DR.

RAM MANOHAR LOHIYA NATIONAL LAW UNIVERSITY

2019-20

SECURITIES AND INVESTMENT LAW PROJECT ON -

UNDERSTANDING COLLECTIVE INVESTMENT SCHEMES

SUBMITTED BY SUBMITTED TO

ADITYA CHHAJED MR. MANOJ KUMAR

B.A.L.L.B (HONS) ASSISTANT PROFESSOR

SEMESTER VIII ENROLLMENT:

160101008
 ACKNOWLEDGEMENT

I would like to use this opportunity to extend my heartiest gratitude to all the people who have
helped me develop this project.

First and foremost, I would to thank Mr. Manoj, who has been constantly supporting me, guiding
me and helping me with all my queries and difficulties regarding this project since its fledgling
stage. Without her enthusiasm, inspiration, and efforts to explain even the toughest of jargons in
the most lucid manner, the successful inception of this project would have been a Herculean task.

Next, I would like thank the librarians of Dr. Madhu Limaye library for helping me find the
correct resources for my research and for helping me enrich my knowledge.

Finally, I would like to extend my gratitude to my batch mates and seniors for providing me
some unique ideas and insights which helped me make this project even better.

I know that despite my sincerest efforts some discrepancies might have crept in, I hope and
believe that I would be pardoned for the same.

Thanking You

Aditya Chhajed
 INDEX

1. INTRODUCTION
2. STATUTES FOR CIS
3. LANDMARK RULINGS IN CIS
4. LATING THE UNREGULATED: SEBI INTERPRETS WHAT QUALIFIES AS A
CIS
5. CONCLUSION AND SUGGESTION
 I. INTRODUCTION

Many of us these days are looking for ways to secure our financial future. The recent economic
woes around the world have only made this need more pressing. There are many different
opportunities to make money and one of these is a Collective Investment Scheme. This is not
something that is going to work for everyone and there are certainly some risks involved. The
returns though can be high and it is worth considering if this option could work for you. The
logic behind a collective investment scheme is that it is easier to make money as part of a group
then as an individual. This is because while working as a collective it will be possible to cover a
much wider range of investments than would be possible alone. You will often hear this type of
scheme referred to as mutual funds or investment funds – it has in fact become one of the most
common ways of investing money in the stock market. In short a collective investment scheme is
where members pool money to invest and then share the profits from this.

What is CIS and How does it Work?

The potential of collective investment schemes is enormous. Collective investments provide a

means for ordinary people to invest in the stock exchange and to beat inflation by getting good
returns. Many people do not have the vaguest idea of what collective investments are. In a way
they can be described as a group of people investing for a common interest.1

A collective investment scheme is a trust based scheme that comprises a pool of assets that is
managed by a collective investment scheme manager and is regulated by the Collective
Investment Scheme regulations. Collective Investment Schemes (CIS) are a popular form of
investment, and they are accessible to all. Each investor has a proportional stake in the Collective
Investment Scheme portfolio based on how much money he or she contributed. The word “unit”
refers to the portion or part of the Collective Investment Scheme portfolio that is owned by the
investor. The “trust” is the financial instrument that is created in order to manage the investment.
The trust enables financial experts to invest the money on behalf of the Collective Investment
Scheme investor. Collective Investment Schemes provide a relatively secure means of investing
on the Stock Exchange, and other financial instruments. With a Collective Investment Scheme,
the money or funds from a group of investors are pooled or collected together to form a
Collective Investment Scheme portfolio.

There are many different types of collective investment schemes but most will have a fund
manager. This fund manager is responsible for making the investment decisions and keeping
members informed of what is going on, there is also usually a board of trustees to ensure that
everything runs smoothly. The two main types of collective investment schemes are those that
are official (usually recognized by official bodies) and those that are unofficial (for example, a
group of people just joining forces to invest their money as a group). A collective investment

1
“What is Collective Investment Scheme and how does it work?” http://www.econguru.com/understandinghow-a-
collective-investment-scheme-works.
scheme can have a limited number of shares (called a closed end fund) or one where new shares
can be created if more money is invested (called an open end fund).2

