders have been passed around three years post these interim orders. For example, in the Rose valley scam, wherein the scheme was functional since 2004, and had raised over 500 crore rupees in a span of few years. However, it was three years after the interim order, that in the year 2014, the SEBI passed it final order for winding up the scheme.  This resulted in the continued operation of the scheme till March 2013, raising over Rs 742 crore, duping thousands of investors even after SEBI took cognizance of its fraudulent nature.

Conclusion

The Collective Investment Schemes are one of the quintessential intermediaries of the Securities Market, yet they are being covered by an anachronistic law, in the form of SEBI (CIS) Regulations,1999. There may come a situation when the investors may lose confidence in these schemes if these regulations are not overhauled. Understanding the gravity of the situation, the SEBI in the year 2016 did initiate talks with the central government for tighter CIS norms, however, the central government did not lend any ear to the concerns raised by the SEBI. Over the course of last decade, the landscape of the securities market in India has been marred by numerous CIS scams, yet it seems that the government has still not learned its lesson.

This article is authored by Parth Tyagi. Parth is a student of law at National Law Institute University, Bhopal.

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