US64 Ponzi Scheme by UTI

A major casualty of the stock market crash was UTI’s flagship mutual fund scheme US-64. Just before it went under in July 2001, the scheme had 1.9 crore unitholding accounts – 99 per cent of them belonging to retail investors – and around Rs 16,500 crore of funds under management. A flawed pricing mechanism meant that the price at which investors purchased US-64 units, as well as the price at which they sold the units back to UTI, had no relation to 101 the NAV – or the true value – of the scheme. UTI would increase the sale and repurchase of US-64 by 20 paise every month. To a large extent, these fresh inflows helped pay the unit holders who wanted to exit. Such a pricing mechanism gave certain returns to existing and exiting investors, but also created the perception among investors that US-64 was an ‘assured returns’ scheme without any risk.

Till the early 1990s, equity investments accounted for 20 percent of the US-64 portfolio, and debt instruments for the rest. By June 2001, as the bull run was in its death throes, equities accounted for 75 percent of US-64’s portfolio, and included a good many dubious stocks purchased for nefarious reasons. Despite its deteriorating asset quality, the scheme had managed to stay afloat for longer than most people thought it would. As with Ponzi schemes, the steady inflow of fresh money from new investors helped pay off the existing investors in US-64. But once inflows dried up, around March 2001, it became an uphill task for US-64 to meet redemption requests.

Rumors of a crisis at UTI started doing the rounds, leading to more redemption requests from unitholders. Corporations and institutional investors started pulling out in droves from May onwards, sensing their investments were in danger. The losers were individual investors who had no inkling of the true health of US-64 and stayed invested. It was obvious that the unusually heavy redemption pressure in May and June had to do with inside information that UTI would announce a halt in the repurchase of US-64 units at its 2 July board meeting.

In what was a clear breach of confidentiality, SBI, which had a nominee on the board of trustees of UTI, redeemed Rs 355 crore in May. UTI had borrowed heavily from many banks in June to meet redemption requests. Each of these banks was an investor in US-64, and, knowing the scheme’s perilous financial health now, joined the queue for redemption. At its board meeting on 2 July, UTI announced that it was freezing redemptions in US-64, stunning the market and shattering the faith of millions of individual investors. The scheme was restructured, and a repayment schedule was worked out, but almost every US-64 investor had to take a knock on his original investment. Worst of all, the crash also claimed a few lives.

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