Arindam Chaudhuri is the Subrata Roy of the MBA business

arindamVivek Kaul
One of my bigger regrets in life is that I spent two years doing a post graduate diploma in management (or what is better known as an MBA). Around 16-17 months into the course came the realisation that I was wasting my time. Since I had already wasted a lot of time, I thought wasting a few months more and completing the course would do me no harm. And which is precisely what I did.
The course barely helped me improve intellectually (though I have to concede that I ended up learning some versions of compound interest, which I still use to make a living) but it did help me improve my job prospects.
The institute I did my MBA from was neither recognised by the All India Council for Technical Education(AICTE) nor was it affiliated to any university. Despite that students did not shy away from applying and the application to acceptance ratio was around 200:1 (which meant for every 200 people who applied only one was finally selected).
To give the institute due credit at no point did they try to mislead. Time and again they repeated the fact that their course was not recognised. But that did not make any difference to those applying. They came by the droves. What also helped was a lot of positive coverage in the media.
This was primarily because the institute figured in the top 20 in most business school rankings at that point of time. What it told the potential applicants was that despite not being recognised the institute was reasonably good and one would have decent job prospects after completing the course.
While I did not gain much from the course (having chosen the wrong specialisation and then losing interest totally), most of my batchmates thought the education offered was good (if not excellent) for the kind of money that was charged. In MBA lingo, there was great bang for the buck. And more than 10 years later, most of my batchmates have high paying high flying jobs .
The point I am trying to make here is that being affiliated to a university or being recognised by the AICTE has nothing to do with offering quality education which can make one employable. If that was the case our universities wouldn’t be churning out so many unemployable graduates and engineers. So in that sense I really do not have a problem with the existence of an MBA chain like Indian Institute of Planning and Management (IIPM).
There is a clear cut reason behind the mushrooming of MBA institutes(like IIPM) across the country. As the Indian economy expanded over the last two decades there has been a greater need for people who have some understanding of management and business.
The seats in government run MBA institutes (the IIMs, and business schools run by universities) have remained stagnant over the years. Only in recent years has the government started expanding, by setting up more IIMs.
Hence there has been a great demand for an MBA degree, given the perception that it improves job prospects significantly. And since everybody couldn’t get into an IIM, entrepreneurs all over the country sniffing an opportunity jumped in setting up MBA institutes. The AICTE was more than helpful when it came to approvals and that explains how all kinds of institutes got approved.
In states like Maharashtra where politicians run most education institutes, these MBA institutes immediately got a university affiliation.
Setting up an education institute with approvals is one thing but providing quality education is totally another thing. So even though all these institutes with approvals were set up, the quality of their education and infrastructure was suspect and continues to remain suspect.
The point here is that since the government couldn’t cater to the demand given that it had more pressing needs, the private sector came in. Hence, all kinds of institutes were set up, the good, the bad and the ugly. In fact one education entrepreneur regularly set up MBA institutes when the economy was on its way up, and shut them down when the economy flagged.
A fair comparison for the MBA education system in our country is the banking system. A November 2011 presentation made by the India Brand Equity Foundation ( a trust established by the Ministry of Commerce and the Confederation of Indian Industries (CII)) makes some very interesting points:
– Of the 600,000 village habitations in India only 5 per cent have a commercial bank branch
– Only 40 per cent of the adult population has bank accounts.
Given this it is no surprise that a lot of Indians don’t deposit their savings with banks because around where they live there are no banks. Or the amount of money they want to save is so small that it is not profitable for banks to entertain them.
Hence, they end up saving money with firms like Sahara and other non banking firms. The lack of banking facilities has allowed firms like Sahara to thrive and become very big. And one of the things about becoming big is that you want to continue to remain big, doing whatever it takes. As Raghuram Rajan and Luigi Zingales write in the Saving Capitalism from the Capitalists “Those in power – the incumbents – prefer to stay in power.”
In that sense Sahara led by Subrata Roy and IIPM led by Arindam Chaudhuri are very similar. Both thrived primarily because the system that was in place was not big enough to meet the demand of the citizens of this country. They created their own system to exploit this demand and became very big in that process. And now that they are big, they want to remain big. It is a natural progression of things.
This has led to Sahara trying almost every possible way to stay in business and not hand over the Rs 24,000 crore that the Supreme Court has directed it to pay the Securities and Exchange Board of India. In IIPM’s case it has meant an all out effort to remove almost every negative thing that gets said against it and Arindam Chaudhuri. Also being a big advertiser in newspapers has meant that no newspaper of standing writes anything against it.
To conclude, getting a government approval to set up an MBA institute is no guarantee for quality education. Hence, I really have no problem in non AICTE affiliated/non university recognised business schools operating because those with approvals aren’t any great shakes either.
But at the same time, it is important that prospective candidates who want to do an MBA make informed judgements. And to do that they need access to all kinds of information and not only the brochure of the institute they want to apply to.
Hence, it is preposterous that any negative information on IIPM gets contested in lower courts around the country and is ultimately removed from the internet. If after going through this information students still want to apply and join IIPM, then it is really their choice and that should be respected.
The point is that if prospective MBA candidates would have to make their decisions to figure out which institutes to apply for only on the basis of information provided by those institutes and their brochures, then they would end up counting chickens before they are hatched.

