PONZI SCAMS IN INDIA

BY- R VIGHNESH KAIMAL

A Ponzi scheme (also called as pyramid scheme or money circulation scheme) essentially is any
scheme wherein the money from the new investors is used to pay the dividends/returns of any
form to older investors1. It involves investments into non-existent entities or bogus products,
while promising high rate of returns to the investors at little or no risks. Person or business entity
that engages in Ponzi scandals constantly strive to attract new investors, so that the new capital
can be used to pay off the older investment. The characteristic feature of a Ponzi scheme is that
there is a consistent inflow of capital with absolutely no utilization of the same, except for the
purpose of paying dividends. Such schemes fall apart when the new investment stops, and
typically the promoters of the Ponzi entity abscond with all the money.

The term “ponzi” originates from the name of a notorious white collar criminal, Charles Ponzi2.
In 1919, United States Postal Service had developed a policy wherein international reply
coupons could be exchanged for postal stamps. The postal service stamps were expensive and
they had huge redemption value at post-offices. Charles Ponzi would import reply coupons from
countries like Spain, exchange them for stamps, and in-turn redeem those stamps for money.
Since there was no law that expressly declared this as an offence, Ponzi started operating with
much more impunity. He started his company for arbitrage, wherein he promised abnormally
high returns from this business. Gradually, greed took over Ponzi, and instead of investing the
money he would merely distribute it amongst the investors as profits. The scheme was finally
busted by the SEC(Securities Exchange Commission, the American equivalent of SEBI) in 1920,
and Charles Ponzi was ignobly put behind the bars.3

In India, the word “Ponzi” is not expressly defined by any statute. Prize Chits and Money
Circulation (Banning) Act 1978 is a statutory provision that comes the closest in defining a
money circulation scheme and imposing sanctions over those involved in the same. Section 2
sub-clause c of the said enactment says-

1
Sarah Peck’s “Investment Ethics”; extracted from: https://www.slideshare.net/SungLuvPapa/investment-ethics
2
http://www.biography.com/people/charles-ponzi-20650909
3
http://www.investopedia.com/terms/p/ponzischeme.asp
“money circulation scheme means any scheme, by whatever name called,

 (i) for the making of quick or easy money, or

 (ii) for the receipt of any money a valuable thing as the consideration for a promise to
pay money,

 on any event or contingency relative or applicable to the enrolment, of members into

the scheme, whether or not such money or thing is derived from the entrance money of
the members of such scheme or periodical subscriptions “

Further each financial regulator is entrusted with the responsibility to deal with Ponzi schemes in
their respective domains. Post Sharada scam, Securities Amendment Act 2014 was put in place
to empower SEBI to deal with Ponzis operating under the garb of collective investment schemes.
If a Bank or NBFC indulges in such schemes, the onus falls upon RBI to file a case against them.
When a Ponzi is perpetuated by a Nidhi Company or by any other company in violation of
section 73 of the companies act, the concerned regulator is the Ministry of Corporate affairs.

With a major low-income population base and an inherent lack of public access to financial
services, India offers a perfect habitat for complex Ponzi pyramids. The proposition is dangerous
to the economy since the pooling of financial resources and unbridled deployment of the same
consequently results in concentration of economic muscle. One of the first known instances of
Ponzi scandals in India was the Sanchaita scam of the 1980s. Sanchaita Investments was a firm
that began its operations in the year 1975 with a capital of mere Rs. 7000, but by 1977 it was a
multi-crore company. Sanchaita accepted loans and deposits from the public for a fixed period of
four years and the terms of the agreement promised that the amount was repayable with an
interest of 12% p.a. The depositors had the right to withdraw their money before the investment
horizon, but such premature withdrawal would make them lose interest at a rate of 1%. The
fraudulent aspect of the said scheme was that the firm could repay the amount with interests to
the depositors at any time before the stipulated period, without being subject to justifications for
the same. The scheme raised many eyebrows amongst the regulators and in 1980 a conscious
stricken Commercial Tax officer lodged a complaint against the firm. It was found that Sanchaita
had been offering interest at 36%-48% to the depositors(which was even contravening its own
loan certificates stating 12% interest)4. After a pitched legal battle, the SC held in 1982 that
Sanchaita was operating a money circulation Ponzi scheme. By the time Sanchaita imploded,
1,30,000 investors had been duped.5

By the 90s the financial landscape of the country had changed, with the liberalization, Indian
companies started to raise equity capital from the public as opposed to the market practice of
raising the deposits until then. Being the pre-SEBI era, many banana companies simply vanished
after raising investments. According to a Joint Parliamentary Committee Report on investor
protection, around Rs 90,000 crores were defrauded from over 1 crore small investors who had
invested for the first time. The money was fraudulently frisked by some four thousand odd
companies, out of which only 229 companies have been identified and lesser have been
prosecuted so far.6 Post 1992, when the stock markets were crashing and banks were reducing
interest rates on deposits, plantation schemes became attractive options for the middle class
investors. This period witnessed a bubble of plantation schemes wherein investors were given
options of agro-bonds with promises of huge returns. The companies gave colorful explanations
as to how they would make profits. One of the most infamous Teak Plantation Scheme was the
one run by Golden Forests India Limited, which duped 2.5 lakh investors7 and amassed a total of
Rs 910 crores. The sheer numbers of such plantation schemes made SEBI issue public notice of
caution against many companies. Due to these scams the government was forced to give
statutory backings to SEBI in order to capacitate the regulator.

