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Regulation of Collective Investment Schemes

Investment is one of the major political planks of the present political regime which help them to retain the throne. The government is also taking investment friendly steps to meet their promises. It also raises potential regulatory challenges which may arise in near future. Already country has witnessed many big scams like Harshad Mehta vs CBI[1] which led to the formation of regulatory bodies like Securities and exchange Board of India (SEBI) in 1992. After SEBI proper registration method is followed aimed at curbing such scams in future. SEBI has been successful in achieving its objective until now.

In the late 90s many entities were floating many schemes which pooled money from the general public for exorbitant returns. But many schemes failed in giving returns which made huge loss to the people who invested enormous amount of money with the hope to get something better return. SEBI was appointed as an official regulator of the collective investment schemes. These fraudulent money pooling activities are causing huge loss to the innocent investors and these results in huge loss to the economy of the nation.

Adequate finance is integral to growth of the economy. The growth of the economy is dependent on the production and distribution of goods and services, which in turn is correlated to availability of capital. For this purpose, company collects huge amount of money from the investors. Collective Investment Schemes is an arrangement wherein any pooled money by the investors is utilized only for the purpose of the scheme.

The contributions made by the investors are made with the object of earning profit, income or produce. Collective Investment Schemes falls under the purview of the SEBI. SEBI regulates it through the SEBI Act, 1992 and CIS Regulation, 1999. There are four main participants in the scheme- Collective Investment Management Company, Trustee, Shareholder and Fund Manager. Collective Investment Schemes though regulated by these two frameworks have not been effective in curbing the scams.

These fraudulent pooling activities are launched in abundance. These fraudulent pooling activities are causing huge loss to the innocent investors and are also eroding the confidence of public in investing their savings in the productive areas. This ultimately results in loss the economy of the nation.

The term Collective Investment Scheme has been defined under Sec 11AA of the SEBI Act, 1992. These are regulated by the SEBI Act, 1992 and CIS regulations,1999. It is a trust-based scheme comprising of pools of assets which is managed by the scheme manager. CIS portfolio is the contribution of group of small investors. The stake of each investor in the total portfolio is represented by the units of scheme held by the investors. These units are securities in terms of Sec 2(h) of the Securities Contract Regulation Act, 1956.[2]

The definition of Collective Investment Scheme is as follows:
Section 2(ba): collective investment scheme? means any scheme or arrangement which satisfies the conditions specified in section 11AA.[3]
Section 11AA
  1. Any scheme or arrangement which satisfies the conditions referred to in sub-section (2) [or sub-section (2A)] shall be a collective investment scheme: 30[Provided that any pooling of funds under any scheme or arrangement, which is not registered with the Board or is not covered under sub-section (3), involving a corpus amount of one hundred crore rupees or more shall be deemed to be a collective investment scheme.]
  2. Any scheme or arrangement made or offered by any [person] under which:
    1. the contributions, or payments made by the investors, by whatever name called, are pooled and utilized for the purposes of the scheme or arrangement;
    2. the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement;
    3. the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;
    4. the investors do not have day-to-day control over the management and operation of the scheme or arrangement.
      2[(2A)] Any scheme or arrangement made or offered by any person satisfying the conditions as may be specified in accordance with the regulations made under this Act.]
  3. Notwithstanding anything contained in sub-section (2) [or sub-section (2A)], any scheme or arrangement:
    1. made or offered by a co-operative society registered under the Co-operative Societies Act, 1912 (2 of 1912) or a society being a society registered or deemed to be registered under any law relating to co-operative societies for the time being in force in any State;
    2. under which deposits are accepted by non-banking financial companies as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934);
    3. being a contract of insurance to which the Insurance Act, 1938 (4 of 1938), applies;
    4. providing for any Scheme, Pension Scheme or the Insurance Scheme framed under the Employees Provident Fund and Miscellaneous Provisions Act, 1952 (19 of 1952);
    5. under which deposits are accepted under section 58A of the Companies Act, 1956 (1 of 1956);
    6. under which deposits are accepted by a company declared as a Nidhi or a mutual benefit society under section 620A of the Companies Act, 1956 (1 of 1956);
    7. falling within the meaning of Chit business as defined in clause (d) of section 2 of the Chit Fund Act, 1982 (40 of 1982);
    8. under which contributions made are in the nature of subscription to a mutual fund;
    9. such other scheme or arrangement which the Central Government may, in consultation with the Board, notify,] shall not be a collective investment scheme.]

