The past two years have seen tens of thousands of people losing their hard-earned savings to fraud in entities that appear to operate in a legitimate and highly regulated environment. Nearly a dozen brokerage firms have collapsed. People who lose money are justifiably angry, aggressive in their demand for justice and certainly don't deserve to be cheated.
I sympathise with people who lose money to unscrupulous fraudsters who come in the guise of stockbrokers, insurance agents, financial advisers, fund managers or bank relationship managers. These are people you should be able to trust. But what is worrying and perplexing is that far too many of people blunder into investments without any due diligence. And, even after losing money, refuse to accept any responsibility for their decisions.
Several investors who contributed to the Rs1,000+ crore kitty managed by Anugrah Stock & Broking and its associates, seem astonished that they could have made an effort to evaluate the promise of high returns, check the legitimacy of operations and find out more about the product and the entity they are entrusting their savings to. These investors include highly qualified professionals—even many chartered accountants.
Anugrah is not the only entity running dodgy schemes offering high returns; scores of others continue to fly below the regulators’ radars. Although we are quick to blame regulatory failures and poor supervision, here’s a look at what investors fail to check.
John Rothschild put it best in A Fool and His Money: “People who spend a week choosing a furniture refinisher will sign up with the first [financial planner] who calls. People who circle junkyards for matching hubcaps will buy mutual funds without reading the prospectus. People who check the expiration date on cottage cheese would not think of investigating the background of their broker...”
Here are a few things that should have acted as red flags.
Assured Returns: Such returns have been under a cloud for over 25 years, after one determined activist, Viren Jain of Midas Touch Investors’ Association, successfully dragged Canbank Mutual Fund’s Canstar Scheme to court when it reneged on its commitment to pay up the returns ‘assured’ to investors in its offer documents. Canbank Mutual Fund’s parent, Canara Bank had to deliver on the promise as did many other public sector banks and insurance companies whose mutual fund subsidiaries had floated ‘assured return’ schemes. Soon after that, the Securities and Exchange Board of India (SEBI) tightened the rules on assured returns. It even has a strict code of advertisement that is available on stock exchange websites saying very clearly that advertisements by brokers and intermediaries shall not contain: “Any promise or guarantee of assured return to the general investors."
Yet, dubious ‘assured returns’ schemes continue to proliferate. Many are caught only when they begin to default. Moneylife reported on VPS Advisory that offered a 20% return. Three years ago, SEBI barred Kassa Finvest and cancelled its broking licence for running a scheme that was very similar to Anugrah’s. This was widely reported in the media, but investors clearly did not pay attention.
So when Anugrah sent out slide-decks ‘assuring’ a 12% return (and 100% capital protection), while also showing off payments of up to 40%pa (per annum), it should have raised questions about its methods and legitimacy. Instead, many investors are only now waking up to the fact that Anugrah’s name and logo were not on the slides and they were not sent from the broker’s official email.
Who said the DAS (Derivatives Advisory Service) is illegal?
“Tell me how it is illegal,” says one investor, bristling with irritation when we said the DAS was illegal. Well, SEBI rules permit a person or entity to manage money in the following categories: mutual fund, venture capital, portfolio management service (PMS) or alternative investment fund. An investment adviser or distributor cannot collect money. A stockbroker is permitted to execute your trades and do this on the basis of a power of attorney (POA), but needs a PMS licence to collect money.
Anugrah’s derivatives advisory service (DAS) as well as that of its associate Teji Mandi Analytics (TMA) did not fit into any of these categories and was, therefore, illegal. Anugrah as a registered stockbroker legitimately asked clients to open accounts and provide POAs (which involves a lot of signatures), but that is for trading accounts and is not to be misused to collect money promising assured returns in pseudo PMS. TMA did not even have a brokerage licence, so everything was routed through Anugrah and, yet, nobody thought about checking what SEBI licence it operated under.
SEBI has extremely onerous rules, capital requirements and specifications about qualifications and reporting for each of these categories. Anugrah imitated some of them and made fake claims like not pooling investors’ money, etc, but nothing was reported to the regulator.
The Turkey Problem
Nassim Nicholas Taleb, author of the best-selling The Black Swan, writes: “Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race... This goes on for months, and the turkey feels better every day. Then, the day before Thanksgiving, the farmer wrings the turkey’s neck. Things can deteriorate, and can deteriorate quickly.”
"A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys with increased statistical confidence." - Nassim Nicholas Taleb in Antifragile
This is exactly what happened to Anugrah’s investors. Those who invested in 2014-15 even got 40% returns. Anugrah and TMA offered slides showing off the good times and people threw caution to the winds. Some even gave unsecured loans to Anugrah based on a promise of high monthly returns, without even the pretence of a broker agreement because he said it would be ‘less of a hassle’.
