Crackdown on Ponzi scheme: Ordinance on unregulated deposits a step in right direction, but states should make it more effective

With a view to save gullible depositors from fraudulent investment schemes, President Ram Nath Kovind on 21 February, 2019 promulgated the Banning of Unregulated Deposit Schemes Ordinance, 2019.

Non-banking entities are allowed to raise deposits from the public under the provisions of various statutes enacted by the Central and state governments. However, the regulatory framework for deposit-taking activity in the country is not seamless. The regulators operate in well-defined areas within the financial sector by regulating particular kinds of entities or activities.

For instance, non-banking finance companies (NBFCs) are under the regulatory and supervisory jurisdiction of the Reserve Bank of India (RBI). Similarly, chit funds, money circulation including multi-level marketing schemes and schemes offered by cooperative societies are under the domain of respective state governments. In the same manner, the Collective Investment Schemes come under the purview of Securities and Exchange Board of India (SEBI).

Despite such diverse regulatory framework, schemes and arrangements leading to unauthorised collection of money and deposits fraudulently, by inducing public to invest in uncertain schemes promising high returns or other benefits, are still operating in the society.

Persons running such schemes exploit existing regulatory gaps and lack of strict administrative measures to dupe poor and gullible people of their hard-earned savings. The intent of the Ordinance is to check illicit deposit or Ponzi schemes that hurt small investors.

Ordinance bans Unregulated Deposit Scheme 

The Ordinance defines Unregulated Deposit Scheme **(**UDS) to mean a scheme or an arrangement under which deposits are accepted or solicited by any deposit taker by way of business and which is not a regulated deposit scheme (RDS).

Thus, the deposit taker primarily has to be in the business of taking or accepting deposits. What is business has not been defined in the Ordinance. But as per the common understanding of the term, it would mean a person’s regular occupation, profession or trade. In case of general trading or manufacturing business, the trading or manufacturing activity remains the prime business activity and not acceptance of deposits.

The Ordinance defines ‘deposit’ in a very wide sense. It covers any amount of money received by way of an advance or loan or in any other form by any deposit taker with a promise to return whether after a specified period or otherwise. It is not necessary that the deposit is given with an intent to earn benefit in the form of interest.

Definition of deposit excludes amounts received from the banks, governments, financial institutions, contributions towards capital by partners or a firm or limited liability partnership (LLP), loans from relatives and any amount received in the course of, or for the purpose of business and bearing a genuine connection.

Thus, on combined reading of the definition of the UDS and deposit, it is clear that the intent of the Ordinance is not to ban loans from relatives or friends for personal needs or loan taken in the ordinary course of the business by persons other than those who are engaged in business of accepting deposits which is not an RDS.

Further the ministry of finance through its tweet earlier this week had also clarified the position as

“Banning of Unregulated Deposit Ordinance 2019, exempts individual, firm, companies and LLP etc., for taking any loan and deposit for their course of business as per section 2(4) e,f ,l and other provisions”.

Defaults in case of RDS and wrongful inducement also covered

The Ordinance requires that in case of the RDS, no deposit taker shall commit any fraudulent default in repayment of the deposit or rendering of service as promised against such deposit. The provision would act as a catalyst in enforcing trust of depositors in the RDS.

The Ordinance prohibits wrongful inducement in relation to the UDS, thereby prohibiting any person to make any statement, promise or forecast which is false or misleading, to induce any person to invest in, or become member of any UDS, thereby also covering the agents, who often mislead the gullible depositors to invest in such fraudulent schemes.

The Ordinance provides stiff punishments for offences committed. The punishment ranges from imprisonment for a minimum term of one year to ten years along with hefty fine.

The Ordinance seeks to put in place a mechanism by which the depositors can be repaid without delay by attaching the assets of the defaulting establishments notwithstanding anything contained in Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act (SARFASI Act) or Insolvency and Bankruptcy Code (IBC) which is a laudable step considering the fact that the persons investing in such schemes are generally from the downtrodden strata of the society.

Step in the right direction

Will it have a retrospective effect on funds that individuals and firms have in their books? Well, we can only wait for the rules to bring more clarity in this regard.

No doubt, the Ordinance is a step in right direction to protect the depositors from the likes of Saradha, Narada or Rose Valley. However, the effectiveness of the Ordinance can only be validated by the rules framed in this regard which is the prerogative of the respective states.

While the objective of promulgating the Ordinance is appreciable, considering the harsh provisions and stiff punishments and fines under the Ordinance, more clarity on its applicability and general awareness about the provisions of the Ordinance will be highly appreciated. Needless to say that the fate of the Ordinance would depend on the 2019 electoral results which will ensue in due course.

(Jain is executive partner and Nishith is associate at Lakshmikumaran & Sridharan Attorneys)