Actions against ponzi schemes

Subject: Economy

Why in the news?

The government and investigative agencies have ramped up enforcement action against those running unauthorised schemes.

Various measures taken:

CENTRAL BUREAU OF INVESTIGATION (CBI):
- CBl has registered 100 cases relating to Ponzi Schemes during the years 2019 to 2022 (up to June 30,2022).
DIRECTORATE OF ENFORCEMENT (ED):
- ED has investigated 87 cases related to Ponzi Schemes under the provisions of the Prevention of Money Laundering Act, 2002.
SERIOUS FRAUD INVESTIGATION OFFICE (SFIO):
- It has been assigned investigation by the Ministry of Corporate Affairs involving 85 companies during the last 3 years, which were allegedly engaged in fraudulent Chit Fund/ Multi-Level Marketing (MLM)/Ponzi activities
SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI):
- SEBI has passed final Orders against 29 unregistered Collective Investment Schemes entities during the last 4 years

Ponzi Scheme

The term “Ponzi Scheme” was coined in 1919 after the name of an Italian con-man named Charles Ponzi.
- He arrived in the US in 1882 and made money through fraudulent schemes.
A ponzi scheme is an investment plan in which the operator or the operating company pays returns to investors from the new capital coming in from new investors instead of the profits of the business.
The investors get attracted to these schemes because of the unusually high rate of return offered within shorter time spans compared to other conventional investment options.
These schemes start off as legitimate businesses. However, they often fail to sustain them with operating income alone. So, in order to meet the promises made to their investors, the capital gathered from new members gets used up.
- This sets off a ripple effect, bringing in new investors to participate. The initial ones then get paid out from the funds received from new investors.
For example, a hedge fund can turn into a ponzi scheme if it faces unexpected losses and cannot legitimately meet the desired returns. The promoters then start forging reports instead of admitting their failures.

What are the characteristics of a Ponzi scheme?

High investment returns with little or no risk
Overly consistent returns-The Ponzi schemes give guaranteed investment opportunity which is suspicious.
Unregistered investments-Ponzi schemes typically involve investments that have not been registered with state regulators.
Unlicensed sellers-Most Ponzi schemes involve unlicensed individuals or unregistered firms.
Secretive or complex strategies: The investments in Ponzi schemes cannot be understood and do not give complete information.
Difficulty receiving payments-promoters routinely encourage participants to “roll over” investments and sometimes promise even higher returns on the amount rolled over.

Laws in India:

Ponzi schemes are generally multi-level marketing schemes, which itself is not illegal in India because there is a product being sold. But direct marketing companies cannot promote pyramid or money circulation schemes.
Ponzi schemes are banned under the Prize Chit and Money Circulation (Banning) Act, 1978.
- It is a Central Act but the respective State governments are the enforcement agency of this law
These are also dealt with by the Enforcement Directorate under the Prevention of Money Laundering Act, 2002.
The Banning of unregulated Deposit Schemes Act 2019 has been enacted to prevent fraudulent schemes.
- It provides for severe punishment ranging from 1 year to 10 years and fines ranging from 2 lakh to 50 crore rupees to act as a deterrent.
- It mentions that the first claim on the recovered money will be that of depositors.
Attempts to regulate Ponzi schemes have taken the form of SEBI’s ‘collective investment scheme’ regulations. By law, any scheme that amasses more than Rs 100 crore requires SEBI’s permission.
- The regulations allow SEBI to take action where it comes across an illegal collective investment scheme.