The article originally appeared on on February 16, 2013
(Vivek Kaul is a writer. He can be reached at [email protected]. He did his post graduate diploma in management (PGDM) from the Symbiosis Centre for Management and HRD. The institute is now a part of the Symbiosis International University, a deemed university)

KFA and Sahara: How they have damaged capitalism

saving capitalism
Vivek Kaul
Capitalism is a bad word these days.
And who made it a bad word? The communists? The trade unionists? Those fired from their jobs? Those who fear they might be fired from their jobs? The politicians? Or simply put you and I?
Well, actually none of the above.
Capitalism has been given a bad name by those who practise it i.e. the capitalists. And the capitalists in this have been helped by the politicians and the other insiders.
In India this role has been played to the hilt by Vijay Mallya of Kingfisher and Subrata Roy of Sahara.
As Raghuram Rajan and Luigi Zingales write in
Saving Capitalism from the Capitalists “Throughout its history, the free market system has been held back, not so much by its own economic deficiencies as Marxists would have it, but because of its reliance on political goodwill for its infrastructure. The threat primarily comes from…incumbents, those who already have an established position in the marketplace…The identity of the most dangerous incumbents depends on the country and the time period, but the part has been played at various times by the landed aristocracy, the owners and managers of large corporations, their financiers, and organised labour.”
Lets look at this statement first in the context of Kingfisher and then Sahara. The Kingfisher crisis has been on for sometime now and the firm has not been allowed to fail. In fact last year there was a lot of talk of even the government of India stepping in to rescue the airline. But thankfully, the government which continues to blow up the taxpayer’s hard earned money on Air India, chose not to do so with Kingfisher.
Before that as per an announcement made in April 2011, the banks which had loaned a lot of money to Kingfisher agreed to convert Rs 1400 crore of it into equity at a premium of more than 60%.
Of course with the benefit of hindsight one can clearly say that what were they thinking? At the time of conversion of debt into equity Kingfisher shares were priced at Rs 39.9 and the debt was converted into equity at a price of Rs 64.48. As I write this the share price of the former airline is at Rs 9.56 on the Bombay Stock Exchange (BSE). Interestingly, there are sellers willing to sell the share at this price but there are no buyers in the market. So this price doesn’t really have any meaning. A stock market like any other market needs sellers and buyers to function.
If there are no buyers there is no market. As of December 31, 2012, the State Bank of India, IDBI Bank, ICICI Bank and Bank of India owned 8.78% of the shares of the company. This was down from the 18.78% that these banks along with Punjab National Bank and UCO Bank held as on March 31, 2011, after the banks had converted their debt into equity. So these banks have managed to whittle down their holding in the airline but even with that they may have been left holding onto a stake which is worth next to nothing now. Since the latest numbers as on March 31, 2013 are not available it can’t be said with clarity what stake banks have still left in the airline.
Also, this is only the part that was converted into equity. Over and above this there is Rs 7,723 crore of debt that Kingfisher Airlines still owes the banks. The banks have a collateral worth Rs 5,237 core against the outstanding loans of Kingfisher. Experts remain sceptical on how much collateral, which includes Mallya’s bungalow at Candolim in Goa among other things, the banks will be able to sell to recover their loans.
The basic question that remains is that why would banks convert debt into equity at a premium of more than 60%, for an airline that even then had never made money? The answer probably lies in the fact that most of the banks that had given loans to Kingfisher, with the possible exception of ICICI Bank, were public sector banks. It can be safely said that political pressure was at play. The fact that Mallya is a member of the Rajya Sabha must have helped.
Hence those who Rajan and Zingales call the incumbents i.e. the promoter, his financiers and the politicians kept Kingfisher going, when it clearly was in no position to continue. And we have now ended up with a situation which is clearly messier.
No one in their right mind will now buy the airline given that it would be cheaper and easier to start a fresh airline than clear up the mess inside Kingfisher and re-launch it.
The moral of the story is that while capitalism creates, it is very important to let it destroy as well, otherwise there are costs for the society to bear.
In the aftermath of Kingfisher going bust the Ministry of Civil Aviation does not seem to be in the mood to issue fresh licenses, such is the fear of another airline going bust. Also, when Spice Jet recently cut ticket prices, the Ministry went out of its way to ensure that other players did not match that price. The logic being that if tickets are sold at a lower price there would be more losses, more airlines getting in trouble (read Air India) and so on.
In the process the prospective consumer i.e. you and me, lose out on cheaper tickets and perhaps better service, which would be the case with more airlines in the fray.
And more than anything the employees of the airline who had gone back to work on the assurances of the top management, continue to remain largely unpaid.
If the process of trying to rescue the airline had not been prolonged for so long, things would have been better for everyone concerned, except perhaps the promoter.
Now lets come to Sahara. Sahara is an even more blatant example of why you need to save capitalism from the capitalists. Here is a firm, which has been directed by no less than the Supreme Court of India to hand over more than Rs 24,000 crore to the Securities Exchange Board of India (SEBI) to repay its investors and is not doing so. In fact as an earlier column pointed out Sahara is probably even going against the decision of the Supreme Court. This cannot happen without political support.
In fact till date, politicians who jump at every opportunity to be seen as messiahs of the masses, haven’t spoken a word against Sahara. This is probably also linked to the fact that most politicians run cricket in India by controlling the state boards and the district cricket associations and Sahara remains the biggest sponsor of what was once called the gentleman’s game. As the old saying goes, you don’t bite the hand that feeds you.
Meanwhile the unsuspecting poor of the country continue to handover their hard earned money to Sahara. It is safe to say that Sahara has inspired a whole host of other firms to raise money from the unsuspecting public in India, knowing fully well that even if they do not follow the law of the land, things would just be fine. It also explains to a large extent why pyramid and Ponzi schemes continue to flourish in India. Nobody ever gets punished.
Rajan and Zingales point out that “Those in power – the incumbents – prefer to stay in power.” And in order to do that they tend to go any extent possible. In the process things get messier.
Hence, it is important for firms which are no longer viable to be allowed to fail, and if they are not in the mood to do it themselves, then they the law of the land should ensure that they do fail. As a certain Frank Borman once said “I’ve long said that capitalism without bankruptcy is like Christianity without hell.”
The article originally appeared on on February 16, 2013

