Two weeks ago, Saradha Group, a financial firm at the centre of an alleged Ponzi scheme, stopped honouring redemptions of its investments.
The company, based in the eastern Indian city of Kolkata, is believed to have raised more than $3.5bn from about 250,000 investors by promising returns as high as 40 percent in less than two years. Sometimes the returns also included a brand-new SUV at the end of the maturity of the schemes, investors said.
Investors into the alleged scheme were paid generous commissions, India’s NDTV reported, and the fund only went bust after the group couldn’t pay some of the policies that had matured.
Sudipta Sen, who rose from a small-time property dealer to lead the fund, was arrested on April 23, after police tracked him down in Kashmir, where he was said to be hiding. Some company officials say they were also duped by Sen and are unsure how the financial drama will unfold.
“I am being hounded by depositors but I have nowhere to go,” said Sanjib Pal, a former company collection agent. “I was paid a fixed commission for every new deposit.” Saradha Group had appointed thousands of collection agents across the region to raise money from investors, Pal said.
Saradha operated a classic Ponzi scheme. It raised money from new investors and paid the existing ones with money from new clients, rather than actual returns from productive capital. The company started defaulting early this year after it was barred from raising more money by India’s market regulator SEBI.
Selling glamour and clout
Investors and other angry people have taken to the streets to demand action from the government on alleged fraudsters. “They told us that our money is being invested in [the] group’s businesses,” said Shyamal Dasgupta, a small-time trader who has been camping in front of Saradha’s offices hoping for a refund.
But there has been no relief yet for Dasgupta and thousands like him. Three persons believed to be investors in Saradha have committed suicide after the scam became public.
Founded in 2006, the rise of Saradha Group has been meteoric. In the span of seven years the group diversified into several businesses including media, real estate, and automobiles. The Group also signed several high-profile sponsorship deals including with Mohun Bagan, one of India’s oldest football teams.
I feel the government has a lot of explaining to do. Could these companies have survived without political patronage?
“They sold us the glamour and the clout,” Dasgupta said. “It was a well-executed plan which tricked us into believing that the company was churning good profits which made those returns on investment possible.” In reality, authorities have now found that many of group’s supposed companies were never operational.
Meanwhile, members of India’s political class are under fire for their alleged complicity in the scam. Reports have surfaced about the involvement of several senior politicians and other figures who allegedly took favours from Saradha Group for looking the other way.
“There have been serious legal violations by Saradha all these years and it is surprising that it has gone undetected,” said Sajid Mohamed, a partner at PDS & Associates, a Mumbai based corporate law firm. “I feel the government has a lot of explaining to do. Could these companies have survived without political patronage?”
The West Bengal government and India’s federal government have ordered separate probes into the case, in what many observers believe is an example of political damage control. The West Bengal government has also created a $10m fund aimed at partly compensating investors for their losses.
India has had a long history of such scams from which little lessons seems to have been drawn. In the eighties and nineties, several such firms went bust and thousands had their savings wiped out, but they hardly proved to be a deterrent.
In September 2012, regulators began a crackdown on the activities of Lucknow-based conglomerate Sahara India Parivar. It was found that the company had raised more than $5bn from small investors by allegedly flouting rules and had failed to return investors’ money when ordered to do so by India’s Supreme Court and its market regulator Securities and Exchanges Board of India (SEBI).
Sahara India too began as a chit fund company in 1978. Chit funds are collective savings schemes practiced in India. Unlike large asset management companies, Chit Funds often have weaker regulatory supervision.
Sahara later diversified into other businesses ranging from media, aviation, real estate and retail. The group owns a cricket team in the Indian Premier League and is the main sponsor of India’s national cricket team. The group also holds a 42.5 percent stake in Formula One's Force India Formula 1 Team and sponsors India’s national field hockey team.
However, Sahara’s companies do not seem to generate profits high enough to guarantee the returns promised to investors, according to regulatory filings, and consumers are angry.
Sahara denies any impropriety and in full page newspaper advertisements stated that the company "has never been against the law or the spirit of the law". It also claims to have refunded $4.5bn of investor money.
The protestations notwithstanding, such firms in the money market are garnering more attention from the authorities. Last month, for example, SEBI stopped another Kolkata-based company from raising money from the public by promising 30 percent annual returns on potato farms.
“The modus operandi is often similar,” said Mohamed of PDS Legal. “Other businesses are mostly created as fronts to raise money from unsuspecting investors but the real agenda to keep raising money for the Ponzi schemes.”
Poor banking penetration
The success of Ponzi schemes targeting low-income individuals is seen by analysts as indicative of broader failures in India’s banking sector.
Banking penetration in India is estimated to be 52 percent among middle- and high-income groups, but only 5 percent among low-income people, according to numbers cited by banking industry officials.
Named after Charles Ponzi, an Italian businessman who was
convicted in the 1920’s for swindling investor money through a fraudulent investment scheme of postal reply coupons, a Ponzi scheme dupes investors by promising above average returns.
In Ponzi schemes, fraudsters pay returns to existing investors by money raised from new investors. Since a Ponzi schemes is not supported by any real investment that could generate the promised returns, it tends to collapse whenever there is a liquidity crisis in the system triggered by higher redemptions or when a Ponzi scheme is not able to raise
money from adequate number of new investors.
In such schemes, fraudsters take often advantage of lack of investor awareness with respect to the scope of investments and in the context of the promised returns.
It is estimated that only 57 percent of India’s population has access to bank accounts, 13 percent have debit cards and 2 percent use credit cards, Dun and Bradsreet, a research firm, reported in 2011.
“This is a huge problem," said Ramnath Pradeep, former Chairman of Corporation Bank, one of India’s largest public-sector lenders. “The rural poor have very few options available to invest and often end up falling prey to dubious investment schemes. India urgently needs more banks especially in the rural sector,” Pradeep said.
Regulators have been closing down companies considered unfit to run investment schemes, but experts believe that desired results will take more time.
India is home to more than 12,000 registered financial services companies and monitoring the activity of each of them remains difficult. “But there have been improvements and India’s banking regulations have been changed several times to encourage financial inclusion,” Pradeep said.
Between 2011 and 2012 deposits in India’s commercial banks grew at 18.3 percent, and lending has gone up by 22.9 percent, Dun and Bradstreet reported. Average population per branch has also improved from 14,000 in 2010 to 13,466 in 2011. Under India’s revised banking policy, banks have been asked to open at least 25 percent of their new branches in rural areas.
Despite some movement on reform, critics believe the combination of endemic corruption, the greed of investors demanding high returns and a weak banking sector in rural areas mean the problem could get worse.
“These scams happen because smaller investors fall for the high returns,” said Ashis Biswas, a senior journalist.
Even with access to bank accounts, India’s poor may have little to cheer about. For more than five years, inflation has been close to 6 percent in India, while average annual returns on bank deposits have been between 8-9 percent, reducing real income significantly. The worst affected are India’s poor, who often live on less than $2 a day.