The collective investment scheme is well established in many jurisdictions and now serves as an
investment vehicle for a wide range of investment opportunities around the world. Many millions
of people worldwide have invested in Collective Investment Schemes (CIS) and rely upon
operators of the schemes to manage their funds and to act in the best interest of investors. The
distribution of Collective Investment Scheme products has continued to develop across borders
and operators are seeking to maximize their opportunities by utilizing management,
administration and custody services in different jurisdictions.3

To understand the meaning of “collective investment”, consider a group of a few hundred

women, belonging to financially weaker sections in a village, brought together by a self help
group (SHG) to start an investment scheme. Under the scheme, each member contributes a
prescribed amount each month and the amounts so collected are deposited in a bank and then
used to give loans at reasonable rates of interest to members in need. Most of the services
rendered are voluntary in nature and so the expenses are minimal. The profit emerging at the end
of the year is distributed equitably among members and credited to their individual accounts.
This is what is meant by a „collective investment scheme'. The role of the SHG is that of a
mentor and, there is no room in such an arrangement for an external agency driven by profit
motive.4

Overview of the SEBI

The Securities and Exchange Board of India (SEBI) is a regulatory body established by an Act of
Parliament to protect the interests of investors in securities, to promote the development of, to
regulate the securities market and for matters connected therewith or incidental thereto. As
collective investment schemes are included in securities, hence SEBI automatically becomes the
regulatory body who will regulate these collective investment schemes.

Under the SEBI (Collective Investment Schemes) Regulations, 1999 (SEBI CIS Regulations),
only a Collective Investment Management Company (CIMC) which is a company incorporated
under the Companies Act, 1956/2013, and is registered with SEBI for this purpose, is permitted
to launch or operate/manage a collective investment scheme. Such a scheme has to be constituted
under a trust, obtain rating from a credit rating agency and appraised by the appraising agency;
can only be a close-ended scheme, with duration of at least three calendar years and should be
listed within six weeks of the closure of the scheme. CIMC shall obtain adequate insurance for
protection of scheme property. No scheme shall provide guaranteed or assured returns. Any

2
Ibid.
3
“Principles for the supervision of the operators of the collective investment schemes”.
4
Understanding Ulips and Collective investment schemes
http://www.hindu.com/biz/2010/05/24/stories/2010052451191800.html.
collective investment scheme including a mutual fund has to be approved by, and be registered
with, SEBI.

II. STATUTES FOR CIS

The scheme/fund, the trustee company and the management company are organized and
supervised in India principally under the following laws/regulations:

i. The SEBI (CIS) Regulations, as the case may be, issued under the Securities and
Exchange Board of India Act, 1992
ii. The Companies Act, 1956/2013
iii. The Indian Trusts Act, 1882
iv. The Indian Registration Act, 1908
v. Guidelines issues by the Reserve Bank of India (RBI) in respect of Non-Banking
Financial Companies (NBFCs)

Collective Investment Schemes are type of investment scheme that involves collecting money
from different investors and then combining all the money collected to fund the investment.
Securities Exchange Board of India Act, 1992 defines collective Investment schemes in section
11AA5 as any scheme or arrangement made or offered by any company under which –

a) The contributions, or payments made by the investors, by whatever name called, are
pooled and utilised for the purpose of the scheme or arrangement;
b) The contributions, or payments are made to such scheme or arrangements by the
investors with a view to receive profits, income, produce or property, whether movable or
immovable, from such scheme or arrangement;
c) The property, contribution or investment forming part of scheme or arrangement, whether
identifiable or not, is managed on behalf of the investors;
d) The investors do not have a day to day control over the management and operation of the
scheme or arrangement.6

A collective investment scheme may also be called a mutual fund. Similar to a mutual fund, a
collective investment scheme provides almost absolute control of the investment to the company
pooling and investing the money. In other words, any scheme or arrangement made or offered by
any company under which the contributions or payments made by the investors are shared and
applied with an objective to receive profits or income and is managed on behalf of the investors
is a Collective Investment Scheme or CIS. Investors do not have daily control over the
management and operation of these schemes or arrangements.

Regulation 3 of the SEBI (Collective Investment Schemes) Regulations, 1999 permits only a
'Collective Investment Management Company' having certificate of registration from Board to

5
SEBI (Amendment) Act, 1999.
6
C.R. Datta, The Company Law (LexisNexis, Online Book).
launch collective investment scheme. Thus, only a company which has been granted certificate
of registration by the Board in accordance with the Regulations can launch or sponsor a
collective investment scheme.

