Corporate Fraud in India – Case Studies of Sahara and Saradha

Part I of SPI’s India Series

By: Aparajita Pande

First there was Ketan Parekh. Then there was 2G. And then there were Satyam, Tatra, Saradha, Sahara and countless others. Corruption has come to be viewed as an inevitable, if unfortunate, cost of getting things done in India, and corporate and political panjandrums resolutely adhere to this school of thought. This kind of large-scale fraud is aided by the strong political-corporate nexus that exists in India. Market regulators like the Securities and Exchange Board of India (SEBI) are ultimately powerless in exercising strict control over financial institutions due to severe political pressure. This paper looks into the specific cases of the Sahara India investor fraud case and the Saradha Group chit fund scam to reveal the nature of corporate scams in India, their ethical implications and possible solutions.

On February 26, 2014, shock waves were felt through the country as the Supreme Court of India sanctioned a non-bailable warrant for the arrest of Sahara India Pariwar Chairman Subrata Roy. [1] This decision attracted attention for one major, unexpected reason. One would consider investor fraud worth more than US $3 billion as incredulous under any circumstance, but corporate scandals of this nature in India have lost their propensity to amaze. Indeed, what was most surprising about this case was real consequences for the perpetrator, a rarity for corporate crimes in India. Despite immense political pressure and the regulatory body’s own restrained powers, the Securities and Exchange Board of India managed to secure a landmark victory after an arduous, five-year battle against Sahara.

The Saradha Group scam of 2013 also saw as many as 1.7 million investors of a Ponzi scheme lose approximately US $5 billion when it collapsed. [2] Unarguably, networks with high-ranking politicians in the state government of West Bengal allowed the Ponzi scheme to stay afloat undetected for as long as it did. Here, too, regulatory bodies like SEBI were blatantly disregarded until the scheme went bust in April 2013. Complete with ineffectual regulatory bodies struggling to have a voice and coercive political interests, the Sahara and Saradha scandals are the classic examples of everything that makes corporate fraud in India possible.

Case Study 1: Sahara Group

Since 2009, when the Sahara Group’s activities first came under the radar of SEBI leading up to the arrest of Sahara India Pariwar founder Subrata Roy in 2014, both parties have been engaged in an aggressive regulatory conflict. SEBI alleged that Sahara India Real Estate Corp Ltd (SIRECL) and Sahara Housing Investment Corp Ltd (SHICL), which issued Optional Fully Convertible Debentures (OFCD), illegally collected investor money. [3] Meanwhile, Sahara denied SEBI had any jurisdiction in the matter. [4]

SEBI went on to order Sahara to issue a full refund to its investors, which was challenged by Sahara before the Securities Appellate Tribunal (SAT). [5] When the SAT upheld SEBI’s order, Sahara moved to the Supreme Court in August 2012, which ordered Sahara to refund investors’ money by depositing it with SEBI. [6] Sahara then declared that most of the US $3.9 billion had already been repaid to investors, save for a paltry US $840 million, which it handed over to SEBI. [7] This was disputed by SEBI, which claimed that the details of the investors who were refunded had not been provided. When Sahara failed to deposit the remaining money with SEBI and Subrata Roy skipped his hearing, the Supreme Court of India issued an arrest warrant for the Sahara chief in February 2014. [8]

Amid rumors of black money laundering and the misuse of political connections, Sahara vehemently denied all charges and continued to defy SEBI. The regulator persevered through what the Supreme Court referred to as the “ridiculous game of cat and mouse” and finally managed to pin down Sahara chief Subrata Roy in 2014. [9] In this rare victory, SEBI not only brought Sahara to justice, but also made an excellent case for why the regulator, and others like it, require greater autonomy and penalizing powers.