(Vivek Kaul is a writer. He can be reached at [email protected])

Sahara’s numbers don’t add up: ads confuse, don’t clarify

Vivek Kaul and R Jagannathan
The Sahara group sure has a way with numbers. A separate number for separate occasions.
On 1 December this year, an advertisement issued by the group said two of its companies — Sahara India Real Estate Corporation (SIREC) and Sahara Housing Investment Corporation (SHIC), which fell foul of Sebi – had returned Rs 33,000 crore of money collected through optionally full convertible debentures (OFCDs).
The ad read: “We started OFCD in these two companies in 2008/2009. Most of the money deposited with us was for 5 to 10 years. But now we have cleared around Rs 33,000 crores liability.”
On 5 December, a Supreme Court bench headed by Chief Justice of India Altamas Kabirextended the deadline for repayment till February. It ordered Sahara to pay Rs 5,120 crore immediately to Sebi, Rs 10,000 crore by January, and the rest by February. This suggests that the court still thinks nearly Rs 25,000 crore may be owed to investors.
A Sahara ad released on 9 December claimed it owed investors only Rs 2,620 crore as on date. It mentions that “Total liability was around Rs 25,000 crores of both the OFCD companies” (N
ote: since there are no dates, nothing can be verified), but then says only Rs 2,620 crore of this Rs 25,000 crore was left unpaid, for which it had given Sebi a cheque – adding an extra Rs 2,500 crore in case there were any discrepancies.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.
The Supreme Court judgment of 31 August 2012 takes note of an outstanding of Rs 24,029.73 crore as on 31 August 2011 between the two companies that was owed to 29.61 million OFCD investors.
 (Read the full judgment here)
One wonders at what point did Sahara managed to pay investors Rs 33,000 crore when the figure was only around Rs 24,029 crore in August 2011?
The only way the group could have repaid Rs 33,000 crore over the lifecycle of the OFCD investment was if there was a huge churn even in the initial years of the scheme in 2008-11. Sebi banned them from continuing the scheme in June 2011.
Sahara offered investors three types of bonds through SIREC – the Abode 10-year bond, where early redemptions were possible only after five years; the Real Estate bonds of five years, where no early redemptions were possible; and the Nirmaan four-year bond, where redemptions were possible after 18 months.
The bulk of the investors opted for the first two bonds – Abode and Real Estate, where no redemptions were possible for five years. Since the SIREC OFCDs were issued only from 2008 (SHIC began only towards end-2009), how is it possible that such a large bulk of OFCDs were refunded to investors when they were not due?
Firstpost noted earlier, a majority of SIREC’s investors (13.036 million) preferred to invest in Real Estate bonds worth Rs 7,120 crore. And Abode bonds came in for second preference, as 7.06 million invested in them, but the amount invested was larger at Rs 8,411 crore. Nirmaan bonds had a small following of 13.06 lakh investors with an investment of Rs 1,959 crore.
The big question is this: how can Sahara claim that it repaid nine-tenths of the money collected (only Rs 2,620 crore left out of Rs 25,000 crore or more) when the two biggest OFCDs issued by SIREC did not have any clause for premature encashment before five years – which meant only in 2013 and not earlier?
There was, of course, a provision for premature refunds in case of deaths, but Sahara is not claiming that most of its investors had passed away during the term of the OFCDs.
The refund patterns disclosed in the Supreme Court’s judgment tell their own story.
Of the total amount of Rs 19,400.87 crore collected by SIREC till 13 April 2011, only 11.78 lakh investors out of 23.3 million had cashed out with Rs 1,744.34 crore by 31 August 2011 – leaving a balance of Rs 17,656.53 crore.
In the case of SHIC, premature redemptions were a meagre Rs 7.3 crore (involving just 5,306 investors) out of total collections of Rs 6,380.50 crore – leaving a balance of Rs 6,373.20 crore.
These numbers are a part of the disclosures made by Sahara to the Securities Appellate Tribunal, which heard and threw out its appeal against Sebi, as on 31 August 2011, and remained part of the Supreme Court order a year later.
The questions are clear:
Why did Sahara not tell the Supreme Court what it owed investors during the hearings on the case? How come the Rs 2,620 crore figure came up only when the Supreme Court ordered it to pay Rs 24,029 crore?
How did Sahara manage to refund most of the money when the bulk of the bonds were not meant to be prematurely redeemed till 2013? How did dues of Rs 24,029 crore become Rs 2,160 crore, or even Rs 5,120 crore?
Did Sahara really refund the money or shift it to different schemes? Or why else would Sebi issue ads warning investors to avoid Sahara approaches? 
Business Standard clearly reports that investors under pressure are  moving their money.
The newspaper reported that agents of the Sahara group were being pushed to collect 
sehmat patras (consent letters) from investors to show that their money had already been returned to them. “Agents, estimated to be a million strong, who sold OFCDs, often termed housing bonds, have been ordered to collect these letters, failing which their commissions are being stopped. With these consent letters, many of which are pre-dated, with dates ranging from as early as April to show that refunds were spread over a long period, documents such as account statements and passbooks in the hands of the customers are being collected,” the newspaper reported.
Also, money was being transferred to the new Q Shop venture launched by the group. The newspaper adds: “While this documentation process has been on, a significant portion of the money deposited in the accounts have already been transferred to the Q-Shop plan, another money raising plan being marketed as a retail venture.”
What is interesting nonetheless is that the December 1 advertisement of Sahara makes a slightly different point. “Surprisingly in the Hindi belt particularly, we find the name of hundred of different persons, even the area names, including Village, Mohalla, Towns, Cities match. Most surprisingly many many fathers/husbands names also match, so it is very difficult to authentically ascertain the pattern of reinvestment, but through verbal conversations and also through computer data matching we try to understand the pattern. There is always persuasion by field workers out of their good relation with investors for reinvestment. We have vaguely observed that a good percentage of depositors/investors do not come back and go away with 100% of maturity/redemption amount. Another good percentage keep back their principal investment amount but they accept field workers request and reinvest the amount of earning with the company and a big percentage reinvest the full amount”.
How different is good percentage from a big percentage? Why can’t the company put out some real data especially when the advertisement goes onto to claim with utmost confidence that “if you go through the figures, you shall see a similar behaviour in all other institutions where commission is paid like Post Office, LIC etc.”
If Sahara can be so confident about the money going into Post Office investment schemes, and premium being paid towards Life Insurance Corporation of India’s insurance plans, then it can surely give us a little more detail about the money that it raises.
Sahara has a lot of explaining to do. The group, whose attitude has been described as “shaky” by the Supreme Court, is not telling us the real story.

The article originally appeared on on December 10, 2012.

