Tag: Charles Ponzi | Vivek Kaul

23 April, 202120 April, 2021

Charles Ponzi and Bernie Madoff Would Have Been Proud of the Ponzi Schemes of 2021

Bernie Madoff, the man who ran the biggest Ponzi scheme of all time, died in jail on April 14, 2021, fifteen days shy of turning 83.

A Ponzi scheme is a fraudulent investment scheme in which older investors are paid by using money being brought in by newer ones. It keeps running until the money being brought in by the newer investors is greater than the money being paid to the older ones. Once this reverses, the scheme collapses . Or the scamster running the scheme, runs away with the money before the scheme collapses.

The scheme is named after an Italian American, Charles Ponzi, who tried running such an investment scheme in Boston, United States, in 1920. He had promised to double investors’ money in 90 days, which meant an annual return of 1500%. At its peak, 40,000 investors had invested $15 million in Ponzi’s scheme.

Not surprisingly, the scheme collapsed in less than a year’s time, under its own weight. All Ponzi was doing was taking money from newer investors and paying off the older ones.

Once Boston Post ran a story exposing his scheme in July 1920, many investors demanded their money back and Ponzi’s Ponzi scheme simply collapsed, as money being brought in by newer investors dried up, while older investors had to be paid.

Madoff was smarter that way. His scheme gave consistent returns of around 10% per year, year on year. The fact that Madoff promised reasonable returns, helped him keep running his Ponzi scheme for decades. But when the financial crisis of 2008 struck, it became difficult for him to carry on with the pretence and the scheme collapsed.

As I wrote in a piece for the Mint newspaper yesterday, Madoff was Ponzi’s most successful disciple ever. While Ponzi’s investment scheme started in December 1919, it collapsed in less than a year’s time in August 1920. On the other hand, documents suggest that Madoff’s scheme started sometime in the 1960s and ran for close to five decades.

Nevertheless, both Madoff and Ponzi, would have been proud of the Ponzi schemes of 2021. The only difference being that the current day Ponzi schemes are what economist Nobel Prize winning Robert Shiller calls naturally occurring Ponzi schemes and not fraudulent ones like the kind Ponzi and Madoff ran.

A conventional Ponzi scheme has a fraudulent manager at the centre of it all and the intention is to defraud investors and take the money and run before the scheme collapses. A naturally occurring Ponzi scheme is slightly different to that extent.

Shiller defines naturally occurring Ponzi schemes in his book Irrational Exuberance:

“Ponzi schemes do arise from time to time without the contrivance of a fraudulent manager. Even if there is no manipulator fabricating false stories and deliberately deceiving investors in the aggregate stock market, tales about the market are everywhere. When prices go up a number of times, investors are rewarded sequentially by price movements in these markets just as they are in Ponzi schemes. There are still many people (indeed, the stock brokerage and mutual fund industries as a whole) who benefit from telling stories that suggest that the markets will go up further. There is no reason for these stories to be fraudulent; they need to only emphasize the positive news and give less emphasis to the negative.”

Basically, what Shiller is saying here is that the stock markets enter a phase at various points of time, where stock prices go up simply because new money keeps coming in and not because of the expectations of earnings of companies going up in the days to come.

Ultimately, stock prices should reflect a discounted value of future company earnings. But quite often that is not the case and the price goes totally out of whack, for considerably long periods of time.

A lot of money comes in simply because the smarter investors know that newer money will keep coming in and stock prices will keep going up, and thus, stocks can be unloaded on to the newer investors. Hence, like in a Ponzi scheme, the money being brought in by the newer investors pays off the older ones. In simpler terms, this can be referred to as the greater fool theory.

The investors buying stocks at a certain point of time, when stock prices do not justify the expected future earnings, know that greater fools can be expected to invest in stocks in the time to come and to whom they can sell their stocks.

Of course, this is not the story that is sold. If you want money to keep coming into stocks, you can’t call a prospective fool a fool. There is a whole setup, from stock brokerages to mutual funds to portfolio management services to insurance companies selling investment plans, which benefit from the status quo. Their incomes depend on how well the stock market continues to do.

They are the deep state of investment and need to keep selling stories that all is well, that stocks are not expensive, that this time is different, that a new era is here or is on its way, that stock prices will keep going up and that if you want to get rich you should invest in the stock market, to keep luring fools in and keep the legal Ponzi scheme, for the lack of a better term, going.