Case Study 2: Saradha ‘Chit Fund’ Ponzi Scheme

India has been flooded with various Ponzi schemes that take advantage of unsuspecting investors looking for alternate banking options. Lacking access to formal banks, low-income Indians often rely on informal banking. These informal banks invariably consist of money lenders who charge interest at inflated rates and were soon replaced by more sophisticated methods of conning people through disguised Ponzi schemes. Fundraising is done through legal activities such as collective investment schemes, non-convertible debentures and preference shares, as well as illegally through hoax financial instruments such as fictitious ventures in construction and tourism. The rapid spread of Ponzi schemes, especially in North India, has various causes, not the least of which include the lack of awareness about banking norms, steadily falling interest rates, lack of legal action against such activities, and the security of political patronage. [10]

The Ponzi scheme run by Saradha Group collected money from investors by issuing redeemable bonds and secured debentures and promising incredulously high profits from reasonable investments. [11] Local agents were hired throughout the state of West Bengal and given huge cash payouts from investor deposits to expand quickly, eventually forming a conglomerate of more than 200 companies. This syndicate was used to launder money and confuse regulators like SEBI. In April 2013, the scheme collapsed completely causing a loss of approximately US $5 billion and bankrupting many of its low-income investors. [12]

SEBI first detected something suspicious in the group’s activities in 2009. It challenged Saradha because the company had not complied with the Indian Companies Act, which requires any company raising money from more than 50 investors to have a formal prospectus, and categorical permission from SEBI, the market regulator. [13] The Saradha Group sought to evade prosecution by expanding the number of companies, thus creating a convoluted web of interconnected players. This created innumerable complications for SEBI, which labored to investigate Saradha in spite of them. In 2012, Saradha decided to switch it up by resorting to different fundraising activities, such as collective investment schemes (CIS) that were disguised as tourism packages, real estate projects, and the like. [14] Many investors were duped into investing in what they thought was a chit fund. This, too, was an attempt to get SEBI off its back, as chit funds fall under the jurisdiction of the state government, not SEBI. [15] However, SEBI managed to identify the group was not, in fact, raising capital through a chit fund scheme and ordered Saradha to immediately stop its activities until cleared by SEBI. [16] SEBI had previously warned the state government of West Bengal about Saradha Group’s hoax chit fund activities in 2011 but to no avail. Both the government as well as Saradha generally ignored SEBI until the company finally went bust in 2013.

After the scandal broke, an inquiry commission investigated the group, and a relief fund of approximately US $90 million protected low-income investors. [17] In 2014, the Supreme Court transferred all investigations in the Saradha case to the Central Bureau of Investigation (CBI) amid allegations of political interference in the state-ordered investigation. [18]

What is SEBI: Powers and Limitations

In accordance with Section 11(1) of the Securities and Exchange Board of India Act 1992, SEBI is required to protect the interests of investors in securities and regulate and promote the development of the securities market. [] Established in 1988, the Securities and Exchange Board of India (SEBI) was instituted as the official regulator of Indian markets but was only given statutory powers through the SEBI Act in 1992 by Indian Parliament.

SEBI’s primary goal is to cater to the needs of the market, which include investors, issuers of securities and any third parties involved. Its functions include, but are not limited to, regulating the stock market, preventing insider trading, managing company takeovers and acquisition of shares, and investigating fraudulent activities in the securities market. [20] To an extent, SEBI has successfully made tangible changes in the market. It did away with inefficiencies and delays by passing the Depositories Act, which eliminated the need for physical documents and certificates and played a major role in moving markets toward an electronic and paperless platform. [21] Administrative achievements aside, SEBI also made strict changes that demanded corporate promoters disclose more information. [22]

That being said, SEBI has its fair share of problems as well. Many perceive, and perhaps rightly so, the regulatory body is all bark, no bite. One of the major criticisms against the SEBI Act was it did not provide SEBI with sufficient powers. The government, particularly the Finance Ministry, has an unnecessarily constrictive hold on SEBI, which makes the regulator extremely susceptible to political interference for three main reasons. Firstly, although SEBI has the right to create rules and regulations by which capital markets abide, it does not have the right to implement them without the approval of the federal government. Arguably, the Finance Ministry may have a say in the framework of market regulations, and it can have the power to make recommendations. The process of obtaining the government’s authorization invariably causes needless delays and results in watered-down versions of the rules being implemented.

