In this article, Dheerajendra Patanjali, who is currently pursuing M.A. IN BUSINESS LAWS, from NUJS, Kolkata, discusses how to start a collective investment scheme: Process, compliance, best practices and relevant law

Introduction

An investment for better return has several avenues in securities market to avail and collective investment scheme is one of them. Collective Investment schemes serve as a flexible savings vehicle for individuals, corporate bodies etc. to add funds for future needs.

The term Collective Investment Scheme (commonly referred to as ‘CIS’) is a general term used to describe a number of different ways in which Investors can pool contributions and invest collectively in certain investments. This mechanism not only provides larger chunks for investment to investor but also provide good opportunity to contributors to earn higher return.

In India, CIS operation is regulated one and onus to regulate the same lies on securities and Exchange Board of India (SEBI). SEBI has prescribed a detailed mechanism to properly run the CIS and same has contained in Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999(CIS Regulations), as amended from time to time. The Regulation deals with all aspects of CIS in detail.

Development Collective investment scheme In India

• Collective investment scheme is not a new phenomenon for India, it was present in our society since long although in scattered and non-uniformed manner. Investor used to collect money from the contributor and same was invested primarily in agro-related activities.
• However, post-independence the CIS has grown greatly. The non-uniformed and largely irregulated environment has provided good scope to mischief to misuse the funds. Large scale miss-utilisation of funds and consequent fraudulent activities lead to establishing a regulated system for the operation of CIS.
• The Government of India, vide its press release dated November 18, 1997, decided that an appropriate regulatory framework for regulating schemes through which instruments like agro bonds, plantation bonds etc. are issued, has to be put in place. The government decided that the schemes through which such instruments are issued would be treated as “Collective Investment Schemes” coming under the provisions of the SEBI Act[1].
• Towards this end, and in order to examine and finalize the draft regulations for Collective Investment schemes, market regulator SEBI appointed a committee under the Chairmanship of Dr. S. A. Dave in 1997. The committee was tasked to come with a detailed regulatory framework for the operation of CIS in India duly taking into account the best practices of other countries and with an aim to provide a Philip to such activities.

• The preliminary report and regulations were released by SEBI to the public on December 31, 1998. Subsequently, a number of suggestions were received from investors and corporates alike, these were sifted through by the Dave Committee and the ones found to be appropriate for the transparent working of CISs were incorporated in the Final Report dated April 5, 1999.
• Thus, on the basis of the recommendations of the Dave Committee, Section 11AA was added to the SEBI Act and the CIS Regulations were framed[2]. CIS Regulations were framed primarily for the protection of investors in the schemes launched by various entities seeking to dupe bonafide investors into putting their life savings at risk by promising high returns.

 It is important to note that committee also took great pain in defining the term CIS. The definition finalised by the Committee reads as[3],

“collective investment scheme” means any scheme or arrangement:-

1. With respect to property of any description, the purpose of which is to enable the investors to participate in the arrangements by way of contributions and to receive profits or income or produce arising from the management of such property or investments made thereof; and
2. The contributions of the investors, by whatever name they are called. are pooled, and are ·utilised solely for the purposes of the scheme or the arrangement; and
3. The property or such contributions is managed as a whole on behalf of the investors, whether or not such properties or contributions and the investments made thereof are evidenced by identifiable properties or otherwise; and
4. The investors do not have day to day control over the management/operation of the property/scheme.

• The committee recommended that a collective investment scheme shall be constituted in the form of a trust and the instrument of the trust shall be in the form of a deed registered under the provisions of the Indian Registration Act, 1908 and executed by the Collective Investment Management Company (CIMC) in favour of the trustees named in such an instrument.

As a result, presently CIS is Any scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised with a view to receive profits, income, produce or property, and is managed on behalf of the investors is a CIS. Investors do not have day to day control over the management and operation of such scheme or arrangement[4], and same is regulated under Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999 and is required to fulfil the criteria led down in the regulation.