This section provides for pre-conditions necessary for any scheme to be constituted as collective investment scheme.

It provides for four conditions; it is as follows:
  1. The contributions of the small investors must be pooled and deployed for the purpose of scheme only.
  2. Investors have contributed in the scheme with the aim to gain:
    • Profits, or
    • Income, or
    • Produce, or
    • Property � Movable or Immovable
  3. These contributions are managed on behalf of investors.
  4. Investors do not have day-to-day control on the contributions or scheme.

This section also provides for certain exceptions:
  1. Scheme offered by a co-operative society registered under the Co-Operatives Act, 1912 or any state law for registration of the co-operative society. Co-operative societies fall under the purview of the State Government, if its object confine to a single state else Central Government
  2. Schemes will allow acceptance of deposits by NBFCs. Non -Banking Financial Institution are regulated by RBI. RBI has issued NBFCs Acceptance of Public deposits (Reserve Bank) Directions,1998 to regulate the NBFCs.
  3. Contract of Insurance, which is regulated by the Insurance Development and Regulatory Authority of India or pension scheme or provident scheme under the Employees Provident Fund Act.
  4. Schemes offered as chit funds. Chit funds are regulated by the State Government.
  5. Schemes in the form of mutual fund which are regulated by the SEBI Mutual Fund Regulation of 1996.
  6. Deposits accepted by the Companies under Section 74 of the Companies Act and also deposits accepted by the Nidhi Companies under Section 406 of the Companies Act,2013.
  7. Any other scheme notified by the Central Government in consultation with the SEBI.

Any scheme with a corpus of more than Rs. 100 crore which is not regulated by any other authority and does not fall to any of the exceptions to the Collective Investment Scheme would be CIS. This amendment was brought to the definition to regulate the innovative schemes designed in a way that they fall out of the purview of any regulator and thus remains unregulated.

In 1990s many plantations and agro based companies pooled money from the investors for the purpose of investing. Such schemes lured small investors by promising them very high returns. However, they failed to return even the principal amount depriving the small investors of their hard-earned money and bringing misfortune to them.

In the case of PGF Ltd,[4] the Supreme Court of India has discussed the scope of Section 11AA of the SEBI Act, 1992. It stated that the applications of the provisions of this section are not limited to the agriculture or plantation activities or for that matter any specific type of activity. Instead, any activity which satisfies all the condition specified under Section 11AA and is not regulated by any authority/regulator will fall under the category of the collective investment schemes. It is observed that this provision was introduced to protect the interest of the investors thus to give effect to its object it is necessary to give wide connotation to it while any interpretation.

Participants Of The Collective Investment Schemes

  • Collective Investment Management Company:

    The Collective Investment Management Company is characterized as an organization that is incorporated under the arrangements of the Companies Act,2013 and which is additionally enlisted with SEBI under the SEBI (Collective Investment Scheme) Regulations, 1999 which works with the main goal compose, work and deal with a CIS.
  • Fund Manager:

    A Fund Manager or an investment manager a certified and a qualified person who deals with the CIS management choices and decisions. This individual likewise offers to trade reconciliation, valuation, and unit evaluating of the plan or the course of action or the scheme.
  • Trustee:

    An individual who holds the property of the CIS in trust the support the unitholders is known as trustee. Trustee works as per the applicable guidelines ad shields the benefits just as the guarantees the consistency with the principles and guidelines. It is basic that a CIS is established as the Trust according to the CIS Regulation 1999. A organization or company may choose a trustee who could hold the advantages of the CIS to serve its financial specialists.
  • Shareholder:

    The unit holder or normally known as shareholder, are the people who contribute assets in the CIS. These shareholders need to the rights to the advantages engaged with the plans and to the related salary or income produced by the plan or scheme.

