The Banning of Unregulated Deposit Schemes

Ordinance, 2019

Lecture meeting at Bombay Chartered Accountants’ Society

28th March 2019

CA Sandeep Shah
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Abbreviations

Abbreviation Full Form

ARC Asset Reconstruction Companies
CIS Collective Investment Schemes
EPFO Employees' Provident Fund Organisation
FEMA Foreign Exchange Management Act
IRDA Insurance Regulatory and Development Authority of India
LLP Limited Liability Partnership
MCA Ministry of Corporate Affairs
MPID Maharashtra Protection of Interest of Depositors
NBFC Non Banking Financial Companies
NHB National Housing Bank
PFRDA Pension Fund Regulatory and Development Authority
RBI Reserve Bank of India
RDS Regulated Deposit Schemes
SARFAESI Securitisation & Reconstruction of Financial Assets & Enforcement of Security Interest
SEBI Securities and Exchange Board of India
UDS Unregulated Deposit Schemes 2
Coverage

 Genesis

 Salient features

 Key definitions

 Applicability & Exemptions

 Challenges & Confusions

 Administration

 Penalties

 Auditor’s Role
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Scams under the schemes

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Types of schemes

A form of fraud that lures

investors and pays profits to
Ponzi earlier investors with funds
received from more recent
investors. E.g. Prize Chit

A business model that

recruits members via a
Pyramid
promise of payments or
services for enrolling others
into the scheme. E.g. Multi-
level marketing

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Background

• Accepting money from public involves huge responsibility and therefore it needs to be highly
regulated.

• RBI regulates deposits accepted by NBFC’s, SEBI regulates mutual funds, State and Union Territory
Governments regulates chit funds, MCA oversees deposit taking companies other than the NBFC’s
and NHB regulates Housing Finance Companies.

• Despite this, non-compliant companies and dubious individuals have defrauded, predominantly the
poor and illiterate through illicit deposit taking schemes.

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Reserve Bank of India Act, 1934

SECTION 45I Carrying on business of

45I(a) Business of a non-banking 45I (c) Financial institution 45I (f) Non Banking
financial institution’’ Financial Company

means Non banking institution carries on as its business or

part of its business a financial institution which is a company;

Means- Company Financing..

Corporation
acquisition of shares.. a NBI which is a company & has as its
Co.op society principal business the receiving of
deposits, under any scheme or
letting or delivering of any goods to a hirer .. arrangement or lending

of insurance business

Such other NBI as specified..

managing, conducting ..chits, kurries

collecting, for any purpose or under any scheme or

arrangement
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Maharashtra Protection of Interests of Depositors (in
Financial Establishments) Act, 1999

• Section 2 (c) "deposit" includes and shall be deemed always to have included any receipt of
money or acceptance of any valuable commodity by any Financial Establishment to be
returned after a specified period or otherwise, either in cash or in kind or in the form of a
specified service with or without any benefit in the form of interest, bonus, profit or in any
other form, but does not include

• Section 2 (d)"Financial Establishment" means any person accepting deposit under

any scheme or arrangement or in any other manner but does not include a
corporation or a co-operative society owned or controlled by any State Government
or the Central Government or a banking company as defined under clause (c) of
section 5 of the Banking Regulation Act, 1949 (10 of 1949)

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Background

• The Standing Committee in its Seventieth report cited more than 1,000 cases of defrauding through
illicit deposit schemes in the past 4 years itself. The main cause for this is regulatory gaps and lack of
strict administrative measures.

• This bill was first introduced in Lok Sabha on 18th July, 2018. Subsequently, “The Banning of
Unregulated Deposit Schemes Bill, 2019” was passed by the Lok Sabha on 13th February, 2019 but
could not be passed by the Rajya Sabha. Since the Parliament was not in session, “The Banning of
Unregulated Deposit Schemes Ordinance, 2019” has been issued by the President of India vide
notification dated 21st February, 2019.

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Salient features

• The Ordinance was expected to over-ride existing State Laws and all prospective violations to be
covered under the Central Law. However, this ordinance is in addition to other laws (clause 35)

• It covers three types of offences and provides for severe punishment and heavy pecuniary fines.