We Paid Taxes
One aggrieved victim says, “For every transaction on NSE (National Stock Exchange) each one of us has paid service tax, securities transaction tax (STT), stamp duty and SEBI fees. The government collect huge taxes from us through Anugrah and TMA, so how can this be illegal?” All victims would have also paid income-tax on the earnings.
The doctrine applicable to taxation is clear: Any illegality tainted with the earning has no bearing on its taxability. Income-tax authorities are especially not concerned if the income was earned illegally or by resorting to unlawful means. You still pay taxes. As for the rest—stamp duty, STT and service tax—these were legitimately paid by Anugrah on transactions on behalf of investors in its capacity as stockbroker. The know-your-customer (KYC) documents, POA and depository accounts were all opened through this legitimate entity. The rest was not.
Extra Income on Core Investments
In Anugrah’s case, it not only collected cash from investors (offering a higher return), but also ensnared them into parting with core investment in mutual funds and long-term holding of blue-chips (with a haircut in value). These stocks were to be held in their names in depository accounts. Most investors are struggling to salvage at least that portion of their savings and with some help from the Central Share Depository Ltd (CDSL) a few may get their money back.
Many brokers have offered such arrangements with the lure of ‘earning interest’ on shares simply lying in depository accounts. This is sheer greed and basic cross-checking with a sensible investment adviser would have dissuaded people from such deals. The fact is that many investors had been warned by honest investment advisers and CAs to stay away from Anugrah-like offers and pledging their shares. Some listened and are safe. Many didn’t.
Are expectations of trust and integrity too much to ask for?
Unfortunately, yes. And we are not singling out Anugrah in this regard, although it ran a completely illegitimate DAS. Moneylife’s sister entity, Moneylife Foundation, which is engaged in financial literacy, is categorical about who not to trust. This list includes the ‘relationship manager’ assigned to you by the most blue-chip names in Indian and international banking. We have handled and reported innumerable cases of banks decimating wealth, instead of managing it by churning portfolios to earn exit and entry charges, or recommending insurance schemes, complex derivative products, mutual funds and art or realty investments that allow the bank to earn higher fees. The perfectly ‘legal’ mis-selling of insurance products by bankers is one of the biggest rackets that our government and financial regulators refuse to stop under pressure from powerful bank lobbies.
So ‘Caveat Emptor’ or buyer beware remains the guiding principle for investment and that is not going to change. Facts and due diligence will be far safer than blind trust and expectation of integrity.
The expert committee has recommended financial parameters including aspects related to leverage, liquidity and debt serviceability. It has suggested financial ratios for 26 sectors, which can be factored by lenders while finalising a resolution plan for a certain borrower.
The sectors identified by the panel include auto-components, auto-manufacturing, aviation, cement, construction, pharma manufacturing, power, real estate, consumer durables, hotels, restaurants and tourism, among others.
According to L Viswanathan, partner at Cyril Amarchand Mangaldas, the resolution framework is expected to bring in the required level of uniformity (and where relevant sector-specific calibration) and rigour in assessing impact of COVID-19 on companies and preparing resolution plans.
He says, "Such parameters will provide flexibility to the borrower as well as cater to the need to have a sustainable business in the near future where the lending institutions are also free to stipulate other parameters in addition to the mandatory ones. Further these baseline ceiling or floor for the mandatory parameters can also be strengthened based on cash flow projections. Such flexibility also factors in the varying impact of the pandemic on various sectors/ entities, and the RBI has permitted lending institutions to, at their discretion, adopt a graded approach depending on the severity of the impact on the borrowers (which approach could entail classification of the impact on the borrowers into mild, moderate and severe), while preparing or implementing the resolution plan."
"Finally monitoring has been stipulated for these parameters on an ongoing basis. The RBI has sought to strengthen the ICA mechanism by clarifying that ICA is mandatory and compliance of the signing of ICA shall be assessed as part of its supervisory review. This should encourage signing of the ICA and preparation of resolution plans. The requirement for maintenance of escrow accounts will also aid monitoring and control," said Mr Viswanathan from Cyril Amarchand Mangaldas.
The committee selected five parameters based on their relevance while considering the resolution plan. These include ratios such as "total outside liability/ adjusted tangible net worth (TOL/Adjusted TNW), total debt/ebidta, current ratio, debt service coverage ratio (DSCR) and average debt service coverage ratio (ADSCR)."
The lenders can also consider other financial parameters in addition to five mandatory parameters and may, at their discretion, adopt a graded approach depending on the severity of the impact on the borrowers, as per the report.
In respect of sectors where ratios have not been specified, lenders can make their own assessment towards the resolution plan.
