Chit fund Vs Ponzi scheme

The Serious Fraud Investigation Office (SFIO), completing its probe into financial scam of 14 Saradha group firms based in West Bengal, has concluded that these companies have been found to be running 'ponzi schemes' and would face prosecution for violation of several laws. The Saradha group collected hundreds of crores from over 1.7 million depositors before it collapsed in April 2013.

Though incorrectly referred to as a ‘chit fund scam,’ it is actually a Ponzi Scheme which generates returns for older investors by acquiring new investors. Operator pays returns to its investors from new capital paid to the operators by new investors, rather than from profit earned by him or her.

In contrast, a chit fund is a saving scheme practised for hundreds of years in India. It is either a formal or informal association of individuals to convert small savings into lump sums. "Chit" means a transaction (whether called chit fund, chit, kuri or by any other name), by which the operator enters into an agreement with a number of subscribers that everyone of them shall subscribe a certain sum for a certain period and each subscriber in his turn as determined by lot or by auction, shall be entitled to a prized amount. Returns generated are not fixed and depend on the maximum discount that is bid every month. The higher the discount, greater is the dividend and is distributed among the members.

In Saradha scam, promoter Sudipta Sen promised returns to prospective investors in advance, as Business Standard puts it: "Sen offered fixed deposits, recurring deposits and monthly income schemes. The returns promised were handsome. In fixed deposits, for instance, Sen promised to multiply the principal 1.5 times in two-and-a-half years, 2.5 times in 5 years and 4 times in 7 years. High-value depositors were told they would get a free trip to ‘Singapur’.” The fact that a rate of return was promised in advance clearly means that what Sen was running was not a chit fund.

The various investment schemes run by the various divisions of the so-called Saradha chit fund, which were raising money from investors in West Bengal and other Eastern states, can be categorised under what Sebi calls a collective investment scheme. A collective investment scheme (CIS) is defined as "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 receiving 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."