• It enables creation of an online central database for collection and sharing of information on deposit
taking activities in the country.

• Adequate provisions for disgorgement or repayment of deposits have been provided in cases where
such UDS manage to raise deposits illegally.

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Salient features (Continued)

• Provides for attachment of properties / assets by the Competent Authority and subsequent
realization of assets for repayment to depositors.

• It also provides for investigation, search and seizure of any property connected with the offence with
or without warrant.

• Clear-cut time lines have been provided for attachment of property and restitution to depositors.

• Considering the nature of the law, it is applicable with immediate effect with no transition provision /
relief.

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What is a deposit?

• Definition as per section 2(4):

Deposit means an amount of money received by way of an advance or loan or in any other form by
any deposit taker with a promise to return whether after a specified period or otherwise, either in
cash or in kind or in the form of specified services, with or without any benefit in the form of
interest, bonus, profit or in any other form.

• In case of Companies and NBFC’s, the definition of deposit is as per the Companies Act, 2013 and
the Reserve Bank of India Act, 1934 respectively.

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Key receipts which are not considered as deposit

Receipts which are not returnable

Capital contributed by partners

Loans received by an individual from relatives

Loans received by firm [excluding LLP] from relatives of partners

Receipts in the course of / for the purpose of business and having a genuine connection with it
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Key receipts which are not considered as deposit
(Continued)

Loans received from banks, financial institutions and NBFC’s

Amounts received from Governments

Amounts received in accordance with the FEMA,1999

Amounts received by registered ARC under the SARFAESI Act, 2002

Amounts received as credit by a buyer from a seller on sale of any property.

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Key receipts which are not considered as deposit
(Continued)

Amounts received and repayable when goods / services are not sold, hired or otherwise

Advances for immovable property which are adjustable as per the agreement / arrangement

Security deposit for performance of the contract

Advances under long term contracts for supply of capital goods

Note: If the aforesaid amounts become refundable and is not refunded within 15 days of it becoming
refundable, the said amounts would be considered as deposits.
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 Who is a deposit taker? Section 2(6)

Individual or group Proprietorship

Partnership firm
of individuals concern

Association of
Receiving or LLP Company
soliciting deposits by person

Cooperative Society
Any other
Trust or a Multi-State Co-
arrangement
operative Society

Note: Though HUF is not specifically mentioned, in our view it would get covered under any other arrangement.
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Deposit taker does not include

Corporation incorporated under

Banking Company as per Banking
the Act of Parliament or State
Regulation Act, 1949
Legislature

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What is Unregulated Deposit Scheme? Section 2(17)

A scheme or an
arrangement of
soliciting / Which is not a
UDS
accepting of RDS
deposit by way
of business

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Analysis of definition of UDS

A ‘Scheme’ is a An ‘Arrangement’ can be

It is a residual definition
systematic arrangement between two or more
to cover in its ambit any
or plan and will involve a parties not necessarily
scheme that is not
proposal for several involving multiple
specifically regulated.
persons. persons.

Acceptance of deposit - Solicitation of deposit -

whether solicited or not whether received or not

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What are Regulated Deposit Schemes?
(as per the first Schedule)

• Schemes or arrangements of the following regulators are termed as RDS.

SEBI RBI IRDA

State or Union
Territory NHB PFRDA
Government

Central Registrar,
EPFO Multi – state Co- MCA
operative societies
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Regulated Deposit Schemes - as per the first Schedule
(Continued)

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Regulated Deposit Schemes - as per the first Schedule
(Continued)

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Regulated Deposit Schemes - as per the first Schedule
(Continued)

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Regulated Deposit Schemes - as per the first Schedule
(Continued)

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Offences covered by the Ordinance

Soliciting or Fraudulent default Wrongful

Accepting in RDS inducement in
deposits under
relation to UDS
any UDS
(Section 4) (Section 5)
(Section 3)

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Is there any threshold for offence by UDS?

