This article first appeared in Personal Wealth, The Edge Malaysia Weekly on March 20, 2017 - March 26, 2017

The new law governing interest schemes — the Interest Schemes Act 2016 — has provisions for stronger investor protection and greater regulatory powers for the Companies Commission of Malaysia (CCM, also called the registrar). 

The Act, which came into force in January, may serve as a catalyst for reviving interest in these schemes, which have been negatively perceived by many investors. 

“This Act is the first standalone legislation to govern interest schemes. It gives more power to the registrar to take action against perpetrators of fraud and interest scheme providers that engage in misconduct. The law will definitely boost investor confidence and attract more interest,” says Yoon Ming Sun, partner at law firm Cheang & Ariff.

Tan Chee Hong, executive director and CEO of interest scheme provider Swiftlet Eco Park Group of Companies, welcomes the new legislation as it provides the industry with a firm foundation on which it can prosper and investors can be protected. “It is a positive for the industry as it differentiates us from the many illegal pyramid schemes out there. Investors are now clearly protected under an independent legislation,” he says. 

Interest schemes were previously regulated under the now-repealed Companies Act 1965 (Division 5, Sections 84 to 97). Many industry players and investors had said there were grey areas and weaknesses under those regulations, particularly since they did not clearly spell out the definition of “interest scheme”. This allowed illegal schemes to flourish as they were able to avoid prosecution. 

“The previous regulations were incomprehensive and they were mainly related to requirements for trustees and deeds, with the rest of the requirements dealt with in piecemeal guidelines specific to the nature of the scheme,” says Yoon.

The public’s lack of awareness of interest schemes, which has led them to invest in illegal schemes that promise unrealistically high returns, has compounded the problem. The new Act, however, will enable the registrar to prevent any grey-area situations from happening again, he says. 

One of the more important provisions of the new Act is the one clearly defining the forms of “interest” and categorising the types of interest schemes. Yoon says the new law aims to capture all related activities under its umbrella. 

Now, any investment scheme, recreational membership scheme, time-sharing scheme or a combination of these schemes is considered an interest scheme. This reduces the grey areas in which irresponsible interest scheme operators could operate.

“The previous law defined an interest scheme very loosely, which created grey areas. There were all kinds of schemes offered in the past, where the public was not really clear about what the schemes entailed. Some of them just went ahead and participated in schemes which they thought offered good returns. Many did not know these could be bogus schemes,” says Yoon. 

The new Act allows the CCM to intervene if the operators are unable to meet their obligations. The registrar can terminate schemes if it deems fit. It can also direct the operators to protect their investors’ interests or have the schemes undergo an audit. 

Another key feature of the Act is that it lays out the roles and responsibilities of the trustee, including requiring it to immediately report to the registrar if the scheme’s operator does not comply with the provisions of the Act.

The regulations state in detail how a separate trust account is to be put in place by the operator to be maintained and controlled by the trustee to protect the investors’ money. The registrar has the power to stop the trustee from operating a trust account or appointing a new person to administer it in certain circumstances. 

There are new guidelines in the works. They will complement the new Act in governing interest scheme operators in different industries. 

“If implemented, the guidelines will set the minimum paid-up capital requirements of management companies, taking into account the type of schemes and the amount to be raised [depending on whether the schemes are small, premium or foreign],” says Yoon. 

“The management company must pass the profit test, which is an uninterrupted profit after tax of a minimum of four years preceding the date of application, for registration of the scheme. It must also have evidence of an operating history and management capability, which is at least five years of good track record in the same nature of business as the proposed schemes.” 

New Act welcomed by industry players

Tommy Lim, executive director of ICT Zone Ventures Bhd, says the Act is good news for small and medium enterprises (SMEs) looking to raise funds. His company expanded its computer leasing and renting business after raising RM31 million via an interest scheme in 2013. 

“Not only is it good for investors, it is also good for SMEs in that there is an independent legislation to govern the industry as players now have a stronger foundation when they propose interest schemes to people. Previously, when people asked me what interest schemes were and whether there were any laws governing them, I said they were governed by Division 5, Sections 84 to 97 of the Companies Act 1965, which did not sound very convincing,” he says. 

However, the downside to the Interest Scheme Act is that newcomers applying for such schemes will find it harder to meet the stringent requirements.

Choo Chin Thye, managing partner at law firm CT Choo & Co, who has structured the legal framework of interest schemes in the past, says the new regulations place interest schemes on a more solid footing and enables the CCM to easily promote them to the public. “It was hard for the regulator to promote interest schemes when there was no independent legislation to govern them. Now, the CCM can go out and do it.”

Choo, together with Lim and Tan, are founders of the Federation of Interest Scheme Operators Malaysia Bhd (Fisom).

Uphill battle ahead

Interest schemes provide the opportunity to invest in niche businesses, such as computer renting and leasing, swiftlet farming and arowana breeding, and familiar ones like property and palm oil. Despite this, it remains an uphill battle for the CCM to promote these schemes in the market, says Choo. That is because the industry is still at a nascent stage compared with the securities traded on the capital markets, which are governed by the Capital Markets and Services Act 2007 and regulated by the Securities Commission Malaysia. 

He says the first type of interest scheme in 1992 had a time-sharing structure that allowed businesses to pool investors’ money to build and operate a golf club. It was not until 2007 that an interest scheme came out with a structure to provide investors with monetary returns — the Country Heights Grower Scheme initiated by Tan Sri Lee Kim Yew.

After that, more schemes were approved and rolled out, which generated interest from the public, says Choo. “It was also the boom in the industry that prompted the public and registrar to look into the matter. The industry is less mature and sophisticated than the capital markets, which has been developed since the 1990s. Thus, it is unfair to compare them.”

Meanwhile, there has been negative perception surrounding interest schemes as many think of them as illegal get-rich-quick schemes. Selvakumar K, managing partner at law firm Mar & Co, says the public tends to see legitimate interest schemes as a part of illegal money games even though they are registered and regulated. “The awareness of interest schemes is low and the public tends to get the two mixed up, partly due to the word ‘scheme’ used in both.”

Financial planners, meanwhile, express their reluctance to recommend interest schemes to investors. Bryan Zeng, general manager at FA Advisory Sdn Bhd, says the average return of 8% that these schemes provide is lower than the average return of 12% provided by private equity investments, which makes the schemes less attractive. “Interest schemes can be compared with private equity, considering their similar lock-in periods of more than five years,” he points out.

More importantly, the real returns of interest schemes are considered chargeable income under the country’s tax laws. Thus, the returns are lower after a portion is deducted for tax. 

“I studied these products in 2012 and 2013 when they gained traction among the public. However, these two concerns stopped me from investing our clients’ money in them,” says Zeng. 

Yap Ming Hui, founder and managing director of Whitman Independent Advisors Sdn Bhd, says he will only consider interest schemes if they provide good risk-adjusted returns in the future. 

Choo remains optimistic about the future of interest schemes. He says there are a few plans in Fisom’s pipeline. First, the association is looking at utilising the internet and technology to enable interest scheme investors to trade units via an online platform so that they can realise gains before maturity and have liquidity. The association will also negotiate for a certain amount of tax exemption on the schemes’ returns. 

“It is a long journey ahead. But I think it will continue to survive as the new Act has provided more protection for investors and given the registrar more power to take action against corporate misconduct and illegal schemes,” says Choo. 

“Looking from the perspective of businesses, yes, there is the emergence of equity crowdfunding (ECF) and peer-to-peer (P2P) lending, which has created more excitement in the market. However, there is a cap of RM3 million to RM5 million on the total funds raised from ECF while there is no cap for the amount interest scheme operators can raise. Meanwhile, the success of P2P remains to be seen.”

What are interest schemes?

Interest schemes are a channel for small and medium enterprises (SMEs) to raise funds by pooling investors’ money to start or expand their businesses. These schemes offer investors “interest” in an underlying business. However, unlike buying equities, interest scheme investors do not have ownership rights and cannot influence or direct the operations. 

Under the Interest Scheme Act 2016, such schemes are classified as time-sharing, recreational membership or investment schemes, or a combination of them. The schemes typically have a lock-in period of three to five years.

Many investment schemes (which is a type of interest scheme) provide investors with a return of 8% per annum (excluding tax). After three to five years, the investors can sell their interest to the operator, depending on the conditions laid out in the trust deed.

However, the total returns of a scheme upon maturity could be higher as the interest scheme operators will distribute 30% of the company’s net return to investors while keeping 70% for the shareholders. 

As at March 13, there were 150 interest schemes registered with the Companies Commission of Malaysia. In April 2013, there were 188.

Notable schemes that prompted the new Act

Wong Mei Ying, senior associate at law firm Cheang & Ariff, says two notable schemes in the past led the Companies Commission of Malaysia (CCM) to enhance the regulatory framework for interest schemes. 

The first was the Country Heights Grower Scheme (CHGS) launched in 2007. Controversy was created when the company decided to terminate the scheme just five years after its launch, citing inability to continue paying investors the promised return of 8% per annum for the first few years and a variable return for the rest of the scheme’s duration, depending on the prices of crude palm oil futures. 

The scheme, which had raised RM215.5 million at the point of termination, was supposed to run for 23 years. Tan Sri Lee Kim Yew, founder of CHGS and chairman of Plentiful Gold-Class Bhd, which managed the scheme, proposed a voluntary termination of the scheme in January 2013. The investors were asked to attend a general meeting and vote on the termination as the promised payout was unsustainable due to improper terrain for planting palm trees. 

Saying that the company had met its initial guarantee of a total return of 48% over the course of five years, Lee proposed that the company pay back 10% of the participants’ principal within 30 days of the approval of the resolution to terminate voluntarily, while the remaining 90% would be refunded over the next two years. After much debate, the company agreed to shorten the period to six months. 

Some of the investors sent complaint letters to the media, saying that they preferred to vote against the termination of the scheme so that it would be put under the trustee and the proposed terms could be renegotiated between the trustee and investors. They also asked why the CCM had not taken action to protect their interests. 

“The controversy [caused by the early termination] raised the debate on whether interest schemes were sufficiently regulated, which prompted the regulator to look into the existing laws,” says Wong. 

The other case involved a lawsuit filed by the CCM against NV Multi Corp Bhd in 2010. The latter, now known as Nirvana Asia Ltd, operates Nirvana Memorial Park. Back then, while the company sold burial plots to the public at a fixed price, it also collected a continuity fee. The fee was said to be for maintaining the infrastructure and landscaping of the plots.

The continuity fee was placed under a trustee, which then invested it in investments stipulated under Section 4 of the Trustee Act 1949. However, none of the interest and profits earned from the investments was distributed to the buyers. While the company saw this as a trading business, the CCM deemed it an interest scheme. The regulator argued that because buyers have rights to the burial plots, it should be deemed as “interest” under Section 84 of the Companies Act 1965. 

NV Multi Corp won the case but it was overturned by the Court of Appeal. The case was then brought to the Federal Court, which ruled in favour of the CCM. 

“In this case, the Federal Court affirmed the wide definition of ‘interest’ and dismissed the plaintiff’s appeal,” says Yoon Ming Sun, a partner at Cheang & Ariff.

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