Secondly, SEBI still does not have the power to prosecute without the consent of the government. Its powers are restricted to recommending action to the government, rendering it unable to take direct action against any errant company. This is a major reason why the Sahara-SEBI war dragged on for as long as it did. Were SEBI allowed to prosecute without having to constantly answer to the government, the Sahara investor fraud would have been an open-and-shut case. SEBI must have the independent power to prosecute government interference, like the Securities Exchange Commission (SEC) in the United States.

Finally, and perhaps most importantly, the appointment process of the members of SEBI is flawed. The board has eight members: the chairman, who is nominated by the Central Government; one member from the Reserve Bank of India; two officials from the Finance Ministry; and five remaining members who are recommended by the Union Government. [23] The fact the Finance Ministry is directly or indirectly responsible for almost all of these key appointments greatly compromises the legitimacy of SEBI as an independent, unbiased watchdog. A Public Interest Litigation (PIL) challenging the legitimacy of this appointment process has been filed in the Supreme Court. [24]

Political players in Corporate Fraud

Politicians are no strangers to financial scandals in India. Whether it is the Commonwealth Games scandal, which involved the misappropriation of millions of dollars by then-chairman and Congress member Suresh Kalmadi, or the 2G scam, which involved telecom companies being undercharged by government officials for licenses, most prominent cases of fraud usually have a trace of political meddling.

Sahara is not unique in this sense. Many commentators proclaim that Subrata Roy would not have had the nerve to ignore Supreme Court orders so blatantly if there were no political reassurances given to him. [25] In June 2011, former SEBI member KM Abraham wrote a whistle-blowing letter to Dr. Manmohan Singh, Prime Minister of India, blaming the Finance Ministry for interference. [26] He claimed that then-Finance Minister Pranab Mukherjee and his advisor, Omita Paul, were trying to force SEBI Chairman UK Sinha to “manage” high profile cases, including Sahara, though this account was denied by the Finance Ministry as well as Sinha.

The political interference in the Saradha Group case is more apparent. Several members of the West Bengal ruling party, the Trinamool Congress (TMC), personally benefitted from the scheme. For instance, there are many reports that suggest Sudipto Sen, Chairman of the Saradha Group, bought paintings by Mamata Banerjee, the Chief Minister of West Bengal, whose government later issued circulars to public libraries to display newspapers published by Saradha. [27] Several Members of Parliament, such as Srinjoy Bose and Kunal Ghosh, were connected to Saradha. Kunal Ghosh reportedly received a salary of over 1.5 million rupees (US$24,000) per month from the Saradha Group. [28] In an 18-page confessional to the Central Bureau of Investigation, Sudipto Sen admitted to illicitly paying huge sums of investor money to many politicians. Among the few he named were Manoranjana Singh, wife of former Congress member of Parliament Matang Singh, and Kunal Ghosh, whom he accused of blackmail. [29] Many high profile personalities, including Transport Minister Madan Mitra and actor and TMC member Satabdi Roy, publicly endorsed the Saradha Group. [30]

The Ethics of Corporate Fraud: Should We Care?

When we think of corporate fraud, there is a tendency to imagine it as an isolated event with no real repercussions in our lives. We often look at the lofty numbers and associate the loss with an abstract, theoretical entity. In reality, the financial costs of corporate scams have deep ethical considerations and significant implications in our lives. The 2012 Global Fraud Study conducted by the Association of Certified Fraud Examiners (ACFE) reviewed 1,388 incidents of fraud worldwide and found that the average organization loses 5 percent of its annual revenue to fraud. [31] This might not seem pertinent when set against the backdrop of each individual company. However, looking at it in global context, it amounts to a projected annual fraud loss of US $3.5 trillion.

