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Curbing financial frauds: Regulator’s role ain’t enough, states need to Act as well

Sebi data shows that states where most cases of illegitimate fundraising were observed are the ones with a poor track record related to local legislation dealing with financial frauds and their implementation.

Written by Sandeep Singh | New Delhi |
Updated: June 21, 2016 6:06:15 am
financial frauds, financial frauds india, banking frauds, bank fraud rbi, rbi, reserve bank of india, cash transactions, Sebi, Enforcement Directorate, Companies Act, India news The action on a large number of companies across the country in the past three years highlights the regulator’s attention to the magnitude of the issue and to the fact that numerous small investors were duped. (Illustration: C R Sasikumar)

Earlier this month, the Securities and Exchange Board of India (Sebi) released the updated list of companies against which it has passed orders for illegitimately raising funds through deemed public issues. While the list includes names of 235 companies, the state-wise break up shows that more than 50 per cent or 135 companies are from West Bengal. Madhya Pradesh and Odisha are distant second and third position with 30 and 18 companies respectively from the states, according to the list. By comparison, the list has only 3 companies from Maharashtra and 9 from Delhi even though Mumbai and Delhi account for the bulk of the financial transactions within the country.

The action on a large number of companies across the country in the past three years highlights the regulator’s attention to the magnitude of the issue and to the fact that numerous small investors were duped. It also shows that the enormity of the menace is far more in West Bengal as it alone accounts for around 58 per cent of the cases reported by Sebi and three states (WB, MP and Odisha) account for almost 80 per cent of the cases, raises question marks on the state governments’ role in curbing such practices.

Though the data only relates to the companies against which Sebi has taken action (and therefore may not capture the entire spectrum of the issue), experts say that it is also a reflection of governance within the states and is also reflects the kind of reach the formal financial system has over its citizens. Also, the fact that there is low level of awareness about financial products and their regulation in smaller towns and villages— a result of low financial literacy— leads to proliferation of fraudulent deposit and ponzi schemes.


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A government official also pointed to the reach and penetration of the formal financial system and the level of financial education in tier 2, 3 and 4 cities across states.

“There is lack of access to basic financial system in large parts of the country. While the government has embarked upon the Jan-Dhan scheme to reach out to people and to get individuals in rural areas enrolled in the banking system, it will take some time for all this to materialise,” said the official.

break up

Importantly, in 232 of the 235 cases where Sebi took action, the orders have come after September 2012 when the Supreme Court indicted two Sahara Group firms for raising funds through deemed public issues such as optionally fully-convertible debentures (OFCD) and also established Sebi’s jurisdiction to regulate OFCDs and other public offerings made by unlisted companies.

While Sebi has taken action against 235 companies till May 31, 2016, a majority of decisions (231 out of 235) have been taken only in the last 33 months. In fact, after the Saradha Group financial scandal, the Government of India formed an inter-ministerial group to close the loopholes in the regulations that allow such pyramid schemes to operate. The Securities Law (Amendment) Ordinance was promulgated first in July 2013 and was repromulgated in September 2013 and March 2014. While the bill got cleared in August 2014, it gave Sebi more powers to crackdown on fraudulent investment schemes and also power of search and seizure.

Why some states are worse?

While it is difficult to ascertain a particular reason for the failure of some states in curbing such practices, experts feel that having regulations in place and their strict implementation can go a long way in curbing such practices.

“It reflects the governance within those states. I feel that these practices are more prevalent in states where there is not much fear of law and the local surveillance and vigilance is weak. I, however, feel that the data is based on cases that have come to Sebi’s notice and may not be a true representation of the entire universe of such schemes ..,” said Prithvi Haldea, chairman, Prime Database.

While Sebi now has powers to take action against unlisted companies raising funds through issuance of convertible and non-convertible equities, preference shares or debentures without filing application with the capital markets regulator, the state governments also have the authority to take action under the Protection of Depositors Act.

While some states took the lead and put laws in place to protect the interest of depositors in late 90s or early 2000, West Bengal passed its legislation only in December 2013.

Maharashtra passed the Maharashtra Protection Of Interest Of Depositors (In Financial Establishments) Act,1999, in January 2000. Even Andhra Pradesh and Karnataka passed the AP Protection of Depositors of Financial Establishments Act, 1999 and The Karnataka Protection of Interest of Depositors in Financial Establishments Act, 2004 respectively, in early 2000.

The West Bengal Protection of Interest of Depositors in Financial Establishments Bill, 2013 was moved in the state Assembly in December 2013 in light of the Saradha scam that emerged a major issue. Later, in 2015, West Bengal also passed amendments to incorporate several suggestions made by the central government, including a new section that disallows a defaulter (deposit taking company) from seeking anticipatory bail.

Experts say that while states need to strictly implement laws, all concerned authorities and ministries also have a part to play.

“While companies have to mandatorily get registered with the Registrar of Companies, it needs to be seen if any inspection is carried out by RoC to see if companies are abiding by the rules of the Companies Act,” said a source who did not wish to be named.

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