Regulatory Framework
Central Government has given powers to the SEBI to regulate CIS. According to Sec 12(1)(b) of the SEBI Act, 1992 no entity is eligible to launch CIS before registering it with SEBI as collective investment management company. But the constitutional validity of Sec 11AA and Sec 12(1)(b) has been challenged on the grounds of the excessive delegation and violation of Art. 14 of the Constitution of India[5].

The Apex Court was of the view that the provisions which were challenged were introduced to protect the interest of the investors and adequate safeguards have been introduced on SEBI and refrain it from abusing its power. Such provision is not arbitrary. In the case of M/s PGF ltd. Vs Union of India[6], the court applying the doctrine of pith and substance stated that the Parliament introduced such provision to protect the interest of the investors which is the prime object of the SEBI.

Procedure Followed By Sebi

If the SEBI Board has prima facie case that there is case of default then it may appoint an officer as designated authority. The officer so appointed shall not below the rank of division chief. The appointed officer may appoint more 3 members if he desires not below the rank of division chief in case, he feels there�s a need. The designated authority or the bench as the case may be would issue show cause notice to concerned person to state reasons as to why any action must not be initiated against him and the company. The show cause notice must contain proper details about alleged contravention along with the respective provision.

The notice shall be given an opportunity to represent himself along with documentary evidence within the period specified in the notice. Such period should not be more than 21 days from the date on which the notice has been served. The designated authority may also extend the time for representation if satisfactory reasons if exist for non-compliance within the time period. In case the notice does not respond to the show cause notice then the designated authority may proceed against the notice ex-parte. It has to record the reasons for the same in writing.

The designated authority shall prepare a report after taking note of all facts, evidence, provisions of law, etc. The report may also contain recommendations on the appropriate action to be taken such as cancellation of certificate, prohibiting notice to launch further schemes, winding up of existing schemes. The report has to be submitted to the Board. On receiving the report, the Board shall also issue the show cause notice to the concerned person.

The report of the designated authority must also be attached with the show cause notice. The notice has to state reasons as to why any action by the Board must not be taken. The notice must specify the time period for written representation by the notice and in no case such period shall be more than 21 days. After the written reply from the notice, the Board provides him with an opportunity of being heard. After hearing all the concerned person�s, the Board shall pass appropriate orders. Endeavour shall be made to wind up the case within 120 days of receiving the reply on notice.[7]

Powers Of Sebi

Powers Under Cis Regulations,1999

In accordance with the power conferred by the CIS Regulations, Board can pass the following order against the concerned persons, in case of default.
  1. Action Against Concerned Person Of Company

    • To stop collecting any further money from the investors and prohibition on launching any further schemes.
    • Forbid te concerned persons from disposing of the assets connected with the scheme.
    • Direct the concerned persons from disposing of the assets associated with the scheme in prescribed manner.
    • Refund the invested amount with the specified interest to the investors.
    • Forbid access to capital market for certain period.[8]
  2. Action Against Intermediary:

    The Board has power to suspend as well as cancel the registration of any intermediary who did not perform proper due diligence or contravened any of the mandatory duties specified in the regulations. While taking action against intermediary the Board has to follow procedure mentioned in the SEBI (Intermediaries) Regulations, 2008.

    The powers prescribed in the CIS Regulations are in addition to the powers of the Board under the SEBI Act,1992.

Powers Of The Board Under The Sebi Act, 1992.

