SEBI notifies rules to classify illegal CIS schemes as fraud

Written by Press Trust of India | Updated: Sep 11 2013, 03:18am hrs

Tightening the noose around entities running illegal collective investment schemes (CIS), Sebi has notified new norms to classify such activities as frauds and impose penalties of up to three times of their profits.

Besides, the new rules expand 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 amendments have been made with effect from September 6, 2013 to Sebi's Prevention of Fraudulent and Unfair Trade Practices (PFUTP) Regulations, a gazette notification said.

As per amendments, the list of such practices would now include "illegal mobilisation of funds by sponsoring or causing to be sponsored or carrying on or causing to be carried on any collective investment scheme by any person".

Besides, an "explanation" has been inserted into these regulations to state that the list of such practices is not exhaustive in nature and the norms would be applicable to all categories of persons and entities.

The 10-year old norms in this regard have been amended to remove certain regulatory gaps, which enabled penal actions against individuals to be challenged on the ground that they meant only for market entities, and not the individuals.

Sebi has come across many cases where it has been claimed that the norms do not explicitly permit penal action against individuals at fund houses and foreign funds, for certain 'fraudulent and unfair trade practices' like front running, withholding of key information from the investor and making false promises or claims to induce the clients into a securities transaction.

In some cases, these individuals have been employees or associates of market intermediaries like brokerage firms.

'Front running' refers to an intermediary (or an associated individual) buying or selling securities in advance of a substantial client order, or whereby a forward position is taken about an impending transaction in the same or related futures or options contract.

The amendment would allow the list of 'fraudulent and unfair trade practices' to remain open ended, rather than restricting it to 19 broad categories currently.

Sebi has also decided to strictly enforce these norms, which cover a wide array of manipulative activities, such as publishing advertisements with misleading or distorted information to influence the investors' decision, planting of false or misleading news and inducing investors to carry out transactions for personal gains.

With regard to illegal money-pooling schemes, the operators of such activities earlier faced a meagre fine of Rs one crore and the same was not found to be sufficient to deter such unauthorised raising of funds.

A proposal to increase the penalty on such entities to Rs 25 crore or three times of the profits earned through such schemes, whichever is higher, by bringing them under PFUTP Regulations was approved by Sebi board last month and the same has been notified now.

To tackle the growing menace of investors being duped of their hard earned money through various illegal investment pools, many of which are in the nature of 'ponzi' schemes, Sebi has been given the mandate to take action against all such money collection activities involving Rs 100 crore and more.

A typical 'ponzi' scheme involves the operator collecting a large amount of money from investors and paying them returns from their own money or the money collected from subsequent investors, rather than from profit earned by the person or entity operating such a scheme.

Such activities came to be known as 'ponzi' schemes after Charles Ponzi, who became notorious in the US in 1920s for deploying this technique while promising 50 per cent return on investments in 45 days and 100 per cent within 90 days.

A large number of such schemes have come to the fore in India as well, while many of them have faced regulatory actions by Sebi in recent months.

However, Sebi in most of the cases has only asked operators of such schemes to refund the money to investors and stop such unauthorised activities. The schemes that have faced action include those promising huge returns based on investments on potatoes, goat rearing, cattle and butter schemes, emu farming, real estate and holiday memberships.