— Bernie Madoff

This is precisely what has been happening all across the world since the covid pandemic broke out. With central banks printing a humongous amount of money, interest rates are at very low levels, forcing investors to look for higher returns. A lot of this money has found its way into stock markets. The newer investors have bid stock prices up, thus benefitting the older investors. The deep state of investment has played its role.

Of course, the counterpoint to whatever I have said up until now is that unless new money comes in, how will stock prices ever go up. This is a fair point. But what needs to be understood here is that in the last one year, the total amount of money invested in stocks has turned into a flood. Take the case of foreign institutional investors investing in Indian stocks.

They net invested a total of $37.03 billion in Indian stocks in 2020-21. This was almost 23% more than what they invested in Indian stocks in the previous six years, from April 2014 to March 2020. This flood of money can be seen in stock markets all across the world.

Clearly, there is a difference, and the stock market has worked like a naturally occurring Ponzi scheme, at least over the last one year.

This Ponziness is not just limited to stocks. Take a look at what is happening to Indian startups…oh pardon me…we don’t call them startups anymore, we call them unicorns, these days. A unicorn is a startup which has a valuation of greater than billion dollars.

How can a startup have a valuation of more than a billion dollars, is a question well worth asking. I try and answer this question in a piece I have written in today’s edition of the Mint newspaper.

As mentioned earlier, there is too much money floating all around the world, particularly in the rich world, looking for higher returns. Venture capitalists (VCs) have access to this money and thus are picking up stakes in Indian startups at extremely high prices.

Many of these startups have revenues of a few lakhs and losses running into hundreds or thousands of crore. The losses are funded out of money invested by VCs into these unicorns.

The losses are primarily on account of selling, the service or the good that the startup is offering, at a discounted price. The idea is to show that a monopoly (or a duopoly, if there is more than one player in the same line of business) is being built in that line of business and then cash in on that through a very expensive initial public offering (IPO).

As and when, the IPO happens, a newer set of investors, including retail investors, buy into the business, at a very high price, in the hope that the company will make lots of money in the days to come. Interestingly, IPOs which used to help entrepreneurs raise capital to expand businesses, now have become exit options for VCs.

If an IPO is not possible, then the VC hopes to unload the stake on to another VC or a company and get out of the business.

In that sense, the hope is that a newer set of investors will pay off an older set, like is the case in any Ponzi scheme. Of course, this newer set then needs another newer set to keep the Ponzi going.

The good thing is that when investors buy a stock of an existing company or in a new company’s IPO, they are at least buying a part of an underlying business. In case of existing companies, chances are that the business is profitable. In case of an IPO, the business may already be profitable or is expected to be profitable.

But the same cannot be said about many digital assets that are being frantically bought and sold these days. There is no underlying business or asset, for which money is being paid. Take the case of Dogecoin which was created as a satire on cryptocurrencies.

As I write this, it has given a return of 24% in the last 24 hours. An Indian fixed deposit investor will take more than four years to earn that kind of return and that too if he doesn’t pay any tax on the interest earned.

Why is Dogecoin delivering such fantastic returns? As James Surowiecki writes in a column: “There is no good answer to that question, other than to say Dogecoins have gotten dramatically more valuable because people have decided to act as if they’re more valuable.”

As John Maynard Keynes puts it, investors are currently anticipating “what average opinion expects the average opinion to be.” Carried away by the high returns on Dogecoin, the expectation is that newer investors will keep investing in it and hence, prices will keep going up. The newer investors will keep paying the older ones. That is the hope, like is the case with any Ponzi scheme, except for the fact that in this case, there is no fraudulent manager at the centre of it all.

Of course, the only way the value of Dogecoin and many other cryptocurrencies can be sustained, is if newer investors keep coming in and at the same time, people who already own these cryptocurrencies don’t rush out all at once to cash in on their gains.

If this does not happen, as is the case with any Ponzi scheme, when existing investors demand their money back and not enough newer investors are coming in, this Ponzi scheme will also collapse.

–– Charles Ponzi

Given this, like is the case with people who are heavily invested in stocks, it is important for people who are heavily invested in cryptos to keep defending them. Of course, a lot of times this is technical mumbo jumbo, which basically amounts to that old phrase, this time is different.

But this time is different is probably the oldest lie in finance. It rarely is.

And if dogecoin was not enough, we now have investors going crazy about non-fungible tokens (NFTs), which in simple terms is basically certified digital art. As Jazmin Goodwin points out: “For example, Jack Dorsey’s first tweet is now bidding for $2.5 million, a video clip of a LeBron James slam dunk sold for over $200,000 and a decade-old “Nyan Cat” GIF went for $600,000.” The auction house Christie sold its first ever NFT artwork for $69 million, in March.

