A STUDY OF PONZI SCHEME WITH REFERENCE

TO SHARADA SCAM
Dr. Mini Amit Arrawatia1, Mr. Vikram Pande2
1
Research Guide, 2Research Scholar, Department of Management & Commerce,
Jayoti Vidyapeeth Women’s University, Jaipur, Rajasthan, (India)

ABSTRACT
This research paper deals with the study of Ponzi Schemes which are popularly known as Chit funds. It studies
its origin and the modus operandi. It further analysed the Saradha Scam of West Bengal that looted the hard
earned money of several innocent investors. It highlights the financial operation of the scheme and the key
players of the scheme. It also highlights some key points for the safeguard of the investors.

I. INTRODUCTION

Ponzi scheme is the scheme in which investors are paid from money collected from new investors instead of the
scheme's earnings. It works as long as new investors keep coming in.
Ponzi schemes are named after Charles Ponzi, an Italian who conned investors in the US and Canada. He
promised clients a 50 per cent profit in 45 days by buying discounted postal reply coupons in other countries and
redeeming them at face value in the US as a form of arbitrage.
These postal reply coupons were used by people in one country to send to a correspondent in another country,
who could use them to pay for the postage for reply. These were priced at the cost of postage in the country of
purchase but could be exchanged for stamps to cover the cost of postage in the country where redeemed; if these
values were different, there was a profit to be made.
Ponzi claimed a net profit of 400 per cent could be made. In reality, however, the cost of transactions was higher
than the profit to be made. Ponzi, though, continued to pay the promised returns to investors through money
collected from new investors. His scheme caused investors a loss of $20 million in 1920.

II. MODE OF OPERATION

A number of such schemes, termed as Ponzi, Chit funds or pyramid schemes, have been busted by the
authorities in recent years. The way these scammers operate is strikingly similar-assure high returns to investors,
offer to pay in instalments, and pay the first few instalments as promised so that more investors are attracted
through word-of-mouth publicity. For instance, the Citibank manager did give 20 per cent annual returns to
some investors before he was busted.
Most Ponzi schemes operate under the semblance of multi-level marketing (MLM). Some of them are registered
as companies under the Companies Act, some even flaunt an ISO certification, but in most cases they do not
have the approval to collect deposits from the public.

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They market their schemes aggressively, mostly in rural and semi-rural areas, where awareness levels are low.
They also use a network of agents, who are offered high commissions.

III. CASE STUDY OF SARADHA CHIT FUND

India has been flooded with various Ponzi schemes that take advantage of innocent investors looking for
alternate banking options. Because of the lack of the access to formal banks, low-income Indians often rely on
informal banking. These informal banks invariably consist of money lenders who charge interest at inflated rates
and were soon replaced by more sophisticated methods of conning people through disguised Ponzi schemes.
Fundraising is done through legal activities such as collective investment schemes, non-convertible debentures
and preference shares, as well as illegally through hoax financial instruments such as fictitious ventures in
construction and tourism. The rapid spread of Ponzi schemes, especially in North India, has various causes, not
the least of which include the lack of awareness about banking norms, steadily falling interest rates, lack of legal
action against such activities, and the security of political patronage.
The Ponzi scheme run by Saradha Group collected money from investors by issuing redeemable bonds and
secured debentures and promising incredulously high profits from reasonable investments. Local agents were
hired throughout the state of West Bengal and given huge cash payouts from investor deposits to expand
quickly, eventually forming a conglomerate of more than 200 companies. This syndicate was used to launder
money and confuse regulators like SEBI. In April 2013, the scheme collapsed completely causing a loss of
approximately US $5 billion and bankrupting many of its low-income investors.
SEBI first detected something suspicious in the group’s activities in 2009. It challenged Saradha because the
company had not complied with the Indian Companies Act, which requires any company raising money from
more than 50 investors to have a formal prospectus, and categorical permission from SEBI, the market regulator.
The Saradha Group sought to evade prosecution by expanding the number of companies, thus creating a
convoluted web of interconnected players. This created innumerable complications for SEBI, which labored to
investigate Saradha in spite of them. In 2012, Saradha decided to switch it up by resorting to different
fundraising activities, such as collective investment schemes (CIS) that were disguised as tourism packages, real
estate projects, and the like. Many investors were duped into investing in what they thought was a chit fund.
This, too, was an attempt to get SEBI off its back, as chit funds fall under the jurisdiction of the state
government, not SEBI. However, SEBI managed to identify the group was not, in fact, raising capital through a
chit fund scheme and ordered Saradha to immediately stop its activities until cleared by SEBI. SEBI had
previously warned the state government of West Bengal about Saradha Group’s hoax chit fund activities in 2011
but to no avail. Both the government as well as Saradha generally ignored SEBI until the company finally went
bust in 2013.
After the scandal broke, an inquiry commission investigated the group, and a relief fund of approximately US
$90 million protected low-income investors. In 2014, the Supreme Court transferred all investigations in the
Saradha case to the Central Bureau of Investigation (CBI) amid allegations of political interference in the state-
ordered investigation.
IV. FINANCIAL OPERATIONS