All UDS irrespective of whatever No scope should be left for

rate of return they may advertise misuse of any threshold so that
to lure gullible people should be schemes can be designed and
banned. disguised.

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Why is inducement an offence?

Inducement is a grave offence as

actual collection and should be It is a preventive measure to stop
treated at par with running of such scheme from initiating.
UDS.

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Are agents punishable for inducement?

Becoming an agent for illegal

The term ‘deposit taker’ has been
UDS is itself an offence and
defined to include within its
accordingly section 5 provides
ambit all possible entities
that no person should induce any
receiving or soliciting deposits
another person to invest in UDS.

Note: Inducement is an offence irrespective of the amount of commission received by the agent.
Setting a threshold would be against the objective of the Ordinance.

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Are brand ambassadors, advertisers, media, etc.
punishable for inducement?

Section 33 provides that

As per section 5, no person shall
induce any another person to
invest in UDS. Accordingly, they
would be punishable if they
knew that the scheme which they
advertised was an UDS.
Government may direct
newspapers or other publications
for full and fair retraction of
advertisements for promoting,
soliciting deposits and inducing
persons to become members of
UDS.

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 Challenges – Interpretation on Applicability

- Such an - Since the entities

interpretation have accepted the
View 1 would cover loans in the course of
View 2
only financial and for the purpose
Whether the
companies Whether the law of business and have
term “by way
which is against would preclude a genuine
of business” is
the intent of the entities who carries connection with
restricted to
Ordinance. business other than business, the same is
business
that of deposit not covered by the
entities which - The word taking from definition of deposit.
solicits or principle accepting monies
accepts business is not - Accordingly, the
as a loan?
deposits? used. entities can accept
loans for business
purposes.

Considering the preamble, press release and the object of the law: View 2 seems to be more
appropriate
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Challenges & confusions – Case 1
Whether a single transaction
of acceptance of deposit is
considered as an offence?
Word of caution: If the transaction is questioned, the burden of proving that the transaction is not
hit by the Ordinance shall be on the deposit taker.
- An ‘Arrangement’ can be
between two or more parties not
necessarily involving multiple
persons.
- However, having said that, any
sporadic instances of taking
deposit and repayment thereof
may not fall within the definition
of ‘by way of business’.
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Challenges & confusions – Case 2
Whether loans obtained
for personal purposes,
medical exigencies, etc.
is an offence?
Note: This fact has been clarified by the Ministry of Finance in its tweet on banning of UDS w.r.t
individuals, firms, companies, LLP’s etc.
Though loans for personal
or social commitments,
medical or educational
exigencies are not covered
by RDS, they are not
solicited / accepted ‘by
way of business’ and
therefore are not covered
under the definition of an
UDS.
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Challenges & confusions – Case 3

It can be argued that a

transaction between a firm or a
Whether loans obtained LLP and its partner cannot be
from partners is an called as transaction ‘by way of
offence? business’ because the partner is
lending to his own firm where
he has a financial stake.

Word of caution: The language of exclusion of capital contribution by partners of a firm from
deposits has been picked-up from the provision of MPID Act. Therefore, the issue may involve
litigation.

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Challenges & confusions – Case 4
Whether accepting inter-
firm deposits are
considered as an offence?
Word of caution: If the transaction is questioned, the burden of proving that the transaction is not
hit by the Ordinance shall be on the deposit taker.
- The objective behind the
Ordinance is to protect the
interest of small depositors
who are not capable of
taking well informed
financial decisions.
- Since this is not the case
with a business entity [i.e.
firms], there is no question
of giving any protection.
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Challenges & confusions – Case 5

Deposit schemes that work

like advances against
purchase of goods at a later
Whether deposit schemes
date should not be
with builders and jewelers
considered as UDS,
have been banned under
however controversial and
the law?
varying views are floating
around and one may wait
for clarification.

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Other challenges

If necessary approvals to deal in goods or services or properties are not

obtained from appropriate authorities and the advances become refundable, it
would be treated as deposit.

Advances / security amounts being considered as deposits after the expiry of 15

days on becoming refundable even in genuine cases.