Definition and CIS Participants

The expression Collective Investment Scheme (CIS) has been understood to mean any scheme, whereby funds were raised from the members of the general public for the purpose of making investment in any property with an objective of having good return. However, SEBI Act defines Collective Investment Scheme (CIS) under Section 11AA of the SEBI Act, 1992 and lays down the conditions which need to be satisfied before any scheme or arrangement launched by a particular company can be called a CIS. The section runs as under-

Section 11AA of the SEBI Act, 1992

(1) Any scheme or arrangement which satisfies the conditions referred to in sub-section (2) shall be a collective investment scheme.

(2) Any scheme or arrangement made or offered by any company under which,-

(i) the contributions, or payments made by the investors, by whatever name called, are pooled and utilized for the purposes of the scheme or arrangement;

(ii) the contributions or payments are made to such scheme or arrangement by the investors with a view to receive profits, income, produce or property, whether movable or immovable, from such scheme or arrangement; 

(iii) the property, contribution or investment forming part of scheme or arrangement, whether identifiable or not, is managed on behalf of the investors;

(iv) the investors do not have day to day control over the management and operation of the scheme or arrangement.

(3) Notwithstanding anything contained in sub-section (2), any scheme or arrangement-

(i) made or offered by a co-operative society registered under the Co-operative Societies Act, 1912 (2 of 1912) or a society being a society registered or deemed to be registered under any law relating to co-operative societies for the time being in force in any State;

(ii) under which deposits are accepted by non-banking financial companies as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934);

(iii) being a contract of insurance to which the Insurance Act, 1938 (4 of 1938), applies;

(iv) providing for any Scheme, Pension Scheme or the Insurance Scheme framed under the Employees Provident Fund and Miscellaneous Provisions Act, 1952 (19 of 1952);

(v) under which deposits are accepted under section 58A of the Companies Act, 1956 (1 of 1956);

(vi) under which deposits are accepted by a company declared as a Nidhi or a mutual benefit society under section 620A of the Companies Act, 1956 (1 of 1956);

(vii) falling within the meaning of Chit business as defined in clause (d) of section 2 of the Chit Fund Act, 1982 (40 of 1982);

(viii) under which contributions made are in the nature of subscription to a mutual fund; shall not be a collective investment scheme.”

For above it is very clear that under sub section 2 of above section the detailed condition of CIS scheme i.e. the money collected from investors should be pooled and then utilized as a whole for the purposes of the scheme, the investors should have contributed their money with the objective of deriving profits in any form, whether “income, produce or property”, the entire working and operation of the scheme is managed by the concerned company on behalf of the investors, and the investors have no modicum of control over daily activities with respect to the arrangement in question, has been provided.

CIS Participants

Collective Investment Management Company

A Collective Investment Management Company is a company incorporated under the provisions of the Companies Act, 1956 and registered with SEBI under the SEBI (Collective Investment Schemes) Regulations, 1999, whose object is to organise, operate and manage a Collective Investment Scheme.

Trustee

A person who holds the property of the collective investment scheme in trust for the benefit of the unit holders, in accordance with these regulations and safeguards the assets and ensures compliance with the laws and rules. it is required under the CIS regulation 1999 that A collective investment scheme shall be constituted in the form of a trust and the instrument of trust shall be in the form of a deed duly registered under the provisions of the Indian Registration Act, 1908 (16 of 1908) executed by the Collective Investment Management Company in favour of the trustees named in such an instrument. Further, Collective Investment Management Company shall appoint a trustee who shall hold the assets of the collective investment scheme for the benefit of unit holders.

A fund manager or investment manager who is a professionally qualified person and manages the investment decisions of the scheme and also provides the trading, reconciliations, valuation and unit pricing of the scheme.

The shareholders or unitholders who contribute the money in the scheme and are the owner (or have rights to) the assets and associated income generated by the scheme.

