Black money probe team pulls up Sebi

Asks market regulator to check creation of such wealth via stock exchanges, P-notes

A Supreme Court-appointed special investigation team (SIT) on unaccounted money has come down heavily on the creation of such funds through stock exchanges and participatory notes (P-notes). In a report, the SIT said the Securities and Exchange Board of India (Sebi) should have an effective monitoring mechanism to study unusual rises in stock prices and the use of stock exchanges to evade taxes through long-term capital gains.

Sebi has also been asked to put in place a mechanism to monitor the beneficial owners of P-notes.

The SIT has recognised the recent steps taken by the regulator to scrutinise cases of tax evasion through  exchanges.

Sebi has been sharing such information with the income tax department. Now, the SIT has directed it to share that with the Financial Intelligence Unit, too.

The investigation into market manipulations shows the modus operandi involves companies with poor financial fundamentals raising huge capital by allotment of preferential shares to various entities. This is followed by a sharp rise in share prices, once preferential allotment is carried out, through circular trading. The artificially inflated stocks are then offloaded through companies funded by those seeking to convert unaccounted money into ‘white’ money.

Recently, Sebi had barred about 250 entities, both individuals and companies; the overall funds involved in this could be  Rs 20,000 crore.

The SIT, however, isn’t satisfied with a ban on such entities, advocating these entities be prosecuted under the Sebi Act. “The Enforcement Directorate should be informed to take action under the Prevention of Money Laundering Act for the predicate offences,” said the report.

WHAