Ponzi Schemes: The Pyramid Fraud

SOON AFTER giving up his Indian cricket team captaincy in September 2007, Rahul Dravid gave an interview to the news agency PTI. The name of the journalist who interviewed him was Sutram Suresh. This month, both of them hit the news again, but in a somewhat different context. Dravid had lost crores in a Ponzi scheme and the man who introduced him to it was Suresh who had left journalism to be an LIC agent. The main man behind the scam, one Raghavendra Srinath, had appointed a number of LIC agents as the second rung to bring investments into his scheme. Dravid wasn’t the only sportsman to find his money disappear. Saina Nehwal and Prakash Padukone were also victims. As The Indian Express reported of Dravid’s police complaint: ‘The former cricketer reportedly said he was paid the promised returns on investment of Rs 20 crore made through Vikram Investments in the past but the firm had not paid returns on Rs 4 crore invested since 2017. Suresh, who was produced in court last week, said investments worth Rs 34 crore made by him in Vikram Investments had been defrauded by the owner of the company, Srinath, and others. Vikram Investments has been accused of fraud by several people, who said the firm lured high-net worth investors with offers of 40 to 50 per cent annual returns on their principal amounts. Police have accused Srinath and four people who worked as agents, including Suresh, to bring in investors, of defrauding over 800 people to the tune of over Rs 300 crore.’

Anyone with an understanding of finance knows that no one can promise a 40 per cent annual return. The greatest investor in the world is Warren Buffett and the returns he made over his lifetime are around 20 per cent annually. Yet Dravid, not exactly an illiterate villager, easily fell for the scam. He is not alone either. India has been a fertile field of Ponzi schemes, its victims ranging across every class and community. In recent times, Ponzis like the Saradha Chit Fund scam, Q Net, SpeakAsia, etcetera, have looted gullible investors of thousands of crores.

In a classic Ponzi scheme, a high rate of return is offered to lure people and the new money is used to pay off old investors who want to redeem their investment. This keeps running so long as the money coming into the scheme is greater than the money leaving. When this equation is on the verge of reversal, or often much before that, the person behind the scheme takes the corpus and disappears. On why so many get attracted to Ponzi schemes, Vivek Kaul, economic commentator and author of the ‘Easy Money’ trilogy, who has written extensively on numerous Ponzis in recent times, points to a famous quote by the economist Charles Kindleberger: ‘There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.’ “Typically, someone around you has invested in a scheme. The scamster is interested in reaching a certain level of scale. Initial guys tend to get paid off. Then they go talking about it and become votaries for that scheme. The largest Ponzi schemes are essentially word of mouth,” he says.

There are two broad categories of this fraud. One involves an impossibly high return of investment. For example, in the mid-90s, Ashok Sheregar, an employee of Mumbai’s bus transportation body, BEST, began a scheme that within weeks doubled the money anyone put in. Those who invested were also made agents by promising them commissions. When it went bust, by one estimate over 60,000 people in the entire city had lost their money. In the Saradha Chit Fund scam in West Bengal, the scale of the Ponzi became gargantuan with an entire industrial conglomerate being set up through revolving money and aided by the patronage of politicians.

The second category have pyramid or multi-level marketing schemes, where a company offers a product but the real money is made by charging the people appointed to distribute and sell it. The product is immaterial to the business model. “The main money is made by getting in newer members to pay the membership fee, which pays off people who entered the scheme earlier than the others,” says Kaul. An example of this is a company called QNet, which claimed to sell products ranging from bio discs that enhanced ‘the natural properties of water as well as the human body’s energy systems’ to gold coins to vacations. People would be asked to pay a lump sum in return for assured returns. They would have to get other members and thus the chain would grow. The police cracked down on it and when the anticipatory bail application of five arrested directors of the scheme came up, the High Court observed, ‘The motto of the company ‘sell more, earn more’ appears very attractive and innocuous… the true motto is ‘sell more earn more’ by fooling people. In fact it is a chain where a person is fooled and then he is trained to fool others to earn money.’

PONZI SCHEMES ARE pervasive in India. Sucheta Dalal, managing editor of Moneylife magazine, which has been relentlessly campaigning against them, recalls holding a financial literacy seminar for poor scholarship students and being unsure of including the subject. “I thought I will start talking about it and if I find blank looks, I will wind it up quickly and move on to something else. I was completely stunned at the high level of interest. They had so many questions, and each of the kids was saying, ‘Mere building mein aisa hota hai, mere building mein waisa hota hai’. One tells me, ‘I am so glad that I attended the seminar because I didn’t know what was wrong with [a scheme]. I kept telling my mom there has to be something wrong, why will someone give you such high returns? Now you have explained to me why it is wrong and I will be able to tell her’,” says Dalal.

She points out a few commonalities across all Ponzis. “One is extremely high returns. Second, a mandatory ingredient, [initially] they find a way of making the returns available to you really fast. If it is SpeakAsia, you fill up these surveys and get a cheque within 15 days. There is nothing that convinces somebody more about a scam’s genuineness than to get a cheque. People are then waving it around and, the next instant, you have family, neighbours and everyone participating. They are taking the next person’s money and giving it to the first. Then there are 10 more whose money is passed on,” she says.

The numbers involved in these frauds are staggering. In 2016, the 22nd Conference of CBI and State ACBx, Vigilance Bureaux, Economic Offence Wings (EOWs) discussed the spread of Ponzi schemes and plugging legal loopholes. In his address, the then CBI director Anil Sinha had said that the agency alone was “investigating cases in which more than 6 crore investors/victims spread across 26 states involving [about] Rs 85,000 crore of public money. There are hundreds of criminal cases with state police and EOWs”.

“Look at all the bank losses we are talking about today and look at Rs 85,000 crore that people have lost [in Ponzi schemes] and nobody even puts it on the front page of the papers,” says Dalal.

The basic Ponzi trick, where new money is used to paper over an old default, has been in play in sectors like real estate before the recent Real Estate Regulation Act came into force. “What these builders used to do was announce a project, collect money against it and use it somewhere else like paying off debt or buying land. Let’s call it Project A, for which money has already been raised. Then they start a Project B, raise money against that and use it to complete Project A. Likewise for Project B, Project C and so on. But many projects were not developed or delivered on time when their ability to launch a new project and raise money against it collapsed. RERA came in for that and [made it] mandatory that 70 per cent of the money raised for a project must be used for it,” says Kaul.

The most recent example of a fraud involving a Ponzi structure is the Nirav Modi case, where fresh Letters of Undertaking were used to illegally pay off earlier LoUs until they added up to over Rs 11,000 crore. Even though not a classic Ponzi scam, it had a curious fallout. Soon after it broke, the Union Cabinet approved the introduction of The Banning of Unregulated Deposit Schemes Bill, 2018. Said the Press Information Bureau press release: ‘The bill is aimed at tackling the menace of illicit deposit taking activities in the country. Companies/ institutions running such schemes exploit existing regulatory gaps and lack of strict administrative measures to dupe poor and gullible people of their hard-earned savings.’ Such a law had been first mooted in the Union Budget two years ago but thanks to Nirav Modi, there was an impetus to finally get it going. By a The Times of India report, the bill proposes that ‘those soliciting unregulated deposits will face a jail term of one to five years. Unregistered entities, which are accepting deposits, will be liable for up to seven years in jail. Those who default on repayment of unregulated deposits will have to face an additional term of three years…’

EAS Sarma, a former secretary with the Union Finance and Power ministries who has been campaigning for the Government to curb Ponzi schemes, says that at present there is no institutionalised intelligence gathering on firms that suddenly appear from nowhere and cheat large numbers of depositors within months. “To stop this, there should be coordinated effort among the state investigating agencies to keep track of such companies by regularly cross-checking information at the field level with the business associations, commercial tax officers, the police and so on. These state agencies must further be able to cross-check [their findings] with Central regulators like SEBI, RBI, Ministry of Corporate Affairs, Ministry of Consumer Affairs, ED, DRI and so on. The latter should also disseminate information to the states. All this cannot happen through correspondence. Now that we have the possibility of having inter-connected computerised databases, quick retrieval of information and quick verification have become easy. We do not seem to be building such databases and using them,” says Sarma.

The Banning of Unregulated Deposit Schemes Bill, 2018, does propose a central database, but, while the law is an advance, how effective it will be depends on implementation. In a recent Moneylife column, Dalal wrote, ‘There has to be a robust process for reporting fraudulent and unregulated deposit-collection which will need to be followed up by quick action by the competent authority at the Centre or the state to stop and wind up such schemes… Regulators’ accountability is the key; but one is unclear how another Central legislation is going to ensure this, when there is no attempt to make existing financial regulators accountable to savers.’

“Who is going to initiate the action has always been the problem and will remain the problem,” she says.

Prithvi Haldea, founder of Watchoutinvestors. com, a national registry of economic defaulters whose names have come up in orders issued by regulators, says the number of Ponzi scams that have been caught so far is still very small, the real number being many times that. “There is no surveillance mechanism existing on any schemes operating across the country. There is very little fear of law. Then there are loopholes in the law. There is poor investigation. We have to increase our surveillance using the state and Central machinery. Pick up early signs of any such schemes being launched. Ultimately all these schemes are done in public because public money is involved. There would be some hoarding, some poster, some advertisement, some agent. For example, a hoarding in a small village that says ‘if you want 14% annual return on your money come to us’ would be a warning signal. How can anybody promise 14 per cent? Number two, the mass media must increase financial awareness initiatives. And once you have caught an offender, then take stiff and substantive action, publicise that action to create a deterrent amongst others,” he says.

Also, once a Ponzi scam has been busted and those behind it caught, there is the question of investors getting their money back. On whether there have been such instances, Dalal says, “Not a single one that I know of.”

bankingEconomic reformfinanceNarendra ModiPonzi scheme