  1. Powers To Issue Directions:

    After the completion of the inquiry, the Board, if satisfied that the interest of investors is at stake then it may issue directions to the company or intermediary associated with the whole process of default to safeguard their interest. This provision provides huge power to SEBI to issue any direction to protect the investors and regulate the intermediaries. However, such direction must be preventive and remedial in nature.[9]
  2. Power To Order Investigation And Impose Penalty On The Non-Cooperation With The Investigating Authority

    The Board can also appoint an Investigating Authority to investigate into the alleged matter and form a report regarding the same. The investigating authority has power to ask for any books, record or document required for investigation. It can also examine officers and other employees of the company on oath. Also, if the authority has reasons to believe that any relevant evidence might be hampered then it may also order seizure of such evidence. The Directors and other employees of the company have to compulsorily co-operate with the investigating authority and provide him with all relevant information. In case of failure to do so the Board can impose punishment for one year and fine upto Rs. 1 crore.[10]
  3. Power To Impose Penalty For Fraudulent And Unfair Trade Practise:

    Under the Act, SEBI has power to impose penalty for illegal and fraudulent money pooling upto Rs. 25 crores or three times the amount of profit made out of such practice.[11]
  4. Power To Initiate Criminal Prosecution:

    It has power to initiate criminal prosecution against the violators of the Act and Regulations made thereunder. It can also impose fine to the tune of Rs. 25 crores and order civil imprisonment upto 10 years. However, such a power has to be exercised with caution and in rare cases as it has the effect of restraining the liberty of an individual.[12]
  5. Power To Initiate Recovery Proceedings:

    In accordance to Section 28A of the Act, SEBI has power to initiate recovery proceedings against every person who has failed to refund the money of the investors as per an order of SEBI or has not paid the penalty amount. This power is to be exercised by recovery officer. The recovery officer firstly formulated a certificate regarding amount to be recovered and only then recovery proceedings are initiated. The recovery officer can use any of the following methods to recover the amount:
    • Attach and sell the movable property
    • Attach the Bank�s account
    • Attach and sell immovable property
    • Arrest the offender and detain him in prison
    • Authorize a recover for managing the movable and immovable property of the offender.

An appeal to the Securities Appellate Tribunal (SAT) can be preferred against any order or direction of the Board or the adjudicating officer, which is given in accordance with the provisions of the SEBI Act or CIS Regulation.[13] The appeal must be filed within 45 days of the order and not an administrative order.

Supreme Court clearly clarified that any circular issued by SEBI would be in administrative in nature and any order under sections 11(4), 11(d), 12(3) and 15 I of the Act would be as quasi-judicial in nature. Also, an adjudicatory order under any regulation made under SEBI Act would also be by the SAT[14].

The second appeal can lie only on question of law. The Supreme Court if satisfied can extend the period for filing the appeal. The jurisdiction of civil courts has been barred.[15] The matters regarding which the Board or SAT have been empowered is out of the jurisdiction of civil courts. However, the writ jurisdiction cannot be ousted. So, a writ petition can still be preferred.

Case Laws
  1. Maitreya Services Pvt. Ltd

    Maitreya services had floated various schemes wherein they were collecting money from the public for development of land by promising exorbitant returns. Income tax department referred the matter to SEBI alleging that the company seems to have violated SEBI regulations. SEBI conducted enquiry and found that the schemes offered satisfied all the ingredients of CIS and were yet not registered with SEBI. The operations of Maitreya Services were in nature of CIS and not a real estate business as it claimed to be.

    The company had collected a huge amount to the tune of Rs. 1332 crores as advances and had no adequate assets to pay off the investor�s money also there was no work in progress. The investigation also revealed that the company had Rs. 204 crores as the outstanding liability in favour of investors and the assets of the company were no enough to pay off the debts. The liabilities of the company were double its movable and immovable assets.

    This is evident of the fact that the company is running the schemes in detriment of interest of the investors. SEBI ordered that the company has contravened section 12(1)(B) of the SEBI Act,1992 and Regulation 3 of CIS Regulations by launching a CIS without obtaining registration from SEBI.

    Thus it is directed to wind up the schemes and refund money to the investors. It also referred the case to the local police department to initiate a criminal proceeding for the offence of fraud, cheating and misappropriation of public fund. Challenging the orders passed by SEBI, the company filed an appeal to SAT under Section 15 T of the SEBI Act, 1992.

