After Sanchaita, it’s Saradha

“Don’t grow too high lest a storm makes you tumble down”.

Bengali proverb

Thousands of Bengalis must have remembered this as news came in that the Saradha Group — a chit fund company — went bust overnight. Unsurprisingly, there are reports that the group had close links with the ruling party in West Bengal. Apparently, one of the members of the party was the brand ambassador, while another was president of the employees’ union.

Frustrated depositors and agents on Saturday gave vent to their anger by ransacking its offices across West Bengal. An agent in Durgapur committed suicide as news of the Saradha promoter’s disappearance broke out. Depositors had apparently turned up at his door to claim their money. The incident brought back memories of a similar crisis that gripped Bengal in the 1970s, when the Sanchaita chit fund went bust, leaving thousands in the lurch. Being largely unregulated, such instances are bound to occur in the chit fund industry. Earlier this year, a chit fund based out of Orissa, cheekily called Future India, ensured that there was no future for the money given by the depositors.

Collective Investment Scheme

It is not that there is absolutely no regulation of chit funds. Like many Acts passed in those times, The Chit Funds Act, 1982, has just enough operative and administrative provisions to ensure that chit funds do what they were supposed to do.

Section 46 of the Act empowers the Registrar or an officer authorised by the State Government to inspect chit books and all the records of a chit during working hours on any working day at the premises of the foreman, with or without giving notice. Any defects that the Registrar notices are to be brought to the notice of the foreman, who shall ensure that corrective action is taken. The ensuing Section permits the Reserve Bank of India to also conduct an inspection of the books and records if it deems it necessary.

It is apparent that these provisions have been used rather infrequently. A glaring omission in the Chit Funds Act is the lack of powerful penal provisions. The light-hearted nature of the Act and the casualness of the supervisory mechanism could have prompted many chit funds to turn into Ponzi schemes. In 1999, the Securities and Exchange Board of India (SEBI) brought out the SEBI (Collective Investment Schemes) Regulations, 1999.

A Collective Investment Scheme (CIS) was defined as any scheme or arrangement made or offered by any company, under which the contributions, or payments made by the investors, are pooled and utilised with a view to receiving profits, income, produce or property, and is managed on behalf of the investors is a CIS. Investors do not have day-to-day control over the management and operation of such scheme or arrangement. 

There were eight instances given in the regulations as to what would not constitute a CIS Scheme — one of which was any scheme or arrangement falling within the meaning of chit business as defined in clause (d) of section 2 of the Chit Fund Act, 1982 (40 of 1982).

Capital-raising schemes are to be compulsorily credit-rated, appraised by an appraising agency, approved by the trustee and containing disclosures, which would enable the investors to make informed decisions. Financial statements are to be prepared, audited and circulated. SEBI has ensured that the statutory disclaimers are in place — it states that SEBI does not take any responsibility either for the financial soundness of any scheme for which the offer document has been filed, or for the correctness of the statements made, or opinions expressed in the offer document.

Action that SEBI could take includes criminal prosecution, passing directions to the person concerned not to collect any money from the investor or to launch any scheme, prohibiting the person concerned from disposing of any of the properties of the scheme acquired in violation of the regulations, requiring the person concerned to dispose of the assets of the scheme in a manner as may be specified in the directions, requiring the person concerned to refund any money or the assets to the concerned investors along with the requisite interest or otherwise collected under the scheme, and prohibiting the person concerned from operating in the capital market or from accessing the capital market for a specified period. Criminal laws in India would take care of the arrest and other actions.

New regulator

As the groundwork for the single financial regulator gets underway, the Government should contemplate bringing chit funds under the new regulator, along with other unregulated financial entities such as those that promise impossible returns within months. The provisions could be a combination of the Chit Funds Act and SEBI Collective Investment Scheme Regulations.

Instances of clear fraud should be referred to the Serious Fraud Investigation Office. A dash of regulation and some discipline could ensure that future Saradhas are minimised — if not eliminated.

(The author is Director, Finance, Ellucian)

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