In 2014 Amway India was in troubled waters due to its 9-6-3 scheme. As per the scheme a
member had to recruit 9 members under him, those 9 members would further recruit 6 members
and each of those 6 members had to recruit another 3 members. The person on the top of this
pyramid was to receive 21% of all the proceeds that accrued from the sales done by the downline
members8. High Court of Andhra Pradesh held the scheme as fraudulent, since the primary focus
of each member was to recruit more members rather than sale of Amway products. The pyramid
benefitted with the entry of new members, with absolutely no downward (or even outward) flow

4
State of West Bengal v Swapan Kumar Guha, AIR 1982 SC 949
5
West Bengal in Damage Control After Chit Fund Scam, P Tapadar, Outlook India, 23 March 2013.
6
http://www.mtia.in/rel4/scripts/ticker2-jpc.asp
7
National Investor Forum v Golden Forests India Limited, 134 PLR 831
8
Amway India Enterprises v Union of India 2007(4)ALT808
of value corresponding to the upward flow of money, making it an apt money circulation scheme
as per the Prize Chits and Money Circulation Scheme (Banning) Act. In this regard Amway India
CEO and MD William S. Pinckney was arrested by Andhra Police in 20149

Saradha scam was another massive blow in this regard. Keeping in line with the classic Ponzi
schemes10, Saradha group accepted investments and deposits at mathematically impossible rate
of returns. The complex structuring of the group and its multiple cross holdings made
investigations into its activities much more difficult. It presented numerous Collective
Investment schemes in the form of hotel booking schemes, real-estate bonds, tourism packages
etc. The group also was engaged in issuing debt securities from the public without issuing
prospectus and approval from SEBI. To top it up, the group promised commissions to the tune of
25%-45% to its agents in form of cash and gifts. The investors were never informed about the
actual usage of their money, and due to the promise of high returns, not many inquired about the
same. By the time the Saradha pyramid collapsed it caused a loss of billions of rupees and
affected 1.7 million investors. The impact on the local economy was so bad that in order to set up
a relief fund for the victims of the scam the State Government had to increase the tax rates on
tobacco products.

In Kuriachan Chako v State of Kerala11, a partnership that went by the name M/S LIS,
Ernakulam floated a scheme wherein an investor had to pay Rs 625 to the firm. Out of the said
amount promoters promised to use Rs 350 to buy 35 lottery tickets for the member and for the
remaining amount the member would get subscription for a “Trikalam” magazine. At the end of
the investment period(which was never fixed), the promoters promised to pay Rs 1250 to each
member. The scheme was so attractive, that several persons participated in it. Within a span of
two years the firm collected about Rs 500 Crores through this scheme. Aggressive marketing
was done by the promoters for the scheme through television commercials and newspaper
advertisements. The firm claimed that it earned through the commissions paid to it by the State
Lottery Commission and the publishers of the magazine; and the same was proceeded to the

9
http://www.business-standard.com/article/companies/amway-india-chief-held-for-alleged-illegal-money-
circulation-by-firm-114052700587_1.html
10
Subrata Chattoraj Vs. Union of India (UOI) and Ors 2014 (87) ALLCC 250
11
(2008)8SCC708
members as returns to their investments. Supreme Court observed in its judgement that, after
quantification, in order to pay the said amount of Rs 1,250, the promoters were supposed to earn
Rs 1,093.75 for each member. Even with the inclusion of commissions from the magazines and
lotteries the deficit was too large. It was held that the only way the firm paid its members was
through a complicated Ponzi pyramid wherein the money from subsequent subscribers was used
to pay off previous members.

Even internet and social media did not remain untouched by Ponzi scam artists. Two of the
biggest scams in the electronic domain to surface recently are SpeakAsia and Ablaze Noida.
SpeakAsia was the first firm to come with an innovative electronic Ponzi. The company which
was registered in Singapore, presented itself as a portal which was engaged by many Multi-
National Companies for various surveys. The company asked its investors (who were called
“panelists”) to invest Rs 11,000 annually, and in turn they would be allowed to fill online survey
forms every week. For filling the forms, the company offered Rs 52,000 as a reward12. Initially
the company was prompt in its payment. But soon the payments to the investors started to falter,
and criminal complaints with the economic offences wing against the firm were filed by many.
While in the Ablaze case, the firm operated a web portal which went by the name
“socialtrade.biz”. The firm claimed that it acted a social media manager for various big business,
and its primary function was to increase the reach of their client companies on social media. It
offered plans wherein the people would pay to register with Ablaze, and then they would be
given a stipulated number of facebook pages which they had to ‘like’. For each like, the
members were promised by the firm a sum of Rs 513. When investigations unfurled the truth it
was found that in both the said cases the firms did not have any legitimate corporate clients as
they claimed. SpeakAsia would make its own survey forms and portray it to be from its client.
While Ablaze would just make its members like their own pages14.

One of the many interesting aspects on Ponzi schemes is that contrary to its academic definition,
which potrays the Ponzi schemes as a corporate investment fraud, it can happen in any domain of
12
http://www.sify.com/finance/speak-asia--the-latest-mega-scam-to-hit-india-imagegallery-others-
lfskACjeabesi.html
13
http://www.hindustantimes.com/noida/noida-ponzi-scheme-cop-in-charge-simplifies-case/story-
iBzrRuFaSmWLFFZE6d2TUK.html
14
http://economictimes.indiatimes.com/articleshow/56947663.cms
finance. Be it banking (Reserve Bank of India v Peerless Finance15), be it investment (Sharada
scam16), be it Direct Sales and MLMs (Amway Case17), and even sale of goods(Sahara Q-Shop
Fraud18). Ponzi scam artists often target tier-2 towns owing to opportunities presented by
persistent lack of financial awareness there. In Dharmveer Singh v Union of India19, the Supreme
Court observed that prima facie there were 15 companies in Gwalior that engaged in Ponzi
money circulation schemes defrauding about 11,000 investors to the tune of Rs. 27 crore.

There are numerous instances which prove that the approach of the legislature towards the
corporate regulations has always been reactionary. The provisions that regulate the acceptance of
deposits by the companies were only added20 after large scale money laundering cases came up
in the satanic cotton mills of Maharashtra. SEBI came into existence post-Harshad Mehta scam.
It was only after a series of unpleasant incidents came to public domain wherein companies
using the garb of “private Placements” to avoid SEBI regulations, did the government insert
provisions in the companies act limiting the private placement to 50 persons. Satyam scam
formed the driving force for the new companies act. It was only after the Saradha scam that
securities amendment act was passed which further expanded the definition of Collective
Investment Schemes. A lack of proactive approach exhibited by the legislature has been a major
factor towards the recurrence of Ponzis.

To make the matters worse even the existent framework is fragmented and riddled with grey
areas. 1) Mobilization of Deposits by Non Banking Finance Companies is governed by RBI, 2)
Nidhi companies are governed by MCA , 3) Investment and Capital markets are regulated by
SEBI,4) Chit funds and Multi-Level Marketing Schemes are regulated by state governments, 5)
Insurance Funds are regulated by IRDA, 6) Pension Funds are regulated by PFRDA, while 7)
housing finance instituitions are governed by National Housing Bank. Despite having 7

15
AIR1987SC1023
16
Subrata Chattoraj Vs. Union of India (UOI) and Ors 2014 (87) ALLCC 250
17
Amway India Enterprises v Union of India 2007(4)ALT808
18
http://www.firstpost.com/business/hc-issues-notice-to-sebi-sahara-q-shop-over-fraud-scheme-1094899.html
19
2011(3)JLJ95
20
Section 58A of Companies Act 1956 back then. Now the same provisions are found in chapter 5 of
the Indian Companies Act 2013
regulators, about hundred Acts and thousands of rules and directives there still exist cetain
schemes which remain outside the purview of the said regulators. One such example is the
Sahara Q-shop case, wherein the firm offered a unique scheme under which a person could
deposit Rs 1000 with the firm and redeem purchase value of Rs 2354 from its retail stores after a
period of six years. This scheme labeled the amount collected under the scheme as an “advance
payment to goods”, and hence was able to keep multiple regulators off its back for a long period
of time. Lack of synergy between the regulators also provide conducive atmosphere for the
schemes to grow. Sarada chit fund offered various real-estate bonds and holiday packages which
often came under the ambit of Collective Investment Schemes, nevertheless since the firm was
registered as a chit fund it fell under the controls of the Government of West Bengal. Hence,
when the Saradha fraud came up, SEBI could be nothing but a mere spectator until it was
empowered by the Securities Amendment Act 2014.

Ponzi scams are disguised to prevent regulatory oversight. An approach which is capable to lift
the garb that the various schemes cover them in is needed. This can be effectively achieved only
through enhanced market intelligence. The regulators should be well aware of all the new
business models that evolve in their domains. Ultimate weapon against the Ponzi scheme off any
sort is Investor Awareness. Investors need to ask themselves three questions before investing-

1) What will the firm do with my money?

2) How will I get returns?
3) Who is the regulator I can approach in case of a grievance?

To substantiate this, a common grievance redress mechanism needs to be actuated to direct the
complaints to the concerned regulator and in case of ambiguity to use its quasi-judicial powers to
adjudicate the same.