    The appellate tribunal validated the order of SEBI however it extended time for repayment of money by 6 months. Instead of making refund to the investors in compliance of SEBI�s orders the directors of the company floated another company with the name of Maitreya Realtors and Construction Ltd. And transferred all the investments to this new company.

    In form both the companies were separate legal entities but behind the veil they were operated by the same directors. The new company was also engaged in floating illegal CIS. SEBI passes winding up orders against Maitreya Realtors and auctioned 8 properties of Maitreya Services to return the money to the investors. However due to the sale of property at a lower value, it was not able to refund complete investment.
  2. Rose Valley Scam

    In the backdrop of Sharda Scam, the Supreme Court of India in 2014 ordered the investigating agencies to examine other companies which were involved in raising of funds from the general public. The Rose Valley Scam was exposed in this investigation. This group has solicited money from millions of investors by launching illegal CIS. It is assumed that this scandal is one of the biggest financial scams related to Ponzi schemes. This has shaken the very foundation of almost sixty million houses in India. Reports say that the scam is much more enormous than Sharda Scam.
  3. Emergence Of Rose Valley Group:

    The Rose Valley Group was basically started by its ex-Chairman Kajal Kundu in 1990s. he started with the incorporation of Rose Valley hotels and entertainment ltd. Slowly and gradually he expanded the business to real estate, media, entertainment and then in 2002 to agency of LIC. It took almost 18 years� time span to build the empire of Rose Valley.
  4. Modus Operandi:

    The Rose Valley group pooled money from the investors by offering exorbitant rate of returns. It solicited money from thousands of investors by luring them with high returns rates upto 21% of their investments. These funds were collected as an instalment towards purchase of property or holiday packages. Basically, two of the companies were majorly involved in launching camouflaged CIS.

    Firstly, Rose Valley real estate and construction limited was raising funds from the general public by launching schemes for the development of property and the investors were to be given a credit value which could be used as a part payment for buying land or can also be returned at the end with returns.

    Secondly Rose valley hotels and entertainment ltd was raising funds from investors by offering holiday membership schemes. Under these schemes, investors had to pay monthly instalments which could be utilized at the maturity either for booking a holiday package or the investors can also take back the money with additional returns. These companies were not actually investing any money in any business. They collected money from the new investors and repaid the old investors with that amount. In this way they were just rotating the amount among investors.
  5. Sebi�s Intervention:

    SEBI received a letter from the Directorate of economic offence investigation cell, West Bengal on 7 th December 2009 stating that the company seems to be violating SEBI Regulations. It again received a complaint from Directorate of Income Tax on 27th July, 2011 disclosing that the rose valley real estate is raising funds from the public without authorized permission of SEBI. It also received complaints from other regulatory bodies as well as many investors regarding non-Payment of dues, after which it started investigation into the matter.

    On Jan 3rd, 2011 SEBI passed interim order against rose valley real estate prohibiting it to collect any money under the old as well as new schemes as the same is in violation of Regulation 3 of CIS regulation 1999.Meanwhile it also received complaint from ADG of Police Assam stating that Rose Valley real estate and rose valley hotels have together solicited Rs 1006. Crores from the public until Feb, 2012.99 Rose Valley Real Estate had been violating the interim order passed by SEBI

    Also, the activities of Rose Valley real estate were in contravention of SEBI Act as well as CIS Regulation. SEBI also started investigation against Rose Valley Hotels. It observed that the schemes launched by Rose Valley group satisfied all the ingredients of CIS. It stated that in both the scheme the contributions made by the investor were pooled in as there was undivided interest and was used for the purpose of scheme only. It concluded that both the companies had launched Collective investment schemes in the garb of Real estate and time share business. It passed final orders Rose Valley real estate on 18th June 2014 and an exparte order was passed against rose Valley hotels on 10th July 2013.
  6. Method Adopted For Absconding Order:

    The Rose valley group in order to abscond from SEBI orders adopted the very old strategy of fillings appeals and writs for delaying the matter. It adopted all possible means to obfuscate the matter. SEBI passed interim order against Rose Valley Real Estate and Construction limited on 3rd January, 2011 prohibiting the company from raising funds from public under any existing or new schemes.102 Instead of filing a response to the order, the company approached various courts challenging the order of SEBI. Firstly, it filed a writ petition at High court of Calcutta.