Sahara and Ponzi schemes: What are the parallels?


Vivek Kaul

Dr K M Abraham of Securities Exchange Board of India (Sebi), in his June 23, 2011 order, against two Sahara group companies, Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited, had alluded to the possibility of a Ponzi scheme.
In his order Abraham had said “The Learned Counsel, at one point in the submissions before me, mentioned the fact that there are no investor complaints at all, from any investor in the OFCDs (optionally fully convertible debenture) raised by the two Companies. Going by the history of scams in financial markets across the globe, the number of investor complaints has never been a good measure or indicator of the risk to which the investors are exposed. Most major ‘Ponzi’ schemes in the financial markets, which have finally blown up in the face of millions of unsuspecting investors, have historically never been accompanied by a gradual build up of investor complaints.”
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 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).
So does that mean that Sahara is a Ponzi scheme where money is simply being rotated? While there is not enough information available in the public domain to come to this conclusion nevertheless several interesting points can be made.
One of the characteristics of a Ponzi scheme is that the scheme appears to be a genuine investment opportunity but at the same time it is obscure enough, to prevent any scrutiny by the investors. The optionally fully convertible debentures that the two Sahara group companies issued to raise money from nearly 3 crore investors do fall into this category of investment which sounds genuine enough and at the same time is obscure enough to prevent any scrutiny by investors. Further, Sahara raises its money from the lowest strata of the society, a lot of whom do not even have bank accounts. So the chances of questions being asked are very low.
Another characteristic of a Ponzi scheme is that the operators of the Ponzi Scheme persuade the investors to roll over the profits into the next investment cycle. So the returns remain on paper. Since the money remains with the operator the Ponzi scheme keeps running.
This is exactly what was done by a host of Non Banking Financial Corporations (NBFCs) in the nineties. Billboards promising exorbitant rates of return started showing up all over small town India. Money from the later investors was used to pay off the earlier investors. In many cases, once their investments matured, the investors were persuaded to reinvest the principal and interest on the investment back into the scheme.
This seems to be true in case of Sahara by their own admission. As their spokesperson recently told the Business Standard “Right from last 30 years, we have observed that our field workers try their best to pursue the depositors/investors to reinvest in some other scheme of the group because they get their livelihood from that since they earn commission on it. They always impress and hold their introduced depositor/investor by giving best human service throughout the tenure of the scheme.”
Most of the Ponzi Schemes start with an apparently legitimate or legal purpose. Hometrade started off as a broker of government securities, Nidhis were mutually beneficial companies and Anubhav Plantations was a plantations company. They used their apparently legitimate or legal purpose as a façade to run a Ponzi Scheme. Same stands true for the present day Ponzi schemes. Speak Asia was in the magazine and survey business. Emu Ponzi schemes were in the business of rearing and selling emus. And Stockguru claimed to be making money by investing in the stock market.
Similarly Sahara is into a variety of businesses from running hotels to making films and television serials and building homes, which are all legitimate. The money raised by Sahara supposedly finances these businesses. What is questionable however is that are any of these businesses making money? Also has all the money that has been raised put to use?The film business of the company has been scaled down majorly over the years. The listed businesses of the group can’t be said to be doing terribly well either. Very little financial information regarding the group is available in the public domain to perform any reasonable financial analysis on it. (You can access some financial information regarding the group here).
Brand building is also an inherent part of a Ponzi Scheme. MMM, a Russian Ponzi scheme marketed itself very aggressively. In the 1994 football World cup, the Russian soccer team was sponsored by MMM. MMM advertisements ran extensively on state television and became very famous in Russia. Hometrade also used the mass media to build a brand image for itself. It launched a high decibel advertising campaign featuring Sachin Tendulkar, Hrithik Roshan and Shahrukh Khan. When the company collapsed, the celebrity endorsers washed their hands off the saying that they did not know what the business of Hometrade was.
Sahara is the official sponsor of the Indian cricket team. Given this the entire Indian team has been advertising the new Q shop venture of the group. So who are investors more likely to believe while parting with their hard earned money? Sachin Tendulkar, cricketing great and a Member of Parliament, or dull advertisements put out by SEBI asking investors not hand over their money to Sahara Q shop?
In an advertisement headlined “Don’t be forced, don’t be misguided” the Securities and Exchange Board of India (SEBI) had asked investors “not to yield to any pressure from any person, including Sahara or its agents, for converting or switching their existing investments in the bonds to any of the other schemes like Q-shop, etc.”
Sahara also owns the Pune IPL team. It also has a stake in an F1 racing team Sahara Force India, whose other high profile owner is Vijay Mallya.
A final point to remember about Ponzi schemes is that the finally become too big and collapse under their own weight. Let us say someone decides to start a Ponzi scheme with the intention to defraud people.
He gets 100 members to start with and each one of them contributes Rs 10,000 to become a member of the scheme. The members in turn are promised Rs 50,000 back in a period of one year. Given that the scheme is a Ponzi scheme, there is no business model to generate returns and give out the Rs 50,000 promised to each investor. So the guy running the Ponzi scheme has to take the money being brought in by the newer investors to pay off these original investors.
