Scamsters up to their old tricks, and some new ones too

Corporate criminals seem to be coming up with new ways every year to defraud gullible investors. The year 2013 was no exception, as witnessed by the fraud that took place at the National Spot Exchange Ltd (NSEL). However, tried and tested scams are still in circulation, as evidenced by the myriad Ponzi schemes unearthed by various regulators.

The biggest scam of the year was undoubtedly the NSEL fiasco. Involving around Rs 5,500 crore, skeletons came tumbling out of the closet when there was a postponement in settlement of contracts at the exchange.

Empty warehouses The NSEL came under the scanner of the Forward Markets Commission (FMC) when it surfaced that the bourse was facilitating forward trades with a settlement cycle of 20-30 days, even though it was a spot exchange.

The forward contracts involved a set of commodity stockists selling warehouse receipts to investors for immediate payment. They also entered into a buyback arrangement whereby the investor would sell the commodity back to the stockist after a 25-day or 35-day period, with a “return” element of 12-14 per cent. 

In this manner, stockists received financing while investors got returns. But this soon morphed into a system where speculators were selling commodities without proof of underlying stock and entered into similar buyback arrangements. They drew in investors who didn’t understand the markets, but lent money to fund such trades.

FMC’s direction When this came to the attention of the FMC, the regulator directed the NSEL to immediately bring down the settlement period in its contracts and ensure that all existing contracts were settled on the same day. The exchange complied, but investors panicked and wanted to close out their positions immediately. This led to default as most of the commodities traded on the spot exchange never existed. Thus, buying and selling of commodities, such as steel, paddy and sugar was only being conducted on paper. 

The biggest casualty of the scam was Jignesh Shah, the promoter of Financial Technologies India Ltd, the parent company of NSEL, besides several directors at the firm. Stocks of FTIL crashed after the scam broke out and the FMC recently said that Shah was not fit to run any exchange. The market regulator SEBI is now slated to take a call on whether FTIL is fit to hold a stake in MCX.

CIS scam The Rs 1,200-crore Saradha chit fund scam in West Bengal is another tale of crooks cocking a snook at the authorities for years before finally running foul of the law. As in all classic Ponzi schemes, Saradha Group promised astronomical returns in fanciful but credible investments such as tourism packages, forward travel and hotel booking timeshare credit transfer, real estate, infrastructure finance and motorcycle manufacturing.

Its funds were sold by agents who were recruited from local communities. As much as 25-40 per cent of the deposit was returned to these agents as commissions and lucrative presents to build a wide agent pyramid. To keep ahead of the regulators, the group used a nexus of companies to launder money. 

Saradha first came under the scanner of SEBI in 2009, but by the time evidence against the company could be gathered, it was too late. Saradha refused to comply with orders to cease operations and by January 2013, the cash inflow of Saradha Group was less than its cash payout for the first time — the inevitable outcome of any Ponzi scheme.

Rescue fund Although promoter Sudipto Sen tried to talk his way out of the quagmire, the damage was already done and in a letter to the CBI in April 2013, he admitted to running a pyramid scheme while also blaming several politicians for the situation. The funds that he and his associates duped from investors is unlikely to be paid back, even though the West Bengal Government has set up a rescue fund to ensure that depositors were not bankrupted.

  Reports indicate that Saradha could just be the tip of the iceberg of Ponzi schemes running amok in West Bengal. SEBI is investigating at least five other such companies in the State, including Rose Valley, a group that has raised Rs 4,000 crore through collective investment schemes, though it was not registered to do so.

 But after the Saradha scam broke out, worried depositors that queued up at branches of Rose Valley to collect their money before maturity were not given cash, but coupons and a handwritten note that showed how much money was invested and how much money the company owes the investor now.

This raised the hackles of not only investors, but the market regulator as well.

Potato scheme Sumangal Industries, a Kolkata-based company that collected money from investors ostensibly for a potato purchase scheme, has also been given winding up orders by SEBI.  

Besides Ponzi schemes, a host of other financial scams were unearthed in 2013. In Ahmedabad, software firm Sai Info-System’s Chairman and Managing Director Sunil Kakkad went missing after it came to light that the company’s financials were cooked up. Some 1,400 employees of the company were not paid their salaries for months as a result.

The road ahead

 As the saying goes, ‘a fool and his money are soon parted’. It is entirely up to the investors to question companies that approach them with a bait of lucrative returns, to understand where their money is being channelled. SEBI has brought out the collective investment scheme regulations to help bring all ponzi schemes under the regulator’s purview. But the rules have many loopholes through which the guilty can use to escape. We have, therefore, not heard the last on the scams yet.

arvind.jayaram@thehindu.co.in

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