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The companies that were comprised by Saradha Group were incorporated in 2006. Its name is
a cacography of Sarada Devi, the wife and spiritual counterpart of Ramakrishna Paramahamsa—a nineteenth-
century mystic of Bengal. This duplicitous association gave Saradha Group a veneer of respectability. Like all
Ponzi schemes, Saradha Group promised higher returns in fanciful but credible investments. Its funds were sold
on commission by agents recruited from local rural communities. Between 25 and 40% of the deposit was
returned to these agents as commissions and lucrative gifts to quickly build up a wide agent pyramid. The group
used a nexus of companies to launder money and evade regulators.
Initially, the frontline companies collected money from the public by issuing secured debentures and redeemable
preferential bonds. Under Indian Securities regulations and section 67 of the Indian Companies Act (1956), a
company cannot raise capital from more than 50 people without issuing a proper prospectus and balance sheet.
Its accounts must be audited and it must also have explicit permission to operate from the market
regulator Securities and Exchange Board of India (SEBI).
SEBI first confronted Saradha Group in 2009. Saradha Group adapted by opening up to 200 new companies to
create more cross-holdings. This created an extremely complex tiered corporate structure to confound SEBI by
hampering their ability to consolidate blame. SEBI persisted in its investigation through 2010. Saradha Group
reacted by changing its methods of raising capital. In West Bengal, Jharkhand, Assam and Chhattisgarh, it
began operating variations of collective investment schemes (CIS) involving tourism packages, forward travel
and hotel booking timeshare credit transfer, real estate, infrastructure finance, and motorcycle
manufacturing. Investors were rarely informed about the true nature of their investments. Instead, many were
told they would get high returns after a fixed period. With other investors, the investment was fraudulently sold
in the form of a chit fund. Under the Chit Fund Act (1982), chit funds are regulated by state governments rather
than SEBI.
SEBI warned the state government of West Bengal about Saradha Group's chit fund activities in 2011, again
prompting Saradha Group to change its methods. This time, it acquired and sold large numbers of shares of
various listed companies then embezzled the proceeds of the sale through accounts which as of September
2014 have not been identified. Meanwhile, Saradha Group started laundering a large portion of its funds to
Dubai South Africa and Singapore. By 2012, SEBI was able to classify the group's activities as collective
investment schemes rather than chit funds—and demanded that it immediately stop operating its investment
schemes until it received permission to operate from SEBI. Saradha Group did not comply with this ruling and
continued to operate until its collapse in April 2013.

V. POLITICAL PLAYERS IN SARADHA CORPORATE FRAUD

The political interference in the Saradha Group case is more apparent. Several members of the West Bengal
ruling party, the Trinamool Congress (TMC), personally benefitted from the scheme. For instance, there are
many reports that suggest Sudipto Sen, Chairman of the Saradha Group, bought paintings by Mamata Banerjee,
the Chief Minister of West Bengal, whose government later issued circulars to public libraries to display
newspapers published by Saradha. Several Members of Parliament were connected to Saradha. In an 18-page
confessional to the CBI, Sudipto Sen admitted to illicitly paying huge sums of investor money to many

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politicians. Many high profile personalities, including Transport Minister Madan Mitra and actor and TMC
member Satabdi Roy, publicly endorsed the Saradha Group.

VI. HUGE LOSS OF INVESTORS

The schemes run by Saradha were primarily aimed at low-income people who did not have access to formal
banking. Unsurprisingly, these low income investors were hit hardest by the scam. When the Ponzi scheme
collapsed, it caused severe financial loss to its 1.7 million investors, but the poorer population of West Bengal
bore the worst brunt. Many were bankrupted, and a great number resorted to suicide.
The Saradha case undoubtedly represents the worst kind of damage unethical practices in business can beget.
The ramifications of the actions of a few conniving businessmen and politicians can still be felt throughout rural
West Bengal. There is no doubt that conning poor people into investing in a hoax scheme, only to abandon them
when it collapses, falls in the far dark end of the ethical spectrum. Therefore, corporate scams of this nature not
only symbolize the ethical and moral standards of a company but on a larger scale represent those of the country
and her people. This sort of generalization can cause foreign companies to lose interest in investing in a country
and could cost India (or any country, for that matter) dearly.

VII. POTENTIAL SOLUTIONS TO SAFEGUARD INVESTORS

A recent survey by Grant Thornton and Assocham finds that cases of financial fraud have risen in India over the
last few years and become one of the main factors deterring foreign companies from investing in India. As the
economy grows to keep pace with the steadily growing needs of the population, corporate fraud is disastrous for
India. To bring about a visible decline in the culture of corporate scams in India, three major systematic changes
can and need to take place.
Firstly, laws protecting whistleblowers are imperative. The likelihood of people coming forth to willingly
provide information will be a lot higher if they are provided with basic assurances. Safety from political
threats and job security can ensure more people will be willing to volunteer information and increase
transparency in the Indian corporate sector. Secondly, federal and market regulators need a greater level of
autonomy than they presently enjoy. The Reserve Bank of India, SEBI and other regulators can only be efficient
provided their work is not directed by political influences. Thirdly, and perhaps most importantly, there is a
crucial need for judicial reform in India. The judicial system’s slow-moving course causes needless delays and
allows corporate violators to find underhanded methods to evade justice. Corporate cases, especially cases of
such magnitude, need to be fast-tracked to reach resolution quickly so violators can be dealt severe and
immediate consequences.

REFERENCES

[1]. Dr.Amrit Patel and Dr.Gopal Kalkoti, “Rural Credit: How to Take Forward?”, The Indian Banker Vol V
No.2, February 2010..
[2]. Dr.C.P.S. Nayar, “Chit Finance and Explorative Study on the Working of Chit Funds”, Vora and Co.
Publishers Pvt Ltd. (1973)

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[3]. K. Balakrishna, “Prize Chit Racket”, Economic Times, June 30, 1974.
[4]. Manjeshwar, Ananth Pai, “Chit Funds: Some Aspects of Tax Laws”, Paper presented at the seminar on
Economic Liberalization and Chit Funds, Delhi Chit Funds Association, Chamber of Commerce and
Industry, New Delhi, April, (1995).
[5]. Stuart Rutherford, “The Poor and Their Money”, New Delhi: Oxford University Press (2010).

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