    The Honourable Court dismissed the petition directing to exhaust the alternate remedy of appealing to SAT first. However, for delaying the matter the company kept on challenging it in various courts. It challenged the High Court�s order in Division Bench which also dismissed the matter. It again challenged the constitutionality of CIS Regulations in Calcutta High Court. The Court imposed injunction on SEBI�S orders and directed it to not proceed further with investigation until the matter is subjudice. During this time the company continued with acceptance of funds from the public.

    On July, 2013 the court dismissed the matter while upholding the validity of the Act. Now the alleged Company filed an appeal before SAT. The whole procedure delayed the matter to such an extent that it took almost 4 years for SEBI to pass final orders against Rose Valley group on 18th June 2014.
  7. Loss To Investors:

    The whole scandal led to a loss of almost 60,000 crores to almost 60 million investors. They targeted people from low-income group who had low financial literacy. The scam mostly effected the people from West Bengal, Orissa and A.P. This scam brought misfortune to millions of households in India by taking away their lifesavings. It has also shaken the confidence of people from investments.

    Reports state that one out of every twenty persons has been hit by such fraudulent investment schemes. These schemes mostly target those people which do not have easy access to Banking system as they are easily lured by offering high interest. The Direct impact of this is on the economic growth of the country as the savings which could have been invested in the productive arenas is lost to unscrupulous companies in fa�ade schemes.
  8. Current Status:

    CBI and the Enforcement Directorate are separately investigating the Rose valley case. Gautam Kundu, the Director of Rose Valley Group and two of the Trinamool congress leaders have been arrested for alleged connection with the Scandal. Both CBI and ED have filed charge sheets for cheating, fraud and criminal misappropriation of funds against the directors and other persons involved in the case. The investigation is still going on.

While the intent and purport of CIS regulation world over is quite clear, but the provisions have been described as �extraordinarily vague�. In the shared economy, there are numerous examples of ownership of property being given up for the right of enjoyment. As long as the intent is to enjoy the usufructs of a real property, there is evidently a pooling of resources, but the pooling is not to generate financial returns, but real returns. If the intent is not to create a functional equivalent of an investment fund, normally lure of a financial rate of return, the transaction should not be construed as a collective investment scheme.

CIS Regulations, if made effective by plugging in the loopholes, can serve as an efficient instrument for financial inclusion. Collective investment schemes could very effectively be used for channelling small savings of people into the economy. The entry size of these schemes is usually very low. It can promote participation of large number of people in the economic system. Thus, it is necessary to bring changes in the regulation in order to build the confidence of public in investments and enhancing economic growth of the nation.

  1. 1992 (24) DRJ 392
  2. Sec 2(h)- �securities� includes-
    (ib) units or any other instrument issued by any collective investment schemes to the investors in such scheme
  3. Inserted by the Securities Law (Amendment) Act, 1999, w.e.f. 22-2-2000.
  4. M/s P.G.F. Ltd. & ors vs Union of India & Anr [2013
  5. M/s Rose Valley Real Estate & Construction Ltd. Vs Union of India
  6. [2013] Insc 312
  7. Chapter VII, CIS Regulation, 1999
  8. Regulation 65, CIS Regulation, 1999
  9. Sec 11B of the SEBI Act,1992
  10. Sec 11C of the SEBI Act,1192
  11. Sec 15HA of the SEBI Act, 1992
  12. Sec 24 of the SEBI Act, 1992
  13. Sec 15T of the SEBI Act, 1992
  14. NSDL vs SEBI [2017] 79 247 SC
  15. Sec 15Y of the SEBI

    Award Winning Article Is Written By: Ms.Rasika Sanjay Ghate
    Awarded certificate of Excellence
    Authentication No: JU115851306543-7-0621

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