In a world of extremely low interest rates and massive amount of printing carried out by central banks, there is too much money going around chasing returns.

There aren’t enough avenues and which is why we have financial and digital assets now turning into naturally occurring Ponzi schemes, giving the kind of returns that the original Ponzi scamsters, like Ponzi himself and his disciple Madoff, would be proud off.

Madoff’s scheme delivered returns of 10% returns per year. Ponzi promised to double investors’ money in three months or a return of 100% over three months. As I write this, Dogecoin has given a return of more than 600% over the last one month.

Here’s is how the price chart of Dogecoin looks like over the last one month.

Source: https://www.coindesk.com/price/dogecoin.

4 March, 2015

The great Indian govt Ponzi scheme is here to stay

Vivek Kaul

In the budget speech that he gave in July 2014, while presenting his first budget, the finance minister Arun Jaitley had said: “My Road map for fiscal consolidation is a fiscal deficit of 3.6 per cent for 2015-16 and 3 per cent for 2016-17.” Fiscal deficit is the difference between what a government earns and what it spends. It finances the deficit through borrowing.
In the budget speech that Jaitley gave on February 28, 2015, he put fiscal consolidation on the back burner, when he said: “I will complete the journey to a fiscal deficit of 3% in 3 years, rather than the two years envisaged previously. Thus, for the next three years, my targets are: 3.9%, for 2015-16; 3.5% for 2016-17; and, 3.0% for 2017-18.”
This is a worrying trend. Finance ministers want to increase government expenditure but they do not have much of an idea about how to increase its income. In the process, they end up running higher fiscal deficits, which leads to the government borrowing more.
As can be seen from the table that follows the Ponzi ratio of the Indian government has gone up over the years. In 2009-2010, it was at 0.70, and in 2015-2016, it will be at 1.23. Before I go about explaining what this means, it is important to go back in history and talk about a certain Charles Ponzi.

Year	Interest payment	Repayment of principal	Total debt servicing	Fiscal Deficit	Ponzi ratio
2015-2016	4,56,145	2,25,574	6,81,719	5,55,649	1.23
2014-2015	4,11,354	2,00,955	6,12,309	5,12,628	1.19
2013-2014	3,74,254	1,62,976	5,37,230	5,02,858	1.07
2012-2013	3,13,170	1,15,218	4,28,388	4,90,190	0.87
2011-2012	2,73,150	1,11,933	3,85,083	5,15,990	0.75
2010-2011	2,34,022	1,47,793	4,68,044	3,73,591	1.25
2009-2010	2,13,093	81,764	2,94,857	4,18,482	0.70

Sometime in 1919, Charles Ponzi, an Italian immigrant into the United States, promised investors in the city of Boston that he would double their money (i.e. give them a 100% return on their investment) in 90 days.
Ponzi had hoped that to make this money through a huge arbitrage opportunity that he had spotted among the international postal reply coupons being sold across different countries. But due to various reasons both bureaucratic as well as practical, he could never get around to executing the scheme he had come up with.
But by the time Ponzi realised this, big money was coming into his scheme and he had got used to a good lifestyle. At its peak, the scheme had 40,000 investors who had invested around $ 15 million in the scheme.
Ponzi kept his investors happy by using money brought in by the new investors to pay off the old investors who wanted to redeem their investment. And that is how the scheme operated up to a point. On July 26, 1920, the Boston Post ran a story questioning the legitimacy of the scheme.
Within a few hours, angry depositors lined up at Ponzi’s door, demanding their money back. Ponzi asked his staff to settle their obligations. The anger subsided, but not for long. On Aug 10^th, 1920, the scheme collapsed. The auditors, the newspapers and the banks declared that Ponzi was definitely bankrupt.
Ponzi was not the first individual to run a Ponzi scheme, just that his name stuck to it. A Ponzi scheme is essentially a fraudulent investment scheme in which money brought in by new investors is used to redeem the payment that is due to existing investors.
Governments also degenerate into Ponzi schemes over the years, though there is no intention of fraud. This happens when governments do not earn enough and issue new debt to repay old debt as well as pay interest on it.
Take a look at the table shared above. In 2009-2010, the interest payment on the total debt of government of India stood at Rs 2,13,093 crore. Over and above this, the government had to repay around Rs 81,764 crore of debt that was maturing. The total debt servicing cost came to Rs 2,94,857 crore. This amount divided by the fiscal deficit of Rs 4,18,842 crore was around 0.70. This ratio I refer to as the Ponzi ratio.
In 2015-2016, the interest payment on government debt will be at Rs 4,56,145 crore. The maturing debt that needs to be repaid is at Rs 2,25,574 crore. This leads to a total debt servicing cost of Rs 6,81,719 crore. The fiscal deficit for the year has been projected to be at Rs 5,55,649 crore. This means a Ponzi ratio of 1.23.
Hence, the entire fiscal deficit or the difference between what a government earns and what it spends, and which is financed through borrowing, is being used to pay interest on existing debt as well as repay the debt that is maturing. In fact, this is eating into the government revenues as well. Hence, because of the burgeoning debt the Indian government is spending more and more of its money on servicing debt. This is clearly not a good sign as it leaves a lesser amount of money to be spent on other things.
In the July 2014 budget speech, Jaitley had said: “The Government will constitute an Expenditure Management Commission, which will look into various aspects of expenditure reforms to be undertaken by the Government. The Commission will give its interim report within this financial year.” The Commission led by former Reserve Bank of India governor Dr Bimal Jalan, submitted its report in January earlier this year. Nevertheless, the recommendations of the Commission do not seem to have made it into the budget.
The one big-ticket expenditure item that Jaitley had to deal with in this budget were the recommendations of the 14th Finance Commission which increased the states’ share of central taxes from 32% to 42%. The other big-ticket item that Jaitley should have done something about, he chose to more or less ignore.
The public sector banks need a huge amount of capital in the years to come. The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.” In the next financial year’s budget Jaitley has committed just Rs 7,940 crore towards this.
Further, as Jaitley said in his speech: “uncertainties that implementation of GST will create; and the likely burden from the report of the 7th Pay Commission.” This will make expenditure management even more difficult in the years to come. This means that the government Ponzi scheme will only get bigger than it currently is. Let’s see how this goes.

The column appeared on The Daily Reckoning on Mar 4, 2015

10 September, 2014

Here’s how India’s government unwittingly aids the growth of ponzi schemes

Over the last few years a spate of Ponzi schemes have come to light. These include Sahara, Saradha Chit Fund, Rose Valley Hotels and Entertainment and most recently PACL. A Ponzi scheme is essentially a fraudulent investment scheme in which money brought in by new investors is used to redeem the payment that is due to existing investors.
The instrument in which the money collected is invested appears to be a genuine investment opportunity but at the same time it is obscure enough, to prevent any scrutiny by the investors. So PACL invested the money it collected in agricultural land. Rose Valley, Sahara and Saradha had different businesses in which this money collected was invested.
These Ponzi schemes managed to raise thousands of crore over the years. In a recent order against PACL, the Securities and Exchange Board of India(Sebi) estimated that the company had managed to collect close to Rs 50,000 crore from investors. Sahara is in the process of returning more than Rs 20,000 crore that it had managed to collect from investors, over the years.
The question is how do these schemes manage to collect such a large amount of money. A June 2011, news-report in The Economic Times had estimated that PACL had managed to collect Rs 20,000 crore from investors at that point of time. This means that since then the company has managed to collect Rs 30,000 crore more from investors. An April 2013 report in the Mint quoting state officials had put the total amount of money collected by the Saradha at Rs 20,000 crore.
These Ponzi schemes have managed to collect a lot of money in an environment where the household financial savings in India have been falling. Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc.
The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
While the household financial savings have dipped, the money collected by Ponzi schemes has grown by leaps and bounds. What explains this dichotomy? Some experts have blamed the low penetration of banks as a reason behind the rapid spread of Ponzi schemes in the last few years. K C Chakrabarty, former deputy governor of the Reserve Bank of India, in September 2013 had pointed out that only 40,000 out of the 6 lakh villages in India have a bank branch.
Hence, investors find it easier to invest their money with Ponzi schemes, which seem to have a better geographical presence than banks. While this sounds logical enough, the trouble with this reasoning is that the bank penetration in India has always been low. It clearly isn’t a recent phenomenon. So, why have so many Ponzi schemes come to light only in the last few years?
Another reason offered is that the rate of return promised by these Ponzi schemes is high and is fixed at the time the investor enters the scheme. This is an essential characteristic of almost all Ponzi schemes. Take the case of Rose Valley. The return on the various investment schemes run by the company varied from anywhere between 11.2% to 17.65%.
In case of PACL The Economic Times report referred to earlier pointed out that “If a customer puts down Rs 50,000 for a 500 square yard plot, he or she can expect to get back Rs 1,01,365 in six years, or Rs 1.85 lakh in 10 years.” This meant a return of 12.5% and 14% on investments. An April 2013 report in the Business Standard pointed out that the fixed deposits of Saradha “promised to multiply the principal 1.5 times in two-and-a-half years, 2.5 times in 5 years and 4 times in 7 years.” This basically implied a return of 17.5-22%.
It is clear that returns promised by these Ponzi schemes have been significantly higher than the returns available on fixed income investments like fixed deposits, small savings schemes, provident funds etc., which ranged between 8-10%. Given this, it was the greed of the investors which drove them to these Ponzi schemes, and in the end they had to pay for it.
Again that would be a simplistic conclusion to draw. Rose Valley was paying 11.2% on one of its schemes. PACL was offering 12.5%. This returns weren’t very high in comparison to the returns on offer on other fixed income investments.
In fact, most Ponzi schemes tend to offer atrociously higher returns than this. Charles Ponzi on whom the scheme is named had offered to double investors’ money in 90 days. Or take the case of the Russian Ponzi scheme MMM, which came to India sometime back. Its sales pitch was that Rs 5000 could grow to Rs 3.4 crore in a period of twelve months. Speak Asia, a Ponzi scheme which made a huge splash across the Indian media a few years back, promised that an initial investment of Rs 11,000 would grow to Rs 52,000 at the end of an year. This meant a return of 373% in one year. Another Ponzi scheme Stock Guru, offered a return of 20% per month for a period of up to 6 months.
In comparison, the returns
offered by the likes of Rose Valley, Saradha, Sahara and PACL are very low indeed. But investors have still flocked to them. In fact, in its order against PACL, Sebi estimated that the company had close to 5.85 crore investors. So, the question is why are so many people investing money in such schemes?
The answer lies in the high inflation that has prevailed in the county since 2008. For most of this period the consumer price inflation and food inflation have been greater than 10%. In this scenario, the returns on offer on fixed income investments have been lower than the rate of inflation. Hence, people have had to look at other modes of investment, in order to protect the purchasing power of their accumulated wealth. A lot of this money found its way into real estate and gold. And some of it also found its way into Ponzi schemes. This is the “real” reason behind the explosion in the kind of money that has been raised by these Ponzi schemes.
But why is the rate of interest on offer on fixed income investments been lower than the rate of inflation? This is where things get really interesting. Take a look at the graph that follows. The government of India since 2007-2008 has been able to raise money at a much lower rate of interest than the prevailing inflation. The red line which represent the estimated average cost of public debt(i.e. Interest paid on government borrowings) has been below the green line which represents the consumer price inflation, since around 2007-2008.

How has the government managed to do this? The answer lies in the fact that India is a financially repressed nation. Currently banks need to invest Rs 22 out of every Rs 100 they raise as deposits in government bonds. This number was at higher levels earlier and has constantly been brought down. Over and above this Indian provident funds like the employee provident fund, the coal mines provident fund, the general provident fund etc. are not allowed to invest in equity. Hence, all the money collected by these funds ends up being invested in government bonds.
As the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework points out “Large government market borrowing has been supported by regulatory prescriptions under which most financial institutions in India, including banks, are statutorily required to invest a certain portion of their specified liabilities in government securities and/or maintain a statutory liquidity ratio (SLR).”
This ensures that there is huge demand for government bonds and the government can get away by offering a low rate of interest on its bonds. “The SLR prescription provides a captive market for government securities and helps to artificially suppress the cost of borrowing for the Government, dampening the transmission of interest rate changes across the term structure,” the Expert Committee report points out.
The rate of return on government bonds becomes the benchmark for all other kinds of loans and deposits. As can be seen from the graph above, the government has managed to raise loans at much lower than the rate of inflation since 2007-2008. And if the government can raise money at a rate of interest below the rate of inflation, banks can’t be far behind. Hence, the interest offered on fixed deposits by banks and other forms of fixed income investments has also been lower than the rate of inflation over the last few years.
This explains why so much money has founds its way into Ponzi schemes, even though the rate of return they have been offering is not very high in comparison to other forms of fixed income investment. To conclude, the government of India has had a significant role to play in the spread of Ponzi schemes.