In perspective, this is US $3.5 trillion that would have otherwise been used to provide other services and products. Many of these scams include taxpayer money that would ideally go toward improving amenities for citizens. Clearly, corporate fraud has deep financial ramifications for all of us, even if we don’t see them immediately. So yes, we should care. However, should financial aspects be the only reason we care? Ethics no longer remain a matter of personal opinion and strict guidelines need to be enforced in order to clearly differentiate between right and wrong. Companies that commit fraud cross ethical lines that have far reaching consequences.

With a population of over 1.2 billion, more than 250 million people in India live in abject poverty. [32] Corruption at the top and grassroots level is at an all-time high, and GDP growth has slowed to 4.7 percent in 2014. [33] The Indian economy relies significantly on the corporate sector, and the rising number of financial scams has pertinent ethical implications now more than ever. The Sahara and Saradha Group scandals represent the antithesis of all business ethics. Sahara, for one, has been convicted of wrongfully acquiring investor money without proper authorization. Of course, there is the obvious issue of misrepresenting funding activities to investors as well as SEBI, but that is simply the tip of the iceberg. There is widespread speculation that the 40 million investors of the Sahara schemes were a front made up to hide black money from influential donors. [34] It is hardly any secret that Sahara made it extremely difficult for SEBI to track down investors, not only by sending a plethora of paperwork in 127 trucks for them to sift through, but also by refusing to refund the money to SEBI in the first place. Indeed, SEBI has found that the documents Sahara provided do not provide sufficient, verifiable information, and SEBI has heard back from less than 1 percent of the 20,000 investors it contacted, with many addresses turning out to be invalid. [35]

If there is any truth to the accusations of Sahara laundering black money, this is a clear breach of ethics on their part. By definition, black money includes money siphoned off by illegal means that was ideally meant to provide other services. Not only is this a blatant misuse of other people’s money, it also raises serious questions about government resources that were wasted on this unnecessarily long investigation.

On the other hand, the ethical violations committed by the Saradha Group were more obvious and possibly more damaging. The schemes run by Saradha were primarily aimed at low-income people who did not have access to formal banking. Unsurprisingly, these low income investors were hit hardest by the scam. When the Ponzi scheme collapsed, it caused severe financial loss to its 1.7 million investors, but the poorer population of West Bengal bore the worst brunt. Many were bankrupted, and a great number resorted to suicide. [36]

The Saradha case undoubtedly represents the worst kind of damage unethical practices in business can beget. The ramifications of the actions of a few conniving businessmen and politicians can still be felt throughout rural West Bengal. There is no doubt that conning poor people into investing in a hoax scheme, only to abandon them when it collapses, falls in the far dark end of the ethical spectrum. Therefore, corporate scams of this nature not only symbolize the ethical and moral standards of a company but on a larger scale represent those of the country and her people. This sort of generalization can cause foreign companies to lose interest in investing in a country and could cost India (or any country, for that matter) dearly.

The Purge: Potential Solutions

A recent survey by Grant Thornton and Assocham finds that cases of financial fraud have risen in India over the last few years and become one of the main factors deterring foreign companies from investing in India. [37] As the economy grows to keep pace with the steadily growing needs of the population, corporate fraud is disastrous for India. To bring about a visible decline in the culture of corporate scams in India, three major systematic changes can and need to take place.

Firstly, laws protecting whistleblowers are imperative. The likelihood of people coming forth to willingly provide information will be a lot higher if they are provided with basic assurances. Safety from political threats and job security can ensure more people will be willing to volunteer information and increase transparency in the Indian corporate sector. Secondly, federal and market regulators need a greater level of autonomy than they presently enjoy. The Reserve Bank of India, SEBI and other regulators can only be efficient provided their work is not directed by political influences. Thirdly, and perhaps most importantly, there is a crucial need for judicial reform in India. The judicial system’s slow-moving course causes needless delays and allows corporate violators to find underhanded methods to evade justice. Corporate cases, especially cases of such magnitude, need to be fast-tracked to reach resolution quickly so violators can be dealt severe and immediate consequences.

Editor: Angela Lutz