A tighrope walk for Sebi

It was only in 1995 that the term collective investment schemes found its way into the Sebi

If news reports are right, the Securities and Exchange Board of India (Sebi) is coming full circle with collective investment schemes (CIS) and is seeking to “relinquish” the statutory mandate to regulate such schemes.

It was only in 1995 that the term found its way into the Sebi Act through an amendment to the list of market intermediaries that ought to be registered with Sebi to be able to carry on business in India. Then, too, Sebi had been a reluctant regulator. Schemes promising returns on the basis of plantations, animal farming, chain-marketing and the like mushroomed in the 1990s. The term “collective investment scheme” was not even defined in the Sebi Act. Therefore, despite the amendment to the Sebi Act, Sebi did not want to hold the CIS baby.  

Public interest litigation, a plethora of complaints and a lot of angst later, the term got defined for the first time through an amendment in the Sebi Act in 1999. Sebi also made regulations in 1999, which, if reduced to one sentence, would have read: “No one shall operate a collective investment scheme”. The terms on which one could legitimately register and operate a CIS was akin to Christian states in the US stipulating norms for abortion agencies — keep the standards so rigid and tough that they pose an entry barrier and cannot be complied with. Not surprisingly, right since 1999, there has been only one reported registered CIS in the history of Sebi.

The problem with such an approach to regulation is fundamental — pretending that making it illegal to carry out an activity would put an end to it. The activity continued, the monies raised grew even faster, some of which are even feared to be from non-existent investors — read: money laundering schemes. An even more bizarre amendment sailed into the Sebi Act in 2013. The 1999 amendment had set out four ingredients to be met for any scheme or arrangement of affairs to be regarded as a CIS — essentially, schemes entailing a contribution of funds for earning of profits, management of the funds pooled by someone on behalf of the contributors and the contributors not having day-to-day control over managing the pool. Now, in 2013, the law was amended to say that even if these ingredients were absent, if the corpus of any arrangement of affairs was of Rs 100 crore or more, it would be “deemed to be” a CIS.

This set the cat among the pigeons. Any and every pooling of funds that would have a corpus value of Rs 100 crore would be a CIS, which meant that a registration with Sebi would be necessary for the activity to be legitimate. A pooling of resources by neighbours owning apartments in an expensive city like Mumbai to rebuild and redevelop their building would arguably be a CIS. The provision of holiday schemes where the contribution by guests would give them the right to use a property from the pool of properties built or rented with the contributions would arguably be a CIS. Provision of valuables such as gold coins with contributions in instalments would arguably be a CIS.  

None of these would involve issuing securities and therefore, none of these can ever comply with the regulations governing CIS that Sebi had made in 1999. Therefore, all of it would be illegal. Those who cared for the law, shut down such activity or moulded them. Those who did not care, kept at it — eroding the majesty of the law even further by reason of formulation of law not properly thought through.

Meanwhile, with public furore over some CIS that failed led to some judicial comments about Sebi sleeping on its job, which got reported in the media and then led Sebi to crack down by ordering that monies collected be refunded within a few weeks or months. Now, this would spur asset-liability mismatches further and lead to either a run on the schemes that could not be met, or worse, led to CIS operators starting newer schemes underground to fund repayment of schemes ordered to be closed. In a nutshell, a royal mess is on the regulator’s hands.

It is in this context that reports of Sebi wanting to relinquish this statutory role is interesting. Around the time Sebi piloted legislative amendments to treat any corpus of Rs 100 crore or more as a CIS, it had a muscular tone about how anyone speaking about the need for a predictable framework for running a compliant CIS could only have been aligned with the bad guys. Now, it seems, Sebi is conscious that pushing an entire industry underground is actually counterproductive and brings about worse outcomes. Whether it would at all be politically possible to amend the Sebi Act yet again to remove CIS of this kind from Sebi’s ambit is doubtful. But one must assume that it the mind is set on an outcome, the government will find ways to get that done — whether through a Presidential Ordinance, a Money Bill or blanket provisions in the Finance Act.  

If Sebi pulls off this one, the market would have come full circle back to the 1990s. Who then, would bell the cat? 

The author is an advocate and independent counsel. He tweets at @SomasekharS