A slightly different version of this article appeared on Quartz India on September 10, 2014

(Vivek Kaul is the author of Easy Money: Evolution of the Global Financial System to the Great Bubble Burst. He can be reached at [email protected])

26 August, 2014

How PACL ran a Rs 50,000 crore Ponzi scheme

So another Ponzi scheme has been busted.
The Securities and Exchange Board of India(Sebi) in an order issued on August 23, 2014, banned Delhi based PACL, from collecting any more money from investors. Sebi also asked PACL to refund the money to investors over the next three months.
A Ponzi scheme is essentially a fraudulent investment scheme in which money brought in by new investors is used to redeem the payment that is due to existing investors. The instrument in which the money collected is invested appears to be a genuine investment opportunity but at the same time it is obscure enough, to prevent any scrutiny by the investors.
In case of PACL, the money collected was supposedly invested in “ agricultural land”. As the Sebi order on the company written by Whole Time Member Prashant Saran points out “According to PACL, it mainly deals in the sale and purchase of agricultural land and development of the land…PACL’s business model is not limited to simple trading in barren agricultural land but to provide significant value addition to such low value barren land by developing it into productive agricultural land.”
This land bought by PACL after collecting money from the investors wasn’t handed over to them. As the Sebi order points out “PACL has also submitted that only symbolic possession of plots are handed over to the customers as fragmentation of land/ plot into smaller sizes may not be practical or permissible under the applicable revenue laws.”
The Sebi order goes on to inform that till March 31, 2012, Rs 44,736 crore was invested in PACL schemes. The company further informed Sebi that Rs 4,364.78 crore was collected by it between February 26, 2013 and June 15, 2014. Hence, the total amount collected amounts to a whopping Rs 49,100 crore. “This figure could have been even more if PACL would have provided the details of the funds mobilized during the period of April 01, 2012 to February 25, 2013,” the Sebi order points out.
The order goes on to note that “from the available records, it is also noted that since inception till 2012, PACL has allotted land to about 1.22 crore customers.” PACL also informed Sebi that the company has more than 4.63 crore customers to whom land hasn’t been allotted. Hence, “the total number of the customer of PACL comes to around 5.85 crore.”
To summarize, the company has close to 5.85 crore customers who have invested around Rs 50,000 crore with it. This is the basic back story of PACL, which has been put together brilliantly by Saran in the Sebi order. So what are the holes in this story?
First and foremost if the company has Rs 50,000 crore invested with it, it must have used that money to buy “agricultural land” worth a similar value. But the Sebi order clearly points out that PACL hasn’t done so. “The company has only lands worth Rs 11,706.96 crore [i.e. agricultural lands (Rs 7,322.11 crores) and commercial lands (Rs 4,384.84 crores)] out of which it has not only to satisfy the claim of 4.63 crore customers who have deposited Rs 29,420 crore with it but also to satisfy 1.22 crore customers to whom the land has been allotted but sale deeds have not been executed.”
PACL claims to have more land but hasn’t been able to share those details with Sebi “In view of the above, the proposal does not appear to be serious and reasonable,” writes Saran of Sebi. This throws up several questions? If the company has land worth Rs 11,706.96 crore only, where is the remaining money that it has raised from its customers? Why hasn’t it been invested?
Further, how does it plan to repay the customers at the end of the tenure of their investment? The customers have been promised a certain rate of return. And that return can be paid only when the land which PACL claims to invest in grows in value. But without the company investing money in land, that isn’t going to happen.
Also, at the end of the tenure of his investment, the investor either has the option of taking land or money. Saran of Sebi had asked PACL to provide him a sample of 500 customers. From this sample, 421 customers had taken their money back. The question is how were these customers repaid if the money being raised is not being invested totally?
In fact, in a news report published in The Economic Times in June 2011 PACL director S Bhattacharya had said that “about 80% of customers opt to take the money at the end of the plan term instead of the plot of land they supposedly paid for.” So the remaining 20% must be taking on the land, they had originally invested in, is a fair conclusion that one can draw. But as the Sebi order also points out “Not a single applicant out of the 500 samples selected has registered a sale deed of the land he had proceeded to purchase in the first instance…These facts raise serious doubt the real estate business that PACL claims to carry out.”
In fact, the situation gets even more intriguing when one considers the total number of investors in the scheme. As summarised earlier nearly 5.85 crore investors have invested around Rs 50,000 crore in the scheme. But interestingly Bhattacharya had told The Economic Times in 2011 that the “the company has no more than 50 lakh customers”. So how did the number go from 50 lakh to 5.85 crore in just over three years? Or like Sahara, PACL does not really know how many customers does it really have?
All these lacunae lead Saran to conclude that “the lack of maintenance of proper records/ data is a clear indication that the activities of PACL are in the nature of ponzi scheme.” Hence, like most Ponzi schemes which run for a while, the company over the years has managed to build in the minds of its customers some sort of a façade of a business model, where they make money by buying and selling agricultural land.
But the available data does not lead to that conclusion. What the company seems to have been doing is to take money from new investors and hand it over to the investors whose investment had been maturing. That was all it did. It did not have a business model. It was an out and out Ponzi scheme.