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Administration

• All deposit takers [including those accepting deposit under RDS] are required to inform the
Repository Authority [online central database created for collection and sharing of information on
deposit taking activities] about their business.

• The Ordinance provides for the appointment of the Competent Authority by State and Union
Territory Governments. The Competent Authority will have powers similar to those vested in a civil
court.

• Police officers have powers to enter, search and seize any property believed to be connected with an
offence with or without a warrant.

• The Ordinance provides for the constitution of one or more Designated Courts.

• After provisional attachment of deposit taker’s assets, the Competent Authority needs to approach
the Designated Court within 30 days which can be extended to 60 days. The Designated Court needs
to complete the process within 180 days of being approached by the Competent Authority. 43
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Key penalties for contravention

Section 3 Section 4* Section 5

Solicitation: 1 to 5
years
Imprisonment Upto 7 years 1 to 5 years
Acceptance: 2 to 7
years

Solicitation: Rs. 2 lakhs Rs. 5 lakhs to Rs. 25

to Rs. 10 lakhs crores or 3 times the
Fines amount of profits Upto Rs. 10 lakhs
Acceptance: Rs. 3 made whichever is
lakhs to Rs. 10 lakhs higher or with both

*Same offence may be punishable under any other law.

Notes: All offences under the Ordinance are cognizable and non-bailable. 45
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Role of auditor

• The auditor should communicate the non-compliances to those charged with governance and
request them to regularize the same. [e.g. compounding of offence, refunding the amounts received,
etc.]

• If those charged with governance is involved in non-compliance, the auditor shall communicate to
next higher authority. [e.g. audit committee or supervisory board]

• The auditor should ensure that adequate provision has been made for the penalties in case of non-
compliance.

• Based on the severity of the non-compliance, the auditor should consider the following options:
o giving an Emphasis of Matter paragraph [‘EOM’]
o modifying the audit opinion
o resigning from the audit engagement
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SA 250-CONSIDERATION OF LAWS AND REGULATIONS IN
AN AUDIT OF FINANCIAL STATEMENTS

• Reporting Non-Compliance to Regulatory and Enforcement Authorities

– 28. If the auditor has identified or suspects non-compliance with laws and regulations, the
auditor shall determine whether the auditor has a responsibility to report the identified or
suspected non-compliance to parties outside the entity. (Ref: Para. A19-A20)

– 19. If the auditor suspects there may be non-compliance, the auditor shall discuss the matter
with management and, where appropriate, those charged with governance. If management
or, as appropriate, those charged with governance do not provide sufficient information that
supports that the entity is in compliance with laws and regulations and, in the auditor’s
judgment, the effect of the suspected non-compliance may be material to the financial
statements, the auditor shall consider the need to obtain legal advice. (Ref: Para. A15-A16)

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Non-Compliance with Laws and Regulations (NOCLAR).

• The International Ethics Standards Board for Accountants (IESBA) issued Non-
Compliance with Laws and Regulations (NOCLAR) framework which is effective 15th
July 2017. NOCLAR sets out a framework that requires professional accountants (PAs)
to take actions when they become aware of any illegal or potential illegal act.

• The NOCLAR is applicable to all PAs including

– PA in Public Practice (audit of financial statements, Other assurance services, Professional
services other than audit of financial statement e.g. Tax, Accounting, training etc)
– Professional Accountants in Business ( Employees, senior PA)

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 NOCLAR- contd

• Audit services: PA becomes aware of non compliance including suspecting- inform those in
charge of governance, determine whether further action is needed & whether to disclose
the matter to appropriate authority

• Non audit services: inform those in charge of governance, Communicate the matter to the
entity’s external auditor, Consider whether further action is needed in the public interest e.g.
disclosing to authorities or withdrawing

• PA other than Senior Professional Accountants- subject to protocol inform senior/higher

ups, in exceptional circumstances disclosure to appropriate authority

• Senior PAs (directors, officers or senior employees (kmp)-address the matter,

determine course of action including reporting to authority
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 The statute has the potential to
nip fraud at an early stage and
prevent widespread losses of
the type we saw in innumerable
notorious schemes

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