Also, Securities Contract (Regulation) Act, 1956 mentions of right to receive income from
collective investment scheme in Section 27A. It says that it shall be lawful for the holder of any
securities, being units or other instruments issued by the collective investment scheme, whose
name appears on the books of the collective investment scheme issuing the said security to
receive and retain any income in respect of units or other instruments issued by the collective
investment scheme declared by the collective investment scheme in respect thereof for any year,
notwithstanding that the said security, being units or other instruments issued by the collective
investment scheme, has already been transferred by him for consideration, unless the transferee
who claims the income in respect of units or other instruments issued by the collective
investment scheme from the transfer or has lodged the security and all other documents relating
to the transfer which may be required by the collective investment scheme with the collective
investment scheme for being registered in his name within fifteen days of the date on which the
income in respect of units or other instruments issued by the collective investment scheme
became due. Thus one of the big advantages of investing in a collective investment scheme is
that it is a type of “hands off” investment. You do not have to actively watch every financial
transaction that takes place. You can simply put your money into a good scheme and let the fund
manager take care of the rest. If you choose a good fund to put your money into, it could
potentially bring you some consistent returns.

Even though a collective investment scheme can be very profitable in certain situations, there are
a few things that you need to watch out for as well. One of the potential drawbacks of this type
of investment is that you have to pay a management fee as well as several other types of fees.
These fees can significantly eat into the returns that are generated by the investments. This
means that you have to pay careful attention to the performance of the fund and make sure that it
justifies the fees that you are paying. If the fees get too high, you might be better off going with a
fixed-rate investment with a low interest rate.

III. LANDMARK RULINGS IN CIS

Being the regulatory body in collective investment schemes the Securities Exchange Board of
India has decided many cases regarding the collective investment schemes.

In P.G.F. Ltd. and Ors. Vs. Securities and Exchange Board of India 7 decided by the Securities
Appellate Tribunal on 24 February 2010, it was held that PGF Ltd. and Ors. were restrained from
continuing with the collective investment schemes and had been directed to refund the amount
due to the investors. The fact of the case says that an order dated December 6, 2002 was passed
by the then Chairman of the Securities and Exchange Board of India which was in turn affirmed

7
P.G.F. Ltd. and Ors. v. Securities and Exchange Board of India, SAT (2010).
by the High Court of Punjab and Haryana. By this order dated December 6, 2002, the then
Chairman found that the appellants were continuing with the existing collective investment
schemes without even obtaining provisional registration under the Securities and Exchange
Board of India (Collective Investment Schemes) Regulations, 1999 and that they continued to
mobilise funds under those schemes without filing initial information and without obtaining
credit rating. Accordingly, the appellant company was directed neither to collect any money
from investors nor to launch any new schemes and was also directed to refund the money
collected under different schemes which was due to the investors within one month from the date
of the order.

IV. LATING THE UNREGULATED: SEBI INTERPRETS WHAT QUALIFIES

AS A CIS

Another interesting ruling on the interpretation of SEBI as to what qualifies as a CIS was
delivered in the case of Alchemist Inra Realty Limited and Ors. v SEBI.8

The facts of the case are as follows:

Upon being appraised that Alchemist Infra Reality Limited ("Company") was operating a
scheme to mobilize money from investors, SEBI set into motion an enquiry on its activities.
From its scrutiny, SEBI ascertained the following sequential steps for operating the scheme:

1. Company would invite applications in a prescribed format ("Application Form") from

persons ("Purchaser") for purchase of land owned by the Company.
2. A conveyance deed for sale of land would be executed with the Purchaser ("Conveyance
Deed").
3. Simultaneously with the Conveyance Deed being executed, the Purchaser was expected
to enter into a supervision agreement ("Supervision Agreement") with the Company for
the latter to develop and supervise the land for a fee. The Purchaser was provided an
option of requesting the Company to identify a suitable party for purchasing the land for
a consideration to be mutually agreed.
4. Purchaser would hand over the Conveyance Deed to the Company. Simultaneously, the
Company would issue a certificate of property ("Certificate") to the Purchaser which
stated the expected value of the property on the expiration of a fixed period of time.