The article originally appeared on www.Firstbiz.com on August 26, 2014.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

24 April, 2013

Another Sahara: How Saradha built a ‘brand’ and duped investors

Vivek Kaul
Sudipta Sen, the man behind the Saradha group, who has been on the run, was finally arrested yesterday in the beautiful alpine valley of Sonamarg in Kashmir. Sen is accused of running a Rs 20,000 crore Ponzi scheme.
A Ponzi scheme is essentially a fraudulent investment scheme where money brought in by the newer investors is used to pay off the older investors. This creates an impression of a successful investment scheme. Of course, as long as money entering the scheme is greater than the money leaving it, all is well. The moment the situation is reversed, the scheme collapses.(For a more detailed and historical treatment of Ponzi schemes click here).
The scheme gets its name from an Italian American called Charles Ponzi who in 1919 ran an investment scheme in the city of Boston, which promised to double the investor’s investment in 90 days. This was later cut to 45 days. At its peak the scheme managed to collect around $40 million and had nearly 15,000 investors.
Ponzi thought he had figured out an arbitrage opportunity which would help him earn stupendous return. In the end he couldn’t execute the arbitrage and started using the money being brought in by newer investors to pay off the older investors whose money needed to be returned.
While every Ponzi scheme is different from another in its details, there are certain key characteristics that almost all Ponzi schemes tend to have. And Saradha was no exception to this.
The rate of return promised is high and is fixed at the time the investor enters the scheme: For an individual to get interested, the returns on offer in a Ponzi scheme need to be higher than the returns he can hope to earn from other modes of investment available at that point of time.
An order issued by the Securities and Exchange Board of India yesterday, explains this point beautifully. This order has asked Saradha Reality, one of the companies being run by the Saradha Group, to wind up operations in three months.
Saradha Reality catered to all kinds of investors. It had had instalment plans with tenure varying from 12 to 60 months where minimum investment was Rs 100 per month. It raised money from investors with contributions ranging from Rs 10,000 to Rs 1 lakh for a tenure of 15 months to 120 months. It also had a lump sum investment scheme (with minimum amount of 1000/- and multiple thereof) with tenure varying from 12 months to 168 months. The rates of interest on offer where different for different investment plans.
At the end of the tenure the investor had the option to get allotment of land or a flat or to simply get a refund of the money he or she had put in, along with the promised interest. And what were the returns on offer? As the Sebi order points out “The average return offered by the noticee (i.e. Saradha), in lieu of the land when the investor opts for returns were between 12% to 24%.”
So clearly the returns being offered by Saradha were higher than the returns on offer through other investment avenues. And most investors seem to have opted for the absolute return option rather than claiming land or a flat at the end of the investment tenure. As the Sebi order points out “As informed by the noticee (i.e. Saradha), not many of investors have opted for allotment of land rather, more investors have opted for the pre-determined returns as promised by it.”
The higher returns clearly got investors to invest in Saradha.
The most important part of a Ponzi Scheme is assuring the investor that their investment is safe.
How did an upstart like Saradha managed to assure investors that their investment would be safe? The story that seems to be coming out is that Saradha employed agents of Peerless General Finance and Investment Co. Ltd. Peerless, formed in 1932 had pioneered the collection of small savings in eastern India, primarily West Bengal. Hence, it had a reasonable reputation among the people of West Bengal.
As The Mint points out “Though it didn’t ever default on repayments, Reserve Bank of India (RBI) forced Peerless to stop taking deposits in 2005-2006. This spawned the growth of unregulated deposit-taking companies in West Bengal and other eastern Indian states.”
Agents of Peerless were used to collect money for the Saradha group. In that way the brand name of Peerless rubbed onto Saradha. The Mint story cited earlier talks about one Debasish Banerjee, who used to work for Peerless and then became the blue eyed boy of Sudipta Sen, and presided ove 10,000 sub-agents working across eight districts in West Bengal.
The instrument in which the scheme will invest appears to be a genuine investment opportunity but at the same time it is obscure enough, to prevent any scrutiny by the investors. If you go to the website of Saradha Group (http://saradhagroup.com/index.html) you will find that they were in multiple lines of business. From real estate to two wheelers to media to tours and travels to even bio gas. The company had presence across sectors. But where they doing any business? Largely, the answer is no. The various businesses were just used as a façade to collect money from investors. They were used to show investors and agents as to what the company was doing with the money it was collecting.