Legal Framework

In India, establishing, operating and winding-up a CIS is a regulated activity and has to be carried out by duly following the related acts, rules, and regulations. We may trace the evolution of regulatory framework with press release dated November 18, 1997, of Government of India, whereby it was decided that an appropriate regulatory framework for regulating schemes through which instruments like agro bonds, plantation bonds etc. are issued, has to be put in place. The government decided that the schemes through which such instruments are issued would be treated as “Collective Investment Schemes” coming under the provisions of the SEBI Act.

Accordingly, SEBI, notified the provisions of section 12(1) (B) of the SEBI Act which prohibits any person from sponsoring or causing to be sponsored any Collective Investment Scheme without obtaining a certificate of registration from the Board in accordance with the regulations.

The section specifically says that “No person shall sponsor or cause to be sponsored or carry on or cause to be carried on any venture capital funds or collective investment schemes including mutual funds, unless he obtains a certificate of registration from the Board in accordance with the regulations”. That is to say registration by the Board is sine qua non for starting of Collective Investment Scheme.

Eligibility Criteria for CIS Registration[5]

The Board shall not consider an application for the grant of a certificate unless the applicant satisfies the following conditions, namely,

1. The applicant is set up and registered as a company under the Companies Act, 1956;
2. The applicant has, in its Memorandum of Association specified the managing of collective investment scheme as one of its main objects;
3. The applicant has a net worth of not less than rupees five crores: Provided that at the time of making the application the applicant shall have a minimum net worth of rupees three crores which shall be increased to rupees five crores within three years from the date of grant of registration;
4. The applicant is a fit and proper person for the grant of such certificate;
5. The applicant has adequate infrastructure to enable it to operate collective investment scheme in accordance with the provision of these regulations;
6. The directors or key personnel of the applicant shall consist of persons of honesty and integrity having adequate professional experience in related field and have not been convicted for an offence involving moral turpitude or for any economic offence or for the violation of any securities laws;
7. At least fifty per cent of the directors of such Collective Investment Management Company shall consist of persons who are independent and are not directly or indirectly associated with the persons who have control over the Collective Investment Management Company;
8. no person, directly or indirectly connected with the applicant has in the past been refused registration by the Board under the Act.

The CIS regulation made it mandatory for every CIS to be registered by providing that no person other than a Collective Investment Management Company which has obtained a certificate under these regulations (CIS Regulation) shall carry on or sponsor or launch a collective investment scheme[6] and must be launched by collective investment management company through a registered trust by categorically stating that a collective investment scheme shall be constituted in the form of a trust and the instrument of trust shall be in the form of a deed duly registered under the provisions of the Indian Registration Act, 1908 (16 of 1908) executed by the Collective Investment Management Company in favour of the trustees named in such an instrument[7]. Further, the trustee shall hold the assets of the collective investment scheme for the benefit of unit holders.

SEBI has further prescribed other condition to instill confidence of the contributor and maintain more transparency in the operation of the scheme. It obligates Collective Investment Management Company to make such disclosures to the unit holders as are essential in order to keep them informed about any matter which may have an adverse bearing on their investments[8].The regulation further deepened the trust control by mandating that no appointment of Director of CIMC shall be made without the prior approval of the trustee. Furthermore, to curb these companies from fooling the innocent masses, it has been made strictly prohibited for these companies to provide guaranteed or assured returns[9]. The restriction on business activities of Collective Investment Management Company has been provided by prescribing that CIMC shall not undertake any activity other than that of managing the collective investment scheme or to act as a trustee of any other collective investment scheme[10].

Thus CIS Regulation prescribes as referred above, that there has to be a minimum capital requirement. It has prescribed certain corporate governance in the company. For example, at least 50 per cent directors should be independent directors. There should be a trust. The trustees and directors should be fit and proper. They have to be approved by SEBI Board. They cannot appoint on their own. The type of investments that they can make, that has been prescribed along with restriction on the activities of CIMC.

Adoption of International best practices[11]

• Countries in which CIS are well established have been perfecting standards within their domestic financial systems sector for decades. At the same time, there has been considerable sharing of experience among officials responsible for CIS oversight in various countries and articulation of common standards.
• As a result, a considerable body of international standards and best practices has evolved over the past few decades. The objective of international cooperation in CIS regulation is to strengthen domestic legal and regulatory foundations for CIS and to limit the potential for cross-border CIS activity to affect investors’ interests adversely in order to foster the development of the CIS sector.
• In subsequent years, the International Organisation of Securities Commissions (IOSCO) has assumed the leading role in setting global standards as part of IOSCO’s broader mission of promoting international cooperation among securities market regulators. In 1994, IOSCO issued “Principles for the Regulation of Collective Investment Schemes”, and in 1997 issued “Principles for the Supervision of CIS Operators”. 37.
• Both the OECD Standard Rules and the subsequent work of IOSCO address the basic features that all CIS should have in order to be acceptable for public offerings. Such features include an adequate legal and regulatory framework, the segregation of the CIS assets, the role of the depositary/custodian, norms for valuation of assets and the redemption of positions and the obligations of full disclosure.
• Despite agreement on international principles for CIS governance, no legal form or governance regime for CIS has been acknowledged as inherently superior to other systems. Thus each country must choose its own means of implementing international principles. In implementing international principles for CIS governance in their own jurisdictions, countries may wish to make use of the experience of countries that are acknowledged to have high quality CIS sectors.
• Domestic standards and practices should be consistent with internationally accepted standards and principles developed by recognised international bodies. The legal and governance forms and practices in countries where high quality CIS sectors are found constitute an additional source of standards, which are required to be followed.

Conclusion 

Collective Investment scheme, a scheme or arrangement made or offered by any company under which the contributions, or payments made by the investors, are pooled and utilised with a view to receiving profits, income, produce or property, and is managed on behalf of the investors, is not a new phenomenon for India and was present in different structure primarily for the investment in agro-related activities.

In the 1990s, in order to regulate such entities and their businesses, the Government issued a press identifying schemes which would be treated as Collective Investment Schemes under the SEBI Act, 1992. SEBI was tasked with formulating regulations to govern CISs which would lead to the furtherance of licit investment in the securities market. With this goal, a committee was formed under the deft chairmanship of Dr. S. A. Dave by SEBI. Thus, on the basis of the recommendations of the Dave Committee, Section 11AA was added to the SEBI Act and the CIS Regulations were framed primarily for the protection of investors in the schemes launched by various entities seeking to dupe bonafide investors into putting their life savings at risk by promising high returns.

CIS Regulations, inter alia, prescribes certain condition for establishing, running and winding up of the CIS scheme e.g. that there has to be a minimum capital requirement. It has prescribed certain corporate governance in the company. For example, at least 50 per cent directors should be independent directors. There should be a trust. The trustees and directors should be fit and proper. They have to be approved by SEBI Board. They cannot appoint on their own. The type of investments that they can make, that has been prescribed along with restriction on the activities of CIMC.

Apart from the above salutary efforts of market regulator SEBI, Domestic standards and practices should be consistent with internationally accepted standards and principles developed by recognised international bodies. The legal and governance forms and practices in countries where high quality CIS sectors are found constitute an additional source of standards, which are required to be followed.

References

[1] SAT, Appeal No. 124 of 2013,DOD 23.07.2013,page no 18

[2] http://www.sebi.gov.in/cms/sebi_data/pdffiles/21683_t.pdf, Retrieved on 27.02.2017

[3] http://www.sebi.gov.in/cms/sebi_data/pdffiles/21683_t.pdf,retrived on 27.02.2017

[4] http://www.sebi.gov.in/sebiweb/home/list/4/37/26/0/Collective-Investment-Schemes, retrieved on 27.02.2017

[5] Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999

[6] Regulation 3,Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999,

[7] Regulation 16,Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999,

[8] Regulation 50,Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999

[9] Regulation 25,Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999

[10] Regulation 13, Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999

[11] GOVERNANCE OF COLLECTIVE INVESTMENT SCHEMES (CIS) Discussion Draft For Comment July 2004,OECD,page no 8