Need a bailout? Join the queue

India’s financial sector, which everyone thought was water-tight, is suddenly turning out to be as full of holes as a sieve.

Some eight lakh investors have filed complaints about unpaid deposits in the Odisha chit fund scam. The Securities and Exchange Board of India (SEBI) is engaged in a protracted battle with the Sahara group to get it to refund monies to a purported two crore investors. The RBI officials recently warned of nearly a hundred unregistered finance firms raising money through public deposits and debentures.

And now, there is the settlement crisis at the National Spot Exchange (NSEL) — an entire exchange, it turns out, was functioning in a sort of twilight zone. But compared to victims of the other scams, those who traded on the paired contracts at the NSEL have been a particularly vocal lot. They have spoken at length in the media, filed petitions with the Economic Offences Wing and Bombay High Court and have even demanded a takeover of the exchange by the Government.

For good measure, they have also appealed for aid to the country’s most visible public figure at the moment — Narendra Modi.

Small investors first

While it is good to see such investor activism, the Government’s response to financial scams should depend, not on how effectively the victims complain, but on how severely they have been hit.

Given the long list of financial scandals now clamouring for the government’s attention, it may pay to have a checklist to prioritise these claims. Here is how it should read.

Needless to say, the small investor, with the tiny nest-egg, deserves more regulatory protection than the fat cat with cash to spare. But how do you decide who is ‘small’ and who is not?

Today, a person who deposits up to Rs 1 lakh in a bank receives deposit insurance because he is a ‘small’ saver. An investor who plonks Rs 2 lakh in a single IPO bags the retail quota. Mutual funds classify those who park up to Rs 5 lakh in their funds as ‘retail’.

Why don’t we have a uniform definition of the ‘retail investor’ across financial products, so that in the event of a scam, regulators can easily home in on the retail faction and solve their problems first? A clear-cut definition would also come in handy if the Government decides to use the exchequer to bail out retail investors who have been defrauded by a scam.

Going by this yardstick, the seven-lakh investors with dues of Rs 500 crore on the NSEL’s e-series should today figure higher on the list of regulators’ priorities than the 13,000 traders with Rs 5,500 crore stuck in forward contracts.

Risk appetite

One can argue that betting one’s shirt on a speculative trade for the thrill of it is very different from being defrauded of the same shirt by a sharp operator. But, as the net result is the same, this distinction is purely academic. While looking to redress claims, regulators must assess the risk that the investor was willing to take when he first signed that cheque.

Going by this yardstick, investors who were lured by promises of ‘safe’ returns from chits or deposits should get priority over those who willingly signed up for strange convertible instruments, potato bonds or the sponsorship of emus.

Investors in the Saradha ‘deposits’ or other Odisha savings schemes are probably more deserving of a bailout than those in Sahara’s ‘‘optionally fully convertible debentures’’. After all, the Sahara investors (and one still wonders if there are flesh-and-blood ones) were willing to risk their capital by owning shares in an unlisted real estate firm — the riskiest of asset classes.

Extending this logic to NSEL, those who bought its e-series units as a buy-and-hold investment definitely need greater regulatory protection than those who were willing to play the derivatives on raw wool or castor-seed.

Whither due diligence

Could investors have side-stepped the fraudulent scheme with some basic due diligence? That’s a question regulators must ask of every aggrieved investor group too, before addressing its problems.

Take the scores of investors who plonked their money on emu-rearing schemes in Tamil Nadu hoping to make fabulous gains from emu meat, oil and sundry products. Did they stop to think if they would buy these miracle products for their own home?

As to teak plantations and apple orchards, even a child is aware of the weather and yield-related risks in any agrarian venture.

The question of due diligence becomes even more pertinent for seasoned investors in the formal financial markets, where access to information is quite easy.

Admittedly, investors trading on an exchange cannot be expected to check out its incorporation certificate or read its by-laws, as policymakers seem to be suggesting in the NSEL case.

But they should surely be expected to know where exactly their money is being deployed and how the returns are being generated. If you are a seasoned investor in stocks and bonds, would you simply go by the verbal assurances of your broker that there is this fabulous derivative trade that ‘guarantees’ a 12 per cent return?

NSEL’s paired contracts were basically about affluent investors agreeing to fund ‘commodity stockists’ through buyback arrangements at a pre-agreed price.

This arrangement in itself should have made investors smell a fish. Electronic trading in India is over three decades old and who has heard of a ‘trade’ on the exchange platform, where both the transaction price and the counter-party are agreed upon in advance?

Financial literacy

Finally, to do any due diligence, understand the literature that comes with financial products or even heed the warnings of regulators about fraudulent entities, you need to be literate and you need to have access to information.

The many instances of financial scams now surfacing across the country suggest that, when it comes to Indian savers, even these basic factors cannot be taken for granted.

How can one expect a housewife in a village, with no exposure to finance, to appreciate the distinction between a registered co-operative savings society and a Saradha Realty? Or savers outside the metro cities, with dodgy Internet access, to check out the long list of vanishing companies or deposit-taking NBFCs, put out by the SEBI or RBI on their websites?

And given that they pose a challenge even to the highly literate, how is any non-English speaking investor expected to wade through the jargon-laden documents filed by insurers or companies raising public money?

Until the policymakers are able to address these yawning gaps in the dissemination of financial information, the ranks of scam victims knocking at their doors will continue to swell. Until then, the doctrine of caveat emptor can only be applied to a select few.

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