The panel has recommended that the resolution framework should be invoked by 31 December 2020.
As per the recommendations, the resolution process should be treated as invoked once lenders representing 75% by value and 60% of lenders agree to do so.
The residual tenor of the loan may be extended by maximum two years, with or without payment moratorium. The moratorium period, if granted, shall come into force immediately on implementation of the resolution plan.
The asset classification may be maintained as standard or upgraded to standard subject to the resolution panel being implemented as per the framework, said the report of the panel.
Here Are Key Highlights of Resolution Framework Submitted by KV Kamath Committee...
Resolution under this Framework extended only to borrowers having stress on account of COVID-19.
Only those borrowers which were classified as standard and with arrears less than 30 days as at 1 March 2020 are eligible under the framework.
Invocation Date and implementation
Resolution framework may be invoked not later than 31 December 2020.
RP needs to be implemented within 180 days from the date of invocation.
Signing of ICA and provision requirements
Resolution process shall be treated as invoked once lenders representing 75% by value and 60% by number (Majority Lenders) agree to invoke the same.
ICA to be signed by all lenders within 30 days of invocation.
Lenders who have signed ICA, to make provision, higher of 10% or IRAC norms.
Lenders who have not signed ICA, to make a provision higher of 20% or as per IRAC norms, upon expiry of 30 days from invocation.
The residual tenor of the loan may be extended by maximum two years with or without payment moratorium. The moratorium period, if granted, shall come into force immediately upon implementation of the RP.
The asset classification may be maintained as standard or upgraded to standard subject to the RP being implemented as per the Framework.
For aggregate exposures greater than Rs100 crore, an independent credit evaluation (ICE) to be obtained from any one credit rating agency authorised by RBI.
Conversion of Loans into Securities and Valuation:
RP to include restructuring / regularization / change in ownership, if any, sanction of additional facilities.
RP may provide for conversion of debt into equity or other marketable non-convertible debt securities provided amortization and coupon are similar to terms of debt.
Equity to be valued as per lower of breakup value or DCF value (for unlisted companies) and market price (for listed companies).
Any other instrument to be valued at Re1.
Post Implementation Performance:
In respect of exposures, any default by the borrower with any of the signatories to the ICA during the monitoring period shall trigger a Review Period of 30 days.
If the borrower is in default with any of the signatories to the ICA at the end of the Review Period, the asset classification of the borrower with all lending institutions, including those who did not sign the ICA, shall be downgraded to NPA from the date of implementation of the RP or the date from which the borrower had been classified as NPA before implementation of the plan, whichever is earlier.
In all cases, further upgradation shall be subject to implementation of a fresh restructuring under the Prudential Framework, or the relevant instructions as applicable to specific category of lending institutions where the Prudential Framework is not applicable.
The Reserve Bank of India (RBI) on Friday released its revised priority sector lending guidelines wherein the credit limits have been raised for farmer producer organisations, renewable energy and for health infrastructure.
As announced by the RBI governor, startups have been brought under the ambit of priority sector lending. Bank finance of up to Rs50 crore has been included as a fresh category under priority sector, an RBI statement said.
The RBI statement said that a higher credit limit has been specified for farmers producers organisations (FPOs) or farmers producers companies (FPCs) undertaking farming with assured marketing of their produce at a pre-determined price.
Further, "loan limits for renewable energy have been increased (doubled)" and "credit limit for health infrastructure (including those under 'Ayushman Bharat') has been doubled".
Apart from startups, loans to farmers for installation of solar power plants for solarisation of grid connected agriculture pumps and loans for setting up Compressed Bio Gas (CBG) plants have been included as fresh categories eligible for finance under priority sector.
"RBI has comprehensively reviewed the priority sector lending (PSL) guidelines to align it with emerging national priorities and bring sharper focus on inclusive development, after having wide ranging discussions with all stakeholders," it said.
As per the central bank the revised guidelines will enable better credit penetration to credit deficient areas, increase the lending to small and marginal farmers and weaker sections, boost credit to renewable energy, and health infrastructure.
The guidelines aim to address regional disparities in the flow of priority sector credit, higher weightage have been assigned to incremental priority sector credit in 'identified districts' where priority sector credit flow is comparatively low and the the targets prescribed for "small and marginal farmers" and "weaker sections" are being increased in a phased manner, as per the RBI statement.
Commenting on RBI's circular on revised priority sector lending guidelines, Krishnan Sitaraman, senior director of CRISIL Ratings feels that this will incentivize credit flow to specific segments like clean energy, weaker sections, health infrastructure and credit deficient geographies. " These measures are also aligned to focus areas of development as per extant policy environment and will support funding requirements in these specific sectors," he added.