The recent crisis involving the Saradha group has brought to the fore the issues surrounding the supervision of schemes that style themselves investment vehicles, and attempt to get away with money-circulation or Ponzi schemes. The Securities and Exchange Board of India (Sebi), the capital market regulator, has a major role to play in effective enforcement of the rules of the game in the capital markets and some types of deposit-taking. As Sebi celebrates its 25th year, there is much to commend it. But it also needs to look ahead, because the road will continue to be long and treacherous.
The nature of enforcement action by Sebi and probably of all financial regulators is reactive rather than proactive. However, even a reactive response may be a proactive one, where on the basis of a single complaint, or suo motu cognisance, the market regulator may initiate investigations, call for information, suspend the business of deposit-taking and, if necessary, issue appropriate orders to the erring entity. While financial scams erode public confidence in genuine investment avenues, they may also occupy a dark space where the spotlight of financial regulation rarely falls, or exploit the possibilities that exist on the penumbra of such regulation. While the market regulator does not possess the resources or the ability to snoop and detect, it relies on information or complaints that may be received by investors. Unfortunately, such leads are only forthcoming when the scheme has attracted negative publicity, is on the verge of collapse or has defaulted. This, usually, is the point of little, or no, return and in the usual absence of any safety net in the form of assets, depositors are left staring at losses.
Enforcement being reactive or being proactive is not really a binary option. There are lots of shades in between and, therefore, there is a lot of scope for preventing harm to the investor before it is too late. To give one example, if a Ponzi scheme were to start in a small district in Madhya Pradesh, there could be three variations of enforcement. In the extreme and idyllic version, Sebi would know about the scheme before it is hatched, and the person is stopped from carrying out his (and it is usually a "he") crooked scheme. This could be by way of tapping phones, sending snoops in every district, and so on. In this ultra-idyllic version, no one is ever defrauded. The other extreme is the proactive version, where millions of investors have already been cheated over five years. Sebi comes in, does an investigation that goes on for several months, and then passes an order penalising the person and asking him to disgorge the money raised from the investors. Since the person has little money left, prosecution is launched. Investors get virtually nothing in this extreme.
In between these extremes is where reality lies. So, in the third example, either because an investor complains after three months of the launch of a Ponzi scheme or because Sebi has a local office that keeps its eyes open for such schemes, the regulator swings into action. A few hundred people are, indeed, swindled, more money is recoverable since it is early days of the deceit, and the state government helps put the person behind bars. Clearly, this is possible and there are various versions possible between the two extremes, and the action could start from a few weeks after the fraud has started, or could start closer to the five-year mark. In addition, the speed and alacrity with which Sebi and state governments (perhaps also the Reserve Bank of India, which has some powers over chit funds) react and cooperate would result in the least damage to the investor.
This middle ground between proactive and reactive is not imaginary. In fact, it does happen. Sebi has taken action against several people who put advertisements in newspapers inviting investors for such schemes.
At a different level, Sebi does play a purely proactive role. That it does in a narrow area of activity, i.e. market surveillance of the transactions on exchanges in India. Thus, to take one example where Sebi discovered a massive fraud, it stopped the payouts and ensured return of money to investors. With the electronic paper trail and every rupee used on the stock exchange connected to the PAN number of an individual or company, it is relatively easy to catch people with their arm in the cookie jar. However, Ponzi schemes don't usually occur on the exchange, and there is need to look at the problem at the state level and the district level.
Here is what Sebi and others can do to improve their record on the scale between reactive and proactive. First, be more sensitive to complaints received from small, and sometimes even semi-literate people from small places. Information about fraudulent schemes can often be gathered from these poorly written letters of complaint.
Second, with 600-odd people, there is no way Sebi can address these schemes. Its manpower needs to increase by a substantial factor. The US Securities and Exchange Commission's enforcement staff alone is over a thousand for a country that has a third of India's population.
Third, the speed at which Sebi conducts investigations must be ramped up.
Fourth, state governments need some pressure to cooperate with Sebi, since senior politicians may be supporting the violators. Some accountability of politicians and bureaucrats is required so even if they don't help much, at least they don't get in the way of effective investigation.
Fifth, there should be an investors' charter, which give investors certain rights of redress within a time-bound period.
Lastly, our judicial system needs to be harsher towards economic offenders, who are often let off with a fine rather than a jail sentence.
The author is founder of Finsec Law Advisors and visiting faculty, IIMA