Position under Law and action taken by SEBI

Section 11AA(2) of the SEBI Act, 1992 ("SEBI Act") defines an arrangement to be in the nature
of a CIS if (i) there is a contribution / pooling of investment for the purpose of a scheme or
arrangement, (ii) the contribution is with an expectation to receive some return, and (iii) the
property, contribution or investment forming part of scheme or arrangement, whether identifiable
or not, is managed on behalf of the investors.
8
Alchemist Inra Realty Limited and Ors. v SEBI, SAT - Appeal No 124 of 2013, date July 23, 2013.
SEBI issued a show cause notice to the Company with the charge that the scheme/ arrangement
operated by the Company was in the nature of a CIS.

For an entity to be able to undertake the activities as a CIS, it is mandatory for it to obtain a
certificate of registration from SEBI under Section 12(1B) 5 of the SEBI Act and Regulation 3 of
the SEBI (Collective Investment Schemes) Regulations, 1999 ("CIS Regulations").

Under the CIS Regulations, Regulation 73 provides for the winding up of an existing scheme in
certain cases viz., failure to make an application for registration to SEBI, or refusal by SEBI to
grant provisional registration. Finally, Regulation 74 provides that in case an operator of a
business (which is in the nature of a CIS) does not wish to obtain provisional registration with
the SEBI, it may devise a scheme of repayment of money collected from investors in accordance
with the CIS Regulations.

Hence, SEBI concluded that the Company was operating a CIS without obtaining a registration,
and therefore in contravention of Section 12(1B) of the SEBI Act and Regulation 3 of the CIS
Regulations.

Reasoning by SEBI

SEBI carefully examined the facts and inferred that clauses (i) to (iv) of section 11AA(2) of the
SEBI Act applied to the operations of the Company

Clause (i)SEBI noted that the Company accepts contribution from investors for collective
utilization, pools the investment with the object of carrying out the overall scheme / arrangement
because the Company had the discretion to allot such area in its project as it considered
appropriate. Further, under the Conveyance Deed the area of plot was denoted as 'proportionate
undivided interest'. The Purchaser was not entitled to claim division and/or partition of the said
proportionate undivided interest. The Supervision Agreement restricted the Purchaser from (a)
claiming ownership vis-avistheir interest in the land or disposing their interest, and / or (b)
encumbering their interest without the express consent of the Company, and/or (c) interfere with
the working, managing, controlling and supervising of the said plot in any manner whatsoever.
This in SEBI's view, were not limbs of a buysell arrangement, but a pooling of money pursuant
to a scheme or arrangement.

Clause (ii) requires that the investors pool in money with a motive of receiving profits, income,
produce or property. SEBI noted that the Application Form itself assured the Purchaser towards
yields and profits under the Supervision Agreement. The Company under the Supervision
Agreement guaranteed the Purchaser a realization from the property after a certain period, not
below a certain value, which value /the value for which was also provided in the Certificate.

Clause (iii) and Clause (iv) requires that the property, contribution or investment forming part of
scheme or arrangement is managed on behalf of the investors and such investors do not have a
day to day control over the management and operation of the scheme or arrangement. On this
point SEBI noted that the Purchaser does not manage his investment in the scheme at any stage
and the property in question, the investment involved and the management thereof are all in the
hands of the Company.

Further, SEBI noted that the Certificate stated "The Estimated value of the said undivided share
after development is expected to be not less than Rs.... on expiry of tenure under the said
Agreement.", thereby giving an impression that rather being a certificate of property, it is a
certificate of investment as the Purchasers are allotted an unidentified portion of land from the
Company's land holding which can be considered as units of large land holding.

SEBI’s Findings and SAT Order

Based on the above findings, SEBI concluded that the Company's activity were in the nature of a
CIS and held it to be in violation of Section 12 (1B) of the SEBI Act and Regulation 3 of the CIS
Regulations, as it was carrying on the activity as a CIS without obtaining the required
registration. SEBI accordingly passed directions to the Company and its directors to wind up the
existing CIS and further ordered the Company to refund all the collected money.

SAT confirmed SEBI's finding and upheld the SEBI Order under appeal which was made by the
Company and its directors, by adopting the reasoning similar to that provided by SEBI in the
SEBI Order. However, as a relief to the Company, SAT extended the period for refunding the
collected money to a period of eighteen months, with a rider that the Company shall submit a
report to SEBI every six months giving accurate details regarding the progress made while
executing the scheme of repayment.

Analysis

In the recent past, SEBI has discovered several structures been deployed to raise capital from
investors without following the prescribed regulatory framework. To safeguard the interest of
hapless investors and curb the proliferation of unregulated schemes being operated, SEBI has
brought under the scope of the CIS Regulations all such schemes launched by any operator in
any field as long as they fell within the four corners of the definition of a CIS.

Recent amendments to the SEBI Act provide more powers to SEBI for enforcement against
unregistered pooling vehicles. Under the amendments SEBI has been granted powers to regulate
any scheme or arrangement, if such scheme is not registered with SEBI, and involves a corpus of
INR 100 Crore (INR 1 billion) or more. This power can be viewed as an attempt to limit any
challenges from parties contending that a particular fund raising activity is not covered under the
purview of CIS Regulations merely because it is not specifically covered under Section 11AA of
the SEBI Act. Further, SEBI has now been granted the authority to carry out search and seizure
operations and attach assets in case of non-compliance.
The SAT order and SEBI Order are important as they underline the regulator's seriousness into
bringing the unregulated within the fold of the regulations.

V. CONCLUSION AND SUGGESTION

The various recommendations made by different expert committees formed by SEBI and other
regulatory bodies for regulating such CIS unanimously recommend for the protection of less
educated investors. Some attempts have also been made towards achieving the same. But,
unfortunately we are the citizen of such a country where the polity as well as bureaucracy (as
both are interconnected) runs with its own pace without competing with the fast changing world
in almost each and every matter. So, it is highly advisable that the system of investment should
be strengthened in the country contrary to our trade mark culture of working. Further, the
ranking system of these schemes should be made accessible to the common people so that they
can be easily aware about the upcoming schemes. While these mandatory ratings are required for
each collective investment scheme, it must be given by a recognised credit rating agency. The
rules made by SEBI are highly beneficial like they (CIS proposals) need to be registered with
SEBI within a period of two months from the date of notification. If the required rules are
followed in a letter and spirit then the occurrence of such failure of CIS will reduce and the
scheme that result into misfortune for the investors can turn out to be a great profit for them and
will in turn reduce the risk to the country’s economy. But, the current regulatory regime is still
largely dependent upon the established legal principal of caveat emptor which needs to be
relooked considering the masses which fall prey to these schemes. Because, it is one thing to
argue that the investor must take a well-informed decision. But, it is other thing to realise the
same in our socio-legal condition.

Need for separate laws for investor’s protection

There is need for protecting the rights of the innocent investors investing in such schemes which
only bring misfortune for them. Penalising the defaulting companies will certainly act as
deterrence for them in future. Various committees have been formed for giving their view on this
issue. The committees formed a collective view that it is essential to safeguard the interest of
investors through proper articulation of corporate governance in a manner that ensures
transparency and accountability. The Report on Investor Education and Protection given by
Ministry of Corporate Affairs records on record that the protection of investors right is an
integral part of corporate process. As like all other sectors, legal framework already exists to deal
with the criminal offences. But, the requirement is to provide a suitable orientation to corporate
law so that the investor, irrespective of size, is recognised as a stakeholder in the corporate
processes. It doesn’t imply vouching for a separate Act which would require special enforcement
mechanism with attendant coordination issues. Therefore, a separate Act for investor protection
is not considered necessary. This aspect may be dealt comprehensively and effectively in the
company law itself.
Same position was maintained by Ministry of Corporate Affairs, it said that the interface
between the companies and its stakeholders including investors should be regulated through the
legislative framework of the Companies Act and other civil and criminal laws of the country as
well as by different regulators such as SEBI, RBI, etc. as well as institutions such as the stock
exchanges through their rules of operation. In the Report it was clearly enumerated that various
agencies pursue action in their respective domain without regard to the comprehensive picture.
This results in overlap of jurisdiction or regulatory gaps. There is a need to bring about
coordination in the role and action of various regulatory agencies to enable effective investor
protection.