Now every investor has been promised Rs 50,000. To enter the scheme Rs 10,000 is required. Hence to get Rs 50,000 to pay off one original investor, five new investors have to be roped in. Each one of them pays Rs 10,000 each and thus Rs 50,000 is raised to pay off the original investor.
The point to note here is that the Rs 50,000 that each original investor gets is basically the money being brought in by five new investors. Hence, the money gained by the original investors is basically the money brought in by the five new investors. And that is what makes a Ponzi scheme a zero sum game. The original investors gained only because the latter investors were willing to pay. No new wealth has been created.
This also means that to pay off the 100 original investors 500 new investors need to be brought in.
So that’s the first level of the Ponzi.
What happens next?
After the original lot has been paid off, the 500 investors who entered the second level of the Ponzi need to be paid off, to keep the scheme going. To pay off each of these investors five new investors are required, which in total means 2500 investors. If the fraudster running the Ponzi manages to get 2500 or more investors, the scheme continues.
Let us say the fraudster manages to get 2500 investors and each of these investors pays Rs 10,000. The money thus collected is used to pay off the 500 investors of the second round. In the third round 2500 investors have to be paid, for which 12,500 investors need to invest money in the Ponzi scheme.
If the scheme continues successfully by the ninth round nearly 19.5 crore new investors need to be brought in to keep the Ponzi scheme going. India’s population as per the latest census is around 120 crore. This means that for this hypothetical scheme to continue nearly 16% of the population of India needs to invest in it.
So any Ponzi scheme if it becomes sufficiently big has to collapse because the number of people required to keep it running it simply way too big. One way to avoid this to keep get investors to reinvest their money back into the scheme and live to fight another day.
But all Ponzi schemes collapse in the end under their own weight. A mutli level marketing(MLM) kind of Ponzi scheme is a very good example of a Ponzi scheme that ultimately collapses under its own weight.
In an MLM scheme a company appoints independent distributors, who are not employees of the company. The products of the company are sold to the distributors, who not only sell these products to make a profit, but also appoint more distributors and so the cycle goes on.
The company goes about appointing distributors but the catch is that the products the distributors buy rarely get sold and is just there to build a façade of a business model.
A major part of the commission earned by a distributor comes from appointing new distributors to the company, and thus creating a new level. And so the scheme goes on, with newer levels being created. The return to the upper levels comes from creating new levels rather than the sale of the product. The wealth gained by participants at the higher levels is the wealth lost by participants at lower levels.
Like any other Ponzi Scheme there are only a finite number of people who can enter the scheme. So after some time the number of people required to keep the scheme going becomes very large and the scheme goes bust.
As Debashis Basu wrote in a recent column in Business Standard “Now they(MLM schemes) come under the garb of selling you some expensive products or some vague services: gold coins (Gold Quest), lifestyle products (QNet), surveys (Speak Asia), and so on. So, at any time, they have the fig leaf of providing some “value”. Even Amway, Oriflame and Tupperware rely on a model with recruitment and ever-expanding chain. For those at the end of the chain to get some crumbs and to sustain the whole chain, products have to be hugely expensive. Even then, most people make no money. New recruits are shown a dream — what people in the second link of the chain have achieved. But they are not told that no one beyond the top two or three layers really makes any money.”
While Ponzi schemes keep going bust newer ones keep coming and taking their place. This is sad because for the economy as whole, they are undesirable. Every time a Ponzi scheme is exposed, the confidence of the investor in the financial system goes down. Investors become reluctant to part with their money. This in turn hampers the ability of the capitalist system to raise capital for newer ventures.
The attraction of easy wealth is something that investors cannot resist. Ponzi Schemes offer huge returns in a short period of time vis a vis other investments available in the market at that point of time. With good advertising and stories of previous investors who made a killing by investing in the scheme, investors get caught in the euphoria that is generated and hand over their hard earned money to such schemes going against their common sense.
Greed also results when investors see people they know make money through the Ponzi Scheme. As economist Charles Kindleberger wrote in his all time classic Manias, Panics and Crashes There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. In a country like India where the per capita income is low the chances of people falling for Ponzi Schemes continue to remain high.
The only way out of this menace is by punishing people who run Ponzi schemes quickly. Rather than assuming investors are knowledgeable about investment opportunities, and instead of providing investors with more information about particular investments, disseminating information about investments gone awry may be a better bet to control this problem.
As Basu writes in his column “The ministry of finance and financial regulators may like to believe that they oversee the financial sector well. They are really deluding themselves. The money people lose in pyramid schemes is a few times the size of equity mutual funds or life insurance plans, on which millions of words are written and thousands of regulatory man-hours are spent. And all the literacy workshops funded by the government and industry would seem such a joke if pyramid schemes are allowed to flourish.”
Hence, its time the government woke up to this and did something about this menace, starting by punishing some of the big boys.

