Quick sand

India’s Supreme Court has struck a blow for the little man. Judges have ordered the conglomerate to refund more than $3 billion it had raised from millions of small investors. Add in 15 per cent interest, and the bill could be as high as $5 billion. The question is how the sponsor of India’s cricket team and owner of New York’s Plaza hotel will comply with the ruling.

The case is a high-profile test for India’s financial system. In 2008, two unlisted Sahara group companies, with paid up capital of less than $20,000 each, began raising funds through an instrument known as an optionally fully convertible debenture (OFCD). Sahara argued the fundraising was in the form of a private placement. The Securities and Exchange Board of India countered that a private placement should be for a maximum of 50 investors – not 23 million.

The sums raised by the politically well-connected Sahara group exceed the amount raised in India’s largest ever IPO, that of Coal India. Its largely rural investors exceed the total number of retail investors for India’s entire universe of listed stocks.

While the outcome of the case is positive, it still raises serious questions over how such a huge mobilisation of funds was allowed to take place at all. Investors were sold a product that benefited from neither the protection associated with a public issue nor the safeguards a depositor would get from putting money in a bank.

The case also highlights the fact that very large quantities of money in rural India is looking for a savings home. India’s rural savers deserve better than Sahara. And unless the money is paid back swiftly their confidence in the financial system could take a serious dent.

So how will Sahara manage to return the cash? Over a third of the sum raised through issue of OFCDs has been invested in Aamby Valley, a luxury township project developed by the group in Maharashtra, according to annual reports for the year ended June 2010. Sahara has always maintained that if it loses the case that it has sufficient liquidity to pay the sum back in full. For the sake of India’s financial system, it needs to make good on that promise - soon.