As the Sebi order points out in the context of the reality division “It was prima facie observed that under the scheme of the noticee(i.e. Saradha) the real objective is to mobilize fund from public by showing some real estate projects to the investors and the noticee indirectly promises return of funds with high interest rates.”
The company had even bought a two wheeler company called Global Motors to show off to its agents. As the Business Standard points out “The Hooghly factory of Global Motors, acquired by Saradha sometime back, had closed down in 2011. But 150 of its employees had been kept on rolls to show, when agents made visits, that all was hunky dory and operations were on in full swing.”
All this was enough to create an illusion that the company was putting the money it collected from its investors to some use. Turned out it was not. It was simply rotating money.
The period between the investment and the pay out in a Ponzi Scheme is short. This ensures that the word spreads fast and more money comes in. Every additional investor gives legitimacy to the Ponzi Scheme. As we can see in case of Saradha the minimum tenure on offer was around 12-15 months. While there is no conclusive proof to say that most investors opted for the minimum tenure or lower tenures, I feel it would be safe to say that most new investors who were checking out the scheme would have opted for lower tenures. And gradually as the scheme spread and got some legitimacy only then would the investment tenures have gone up.
Also the fact that the scheme has collapsed tells us at some level that not many investors opted for long investment tenures. If they had, money would still be coming in and Saradha would have managed to continue operations. The fact that its more or less shutdown tells us that money has clearly stopped coming in.
Brand building is an inherent part of a Ponzi Scheme. Sudipta Sen ensured that the Saradha Group had huge presence in the media. “His first entry into the space was through Channel 10 and thereafter he expanded into dailies—Bengal Post & Sakalbela—in 2010. Sen bought out Tara channels, as well. At the time of closing down, the group had 10 media outfits — news TV channels, newspapers and magazine,” the Business Standard points out. This gave the group a lot of credibility and helped build its brand. The cine actor Mithun Chakraborty was the brand ambassador for Channel 10.
Trinamool Congress was also seen to be close to the group. As Reba Mitra a Saradha agent told NDTV.com “We put our faith in Saradha because big leaders of the Trinamool, like Madan Mitra, Didi…the chief minister, Kunal Ghosh, Shatabdi Roy, Mithun Chakraborty – when these big people are with them, government people, then would this money be stolen from us?”
Julie Potua, another agent of Saradha told NDTV that “they told clients in their pitch that other companies could collapse but Saradha would not as “Kunal Ghosh is with us, Mamata didi is with us, so invest in us.”
Kunal Ghosh, was editor and chief executive of Saradha Group’s media business. He is also a member of the Rajya Sabha nominated by the Trinamool Congress. Shatabdi Roy is a Bengali actress who is also a Lok Sabha MP from the Trinamool Congress. Being seen close to the leading political party of the state was like the icing on the cake and attracted investors by the drove.
There are some indications being given now that the Reserve Bank of India had warned the state government on the mushrooming of chit funds in West Bengal.
What is interesting is that the SEBI has been investigating the Saradha Group since June 2010. The Saradha Group, like Sahara now, had managed to delay the process by submitting voluminous documents. At various points of time in 2012, Saradha submitted 16 cartons, 19 cartons, 170 boxes and 35 cartons, as a strategy to avoid submitting the specific information being asked for by SEBI.
After this Saradha Group was directed to provide information in excel sheets. This helped Sebi to nail the group. As the SEBI order points out “On sample study of the data (in excel) provided by the noticee (Saradha), veracity of which cannot be verified, it is noted that agreements for sale was entered into with two investors namely Dhruba Bose and Arindam Pani on January 01, 2010 for flats having number 1A and 1C, respectively, both admeasuring 1437 sq ft. area in the same building i.e., Ten Katha. It is further noted that the consideration amount for flat number 1A was Rs 37,69,000 and for flat number 1C was Rs 1,17,75,850. It is highly unlikely that in a real estate business the difference between consideration amounts for sale of two similar flats at the same building on the same day shall be in the ration of 1:4. In view of these facts the possible inference will be that the allotment of plots/flats are simply a farce, and might have been done to mislead the regulatory authority.”
But by the time the SEBI order came out, Saradha had already collapsed. What is intriguing is that the investigation against Saradha started in mid 2010, but it took the company more than two years to submit the relevant data. If SEBI had cracked the whip and acted a little faster, the situation might have been a little better.
The article originally appeared on www.firstpost.com on April 24, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)