The article originally appeared on on December 12, 2012.

(Vivek Kaul is a writer. He can be reached at [email protected])

Rajat Gupta may never have got convicted in India

Vivek Kaul
Rajat Gupta will be spending two years in prison, which will be followed by one year of supervised release (The supervised release starts after a person is released from prison. After the release the individual goes through a period of supervision in the community. You can read the complete definition here). Gupta will also have to pay a fine of $5million.
Gupta, a former managing director of management consultancy McKinsey & Company, who happened to marry the only girl in his IIT Delhi batch, and a member of the boards of Goldman Sachs and Proctor and Gamble, had been accused of passing on sensitive board room information to hedge fund manager Raj Rajaratnam. The information leaked by Gupta turned out to be enormously profitable stock tips for Rajaratnam. Rajaratnam is currently serving 11 years in jail for securities fraud.
The Securities and Exchange Commission (the stock market regulator in the United States) had filed an administrative civil complaint on March 1, 2011, against Gupta for insider trading with Rajaratnam who ran the Galleon Group of hedge funds. The case from start to finish lasted for a period of around twenty months. The dispensation of justice was fast and quick and it did not take a life time as it does in India.
Take the case of Lalit Narayan Mishra who was the Cabinet Minister for Railways. On January 2, 1975, Mishra was in Samastipur to declare open the broad gauge railway line between Samstipur and Muzaffarpur. A bomb exploded and he was seriously injured. He died the next day.
The case against the accused is still on, thirty seven years later. Eight people were accused in the case. One has of them has since died. As Gurcharan Das writes in India Grows At Night–A Liberal Case for a Strong State “The case against the accused dragged on for thirty-seven years…Meanwhile, thirty one of the thirty-nine witnesses for the defence had died gravely prejudging the case…No less than twenty-two different judges had heard the case over the years. The trial was still going in 2012.”
And there are other cases in which justice is delivered after a generation has passed in the meanwhile. In 1992, four teams of government officials landed up in the adivasi village of Vachathi in search of the sandalwood smuggler Veerapan. On not finding him there the government officials accused the villagers of harbouring Veerapan. The officials took 18 teenage girls from the village into the forest where they were stripped and raped. 133 villagers were arrested and put in jail as well.
Justice was delivered only 19 years later. As Das writes “On the sweltering afternoon of 29 September 2011, principal district judge S Kumarguru began to hand out sentences. There was a hushed silence in the packed courtroom in Dharmapuri, Tamil Nadu. He began at 3.30pm but could not finish until 4.40pm because he had to read aloud punishments awarded to 215 government officials. Among those convicted were 126 forest officials, 84 policemen and five revenue officials. Seventeen were convicted of rape and they received prison sentence from seven to seventeen years; others received from one to three years on counts of torture, unlawful restraint, looting and misuse of office.” Fifty four accused had died in the meanwhile.
Since delivery of justice takes so long, frivolous cases are filed to cut short promising careers. S Nambi Narayanan’s case is a very good example of the same. Narayanan was a senior official in charge of the cryogenics division of the Indian Space Research Organisation. In 1994, he was accused of espionage. The Central Bureau of Investigation (CBI) concluded as early as 1996 that the entire case was a fabrication. The National Human Rights Commission ordered an interim compensation of Rs 10 lakh for Narayanan in 2001. The Kerala government got a stay against this order. The stay was finally vacated by the high court on September 7, 2012. In the meanwhile a lifetime had passed. (You can read the complete details of the case here).
The system is also used to their advantage by those who do not like the idea of working. The famous case of Uttam Nakate a helper at Bharat Forge illustrates this point. Nakate was found sleeping at the workplace at 11.40am in the morning in early 1984. This was the fourth occasion this had happened. The company started proceedings against him under the Industrial Employment Act, 1946, found him guilty and dismissed him.
Nakate then appealed to the Maharashtra labour court and challenged his dismissal under the category of an unfair trade practice. The labour court directed that Nakate be taken back and at the same time also be given 50% of his wages. The company then appealed to an industrial tribunal which struck down the decision of the labour court. Nakate then went to the Bombay High Court which decided in his favour and also directed the company to pay him Rs 2.5 lakh. The case finally made its way to the Supreme Court which ruled in the company’s favour. The two judges on the case said “we cannot say the quantum of punishment imposed was wholly disproportionate to his act of misconduct”. If all this would have happened in a period of 20 months or so as it did in Gupta’s case in the US, things would have been fine. By the time the Supreme Court decision came in 2005, two decades had passed.
But the people who gain the most from the way our judicial system has evolved are the politicians. Take the case of former telecom minister Sukh Ram. In 1996, the CBI had seized Rs 3.6 crore from his official residence which he had collected as a bribe in awarding a telecom contract.  The case dragged on for years and Sukh Ram was finally found guilty in late 2011, nearly a decade and a half later. By this time Sukh Ram was 85 years old and in hospital.
“If this happened in the case of Cabinet ministers, where was the hope of justice for an ordinary person? But former chief justice of the Supreme Court J.S.Verma had a different take. He claimed that although Article 21 of the Constitution guaranteed a speedy trial to every citizen, in reality the status of the person did matter. A powerful person with connections or money could speed up or delay the justice system to suit his needs,” writes Das.
Look at what happened to the Ruchika Girhotra case. The accused SPS Rathore got out of the courtroom smiling in December 2009, after a six months sentence was announced and he got bail immediately.
The late Harshad Mehta is another brilliant example of the system gone wrong. The scam he was running on the Bombay Stock Exchange was revealed in 1992. He died of a heart attack in a Thane jail on the last day of 2001. When he died Mehta was facing trial in 28 cases but had been convicted only in one case which involved the use of funds to the tune of Rs 30 crore belonging to the Maruti Udyog being used in the stock market. All the other cases were pending.
The economist Bibek Debroy carried out a project for the government in the 1990s and found out that nearly 2.5 crore cases were pending in Indian courts. This number has gone up to 3.2 crore since then. Debroy found that it takes up to twenty years to settle a dispute. And it would take nearly 324 years to settle all the cases. Debroy further suggested that a major reason for the huge number of cases was the fact that a large number of laws were simply obsolete. As Das writes “He also concluded that 500 out of the 3500 central laws were obsolete and needed to be scrapped, and half of the 30,000 state laws as well.”
But this was not a major reason for the large number of cases in the Indian court. “The main culprit of the judicial delay was the government, which appealed all judgements automatically and proceeded to lose them again in the higher courts. This crowded out the private individual. The problem lay in the fact that the decision to litigate was made at the lowest level in the bureaucracy but the decision not to litigate was made at the highest level. If this process were simply reversed, government litigation would come down,” writes Das. So for the burden on the Indian judicial system to come down, the tendency of the government to litigate left, right and centre, also needs to come down.
Now let’s get back to Rajat Gupta. What would have happened to Rajat Gupta if he was accused of a similar wrong doing in India? Being at the position that he is he could have easily influenced the judicial system. The case would have dragged on for 20 years. And by the time it would have reached the Supreme Court, Rajat Gupta, like Sukhram now, would have been 85 years old by then and more or less lived his life. Gupta is around 64 years old now.
Of course all this would have happened only assuming that Gupta would have been taken to court for what he did. Passing on stock tips to fund managers isn’t really a big deal in an Indian context. Harshad Mehta who carried out a far bigger scam than what Gupta has been accused of in the United States (actually it’s not even a comparison) got convicted in only one case between 1992 and 2001. And even that wasn’t one of the main cases. And what ever happened to Ketan Parekh and his scams? Look at Sahara and the excuses it keeps coming up with for not paying back the Rs 24,000 crore it owes to its 3 crore investors, the latest one being that 90% of its investors do not have bank accounts. This, despite being directed by the Supreme Court to payback its investors. Even their latest excuse doesn’t quite work. When the Sahara collected the money even then their investors mustn’t have had bank accounts? So if it could collect the money, it should also be able to return it.
What all this tell us is that India is a weak state which cannot enforce things. Das summarises it best when he writes “Weak enforcement is at the heart of a weak state in which the most vulnerable and the weakest are its chief victims.”
The article originally appeared on on October 26, 2012.
(Vivek Kaul is a writer. He can be reached at [email protected])