Evaluating whether an MLM (Multilevel Marketing) scheme that promotes Virtual Digital Assets can be classified as a Collective Investment Scheme.
Both India and the global community are experiencing challenges related to multilevel marketing (MLM) operations that assert the potential of "The TOKEN," which is purportedly the next significant advancement following "Bitcoin."
Unfortunately, Nova Tech, BitConnect, One Coin, Plus Token, Hyperfund, Gain Bitcoin, and several other multilevel marketing (MLM) schemes have defrauded millions of individuals, resulting in significant financial losses.
The newer tokens are being launched with claims of being "backed by commodities" or "backed by diamonds," misleading the public with a false sense of security.
These schemes promoting the VDA’s fly under the radar because they are spread via word of mouth, and also use unhosted wallets to collect deposits.
An unhosted wallet (hardware or software), also known as a self-hosted wallet, provides the holders with comprehensive control over their cryptocurrency, removing any dependence on third-party service providers.
Because transactions do not involve reporting/regulated entities like exchanges or any third party, law enforcement and regulators cannot access the holder's identity, impose freezes, or seize assets.
Prospective investors are therefore advised to exercise heightened caution when considering MLM schemes related to cryptocurrency, particularly if these schemes request deposits into their crypto wallets.
Regulators' main concern is determining whether a scheme that promotes virtual digital assets (VDAs) qualifies as a collective investment scheme (CIS). It is important to note that the Reserve Bank of India (RBI) is currently reviewing the regulatory framework for VDAs. In contrast, collective investment schemes fall under the jurisdiction of the Securities and Exchange Board of India (SEBI), which is responsible for overseeing their compliance and operations.
When evaluating whether a Virtual Digital Asset (VDA) scheme qualifies as a Collective Investment Scheme (CIS) under Indian law, it is essential to consider the following key factors:
- The definition of CIS under Section 11AA of the SEBI Act, 1992 A :
A CIS is defined as any scheme or arrangement that:- Pools contributions or payments from investors
- Is managed on behalf of the investors
- Does not grant investors day-to-day control over management or operation
- Aims to provide returns, income, or produce property for the investors
- The Framework for "Investment Contract" Analysis of Digital Assets by the US SEC 2 , which outlines the following key elements:
- Investment of money
- In a common enterprise
- With reasonable expectation of profits
- Derived from the efforts of others
Applying these frameworks, a VDA scheme could potentially be considered a CIS if:
- It pools funds (in any form, including Fiat currency and/or VDA's) from multiple investors to invest in cryptocurrencies/NFTs
- The scheme managers make investment decisions on behalf of investors
- Investors expect profits primarily from the efforts of the scheme managers rather than their own efforts
- Investors do not have direct control* over the VDA assets
(*where the words "direct control" is interpreted on the basis of the following :- Indirect ownership: In some VDA investment schemes, investors don't directly own or control the underlying digital assets. Instead, they own shares or units in a fund or entity that holds and manages the VDAs on their behalf.
- Custodial arrangements: Many VDA investment schemes involve custodial arrangements where a third party (like an exchange or investment firm) holds and manages the digital assets. Investors may have claims on these assets but don't have direct access to the private keys or wallets.
- Pooled investments: In collective investment schemes, funds from multiple investors are pooled together and managed by professional fund managers. Individual investors don't make decisions about specific asset purchases or sales.
- Limited decision-making power: Investors in such schemes typically cannot decide when to buy or sell specific VDAs within the fund. These decisions are made by the scheme's fund managers or operators or according to predetermined algorithms.
- Investors choose these schemes because they lack the technical knowledge or time to manage VDAs directly and, therefore, rely on the expertise of the scheme operators.
- Restricted access: Unlike holding VDAs in a personal wallet, investors in these schemes may face restrictions (despite of having the access to their keys) on withdrawing or transferring their assets, often subject to the terms of the investment scheme. For example, a crypto fund that pools investor money to trade various cryptocurrencies on behalf of investors would likely qualify as a CIS. However, a platform that facilitates users' direct purchase/sale of crypto may not.
Each VDA scheme's specific structure and operation would need to be analysed on a case-by-case basis to determine whether it meets the CIS criteria.
- Required Licenses/Permissions
If a VDA scheme is classified as a CIS, the following licenses and permissions would be required:- Registration as a Collective Investment Management Company (CIMC) with SEBI under SEBI (Collective Investment Schemes) Regulations, 1999
- Approval from SEBI for the specific CIS scheme before launching
- Appointment of a SEBI-registered trustee
- Compliance with various operational, disclosure and investor protection requirements under the CIS regulationsAdditionally, as per recent regulations, VDA service providers (exchanges) must register with the Financial Intelligence Unit-India (FIU-IND) under anti-money laundering laws.
- Penalties for Violations: Evoking the BUDS Act 2019
The BUDS Act is indeed applicable to violators of its provisions, and it prescribes strict penalties for those who operate or participate in unregulated deposit schemes. Here are the key points regarding its applicability:-
- Scope of application: The BUDS Act applies to any person or entity that operates an unregulated deposit scheme in India. This includes individuals, companies, partnerships, or any other organisation that solicits or accepts deposits without proper regulatory approval.
- Types of violations covered: The Act prohibits various activities related to unregulated deposit schemes, including:
- Promoting or operating an unregulated deposit scheme
- Fraudulently defaulting on repayments in regulated deposit schemes
- Making false or misleading statements to induce participation in unregulated schemes.
- Enforcement mechanism: The Act empowers authorities to take action against violators:
- District Collectors are directed to act promptly on orders issued by the Competent Authority.
- Police officials are authorised to freeze bank accounts and properties of offenders.
- A central database of deposit takers is maintained to track potential violators.
- Penalties for violations: The Act prescribes severe penalties for violators, including:
- Imprisonment ranging from 1 to 10 years, depending on the nature and severity of the offence
- Fines ranging from Rs. 2 lakh to Rs. 50 crore.
- Attachment and auction of properties belonging to violators.
- Non-bailable offenses: Offences under the BUDS Act are considered non-bailable, making it more difficult for violators to evade legal consequences.
- Applicability to cryptocurrency and virtual asset schemes: While not explicitly mentioned the broad definition of "deposit" in the Act could potentially cover particular cryptocurrency or virtual asset schemes if they meet the criteria of an unregulated deposit scheme.
In conclusion, the BUDS Act 2019 is definitely applicable to violators and provides a robust framework for authorities to take action against those operating unregulated deposit schemes. The Act aims to protect investors and deter fraudulent financial activities by imposing strict penalties and enforcement measures.
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Sources
https://www.indiacode.nic.in/bitstream/123456789/1890/1/AA1992__15secu.pdf
