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Be wary of investment schemes with very high

returns
Dipak Mondal

March 29, 2012

Retail investors, who are scared of equity market volatility but not satisfied with returns from
bank fixed deposits, often fall prey to dubious schemes that promise them the moon.
The greed to make 'easy' money is so intense it sometimes overpowers their financial
wisdom. They get attracted to flashy schemes , promises of impossible returns and weird
business models of little-known companies.
{blurb}
Stock market scams involving the likes of Harshad Mehta and Ketan Parekh in the past
explain investors' disillusionment with the stock market, but their vulnerability to Ponzi
schemes despite reporting of numerous such frauds regularly remains inexplicable. Call it
victory of 'greed' over good sense!
We take a look at the most recent investment frauds committed in India, give a low-down on
the modus operandi of the perpetrators and draw lessons for investors . In the end, let's
face it-there's no easy money; wealth creation is a long-term process that needs time and
patience and requires the investor to be vigilant all the time.
Now, consider this: Promoters of a little-known company in Jaipur promised 27 times return
to investors in 18 months, mopped up over Rs 200 crore and then made off with the money,
leaving close to 200,000 people in the lurch. The company, Gold Sukh, was a multi-level
marketing (MLM) company which told investors that their money would be invested in gold.
More than the business model, investors were lured by the promise of stellar returns. The
Rajasthan police caught one of the fleeing directors of Gold Sukh, Narendra Singh, at the
Indira Gandhi International Airport in New Delhi on January 30.
{table}A simple calculation shows that you need 800 per cent annual return to grow your
investment 27 times in 18 months. The price of gold, in which the company was supposed to
invest, has grown at an annual average rate of 23.5 per cent in the past five years. At the
present average bank fixed deposit rate of 9 per cent, your investment will take over 38 years
to grow 27 times.
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Who won't fall prey to such an offer? Many did, and lost all their savings.
This is not an isolated case. Everyday we hear about fraudsters using complex schemes
and false promises to dupe investors. Take Abhinav Gold, a Bhilwara-based company which
promised to pay investors Rs 1.72 lakh after two years on an investment of Rs 6,000. It
duped 20,000 investors in Surat, Gujarat.
Then there was Speak Asia, a Singapore-based company which promised Rs 4,000 monthly
payout on an investment of Rs 11,000. The company claimed it did online surveys for big
companies such as ICICI Bank and State Bank of India. It managed to collect Rs 2,500 crore
in less than two years before the authorities nabbed the company brass in India. Hundreds of
investors could not even recover their initial investment.
Another such scheme was floated by Mumbai-based City Limousine (India). The company
promised investors Rs 4,000 every month for five years if they made an initial investment of
Rs 97,000.
The scheme, launched in 2002, was supposed to invest the money collected to buy cars that
were to be run as taxis. The post-dated cheques for monthly payouts that the company had
issued started getting dishonoured in 2007.
If you think only small investors fall prey to such frauds, you are wrong. Think of the 30-odd
high net worth individuals fleeced by a relationship manager of Citibank. The manager
promised clients 2-3 per cent returns every month.
He even produced fake bank statements and forged circulars issued by the Securities and
Exchange Board of India, or Sebi, to show that the scheme had the approval of the market
regulator.
The money that he collected was routed to bank accounts of his family members. He
managed to hoodwink the system and cheat investors of over Rs 300 crore.
One of his victims was Sanjeev Aggarwal, a co-founder of Daksh, a business process
outsourcing company, and Helion Advisors, a venture capital fund. He filed a complaint with
the police alleging 'systemic failure' within Citibank after losing Rs 33 crore.
{table}
MODUS OPERANDI
A number of such schemes, termed as Ponzi or pyramid schemes, have been busted by the
authorities in recent years. However, the worrying part is that many more may still be in
operation.

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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 guise of multi-level marketing (MLM) or plantation
company. Some entities 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.
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.
{table}
REGULATORY HELPLESSNESS
In spite of regulatory oversight, MLM and plantation companies have been blatantly violating
norms for mobilising public money. Their network is so widespread that the authorities have
been finding it difficult to control their activities.
A big handicap for the authorities is lack of clarity on jurisdiction over MLM companies.
Neither Sebi nor the Reserve Bank of India (RBI) regulates these schemes.
Chavi Hemanth, secretary general, Indian Direct Selling Association, says multiplicity of
regulators and lack of comprehensive rules for direct selling companies have been making it
difficult to check the growth of fraudulent entities operating as MLM companies. The Prize
Chits and Money Circulation (Banning) Act, 1978, is one law that is often used to curb the
proliferation of such schemes. The law prohibits promotion of and participation in any money
circulation scheme. Hemanth, however, says it is not sufficient to check MLM frauds.
The RBI and Sebi regularly issue public notices and
warnings about such schemes and companies. In a
July 2011 notice, the RBI observed, "Certain firms
posing as MLM agencies for consumer goods and
services have been mobilising large deposits from the
public (with promise of high return) by opening
accounts at various bank branches. These funds,
running into crores of rupees, were being pooled at the
principal accounts of the firms and eventually flowing
out of the accounts for purposes appearing illegal or highly risky."

Charles Ponzi

The RBI has also asked banks to be more vigilant "while opening agency accounts in the
name of proprietary concerns".
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A 1998 Sebi committee on plantation companies headed by Dr S A Dave observed that

"Invariably, all the (plantation) schemes have assured or indicated high yields (in the region of
18-30 per cent) per annum on investments. These yields have been worked out on the basis
of projected growth and price of the plantations. These estimates vary from company to
company and scheme to scheme. The projected yield estimates have been disputed by
forestry experts, who have concluded that the yields promised by many of these schemes
are optimistic and not achievable."
It further noted that "quite often the schemes come up with novel products, for which there is
no ready market to compare the forecasts. The promise of returns higher than any
conventional debt instrument is a
major attraction for investors."
Despite the similarity in the way these schemes are run and despite warnings from the
authorities and reports of these schemes conning investors, people have been too easily
succumbing to the high 'guaranteed' return sales pitch.
Lack of awareness makes people gullible. It is important for them to see the red flags when
approached with an investment option that's too good to be true.
Here we discuss points common to most investment frauds and signs investors must
always be on the lookout for to avoid getting caught in a trap.
Abnormally high 'guaranteed' returns: First, let's face the truth. Returns are directly
proportional to risk, that is, the higher the return, the higher is the risk. So, there are no
'guaranteed' high return products. If any scheme promises you abnormally (say 40-50 per
cent every year) high returns consistently, it's the first sign of an investment fraud in the
making.
Abhinav Gold promised to return investors Rs 1.72 lakh after two years on an initial
investment of Rs 6,000. That's 28 times in two years. Gold Sukh promised 27 times return in
18 months; City Limousine promised a 48 per cent return every year for five years. In the
Citibank case, the relationship manager promised 2-3 per cent every month, or 24-36 per
cent a year.
It's not that one cannot get 24-30 per cent returns from stocks or equity mutual funds. One
can. But they will not be consistent. Equity investments are highly volatile.
High initial investment: Usually, in a Ponzi scheme, the initial investment demanded from
investors is high. The reason is that the company has no independent source of income and
uses this money for day-to-day operations, to pay for promoters' profits and give the returns
promised to investors.
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City Limousine sought an initial investment of Rs 97,000, Speak Asia demanded Rs 11,000
per account, while Gold Sukh, under three investment plans, sought deposits of Rs 23,000,
Rs 1.2 lakh and Rs 6 lakh, respectively.
Neeta Potnis, senior director, Deloitte Touche Tohmatsu India, says, "While organisers of
such fraud schemes divert the money received from investors for personal gains, a part of
the money received from new members is distributed to the old members as return on
investment. Such frauds are uncovered when new investments slow and the money flow
breaks."
Vague/complicated investment strategy: If the representative of a company approaches
you with a lucrative scheme, ask him the investment strategy they plan to follow. If he gives a
vague and complicated investment strategy, and you are not convinced with his
explanations, it is quite likely you are dealing with a con. As a general rule, most financial
experts advise against investing in schemes you do not understand.
"Firms running Ponzi schemes do not divulge their investment strategy. If asked, they use
vague financial jargon such as hedge futures trading, high-yield investment programmes and
offshore investment to describe their strategy," says Rohit Mahajan, partner and co-head,
forensic services, KPMG India.
Speak Asia, for instance, told investors that it would send them eight online surveys every
month for which they would be paid Rs 4,000 per month or Rs 500 per survey. It charged Rs
11,000 as registration fee per account.
Unsustainable business model: The company promising you 'incredibly' high returns must
have a sound business model. Are you convinced with it? Does it have sustainable cash flow
from core operations, whatever they are? If the answer to these two questions is no, or if you
are not convinced, walk away.
Often, a company, whether it is a MLM or plantation company, which intends to fleece
investors, does not have a sound core business. The cash for operations comes from
money put in by investors.
City Limousine, which asked investors to deposit Rs 97,000 initially, had said the money
collected would be used to buy Maruti vans to be registered in the names of investors. The
investors would be paid out of the profit (Rs 4,000/month) from the income generated by
renting the vehicles.
Rohit Mahajan of KPMG India says the extent of sources of funds from operations as against
deposits received from the public is an important indicator of a company's credibility. "If the
proportion of funds from operations is significantly lower, it indicates that public deposits are
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being used to run the show. New schemes are launched to pay investors in existing
schemes," he says.
Offers of exclusivity and paying back of losses: The offer of exclusive and restricted
access to a scheme and promise that the agent or advisor would pay from his own pocket if
something goes wrong should ring alarm bells. Under no genuine investment scheme will an
agent or advisor make such an offer. It is typical of schemes involving high net worth
investors.
For instance, Bernie Madoff, who was found guilty in a $50-billion fraud by the US federal
court, offered modest but steady returns to an 'exclusive' clientele.
{table}
STEPS TO FOLLOW
To begin with, an investor must check his greed, says the head of portfolio management of a
fund house.
While we agree with what he says, we also believe that greed is on both sides of the fence.
However, investors can avoid becoming victims of others' greed if they do a little due
diligence on their own instead of blindly believing advisors or agents.
Ask for proper regulatory approvals: Being a registered company or an ISO-certified
company does not give an entity permission to mobilise public money. It needs approval
from either Sebi or RBI. None of the schemes mentioned earlier had approval to raise
money from investors.
Do not issue cheques in the name of a third party: Issue payment advice only in the
name of a bank or an institution and not any individual or third party. Do not issue blank
cheques or sign on blank papers.
Ask for regular account statements: A genuine investment scheme must provide
account statements at regular intervals ' monthly, quarterly, half-yearly or annually. If it
isn't doing so, something may be wrong.
Match performance with stated investment strategy: The performance of the
scheme should be in line with the return promised. If not, ask questions, seek
explanations, and if need be, take necessary recourse.
All Ponzi schemes take advantage of people's greed. They continue to capitalise on this.
Investors must understand that there are no short-cuts to earning money. As one of Speak
Asia's victims, who lost not only his money but also of 55 others whom he roped in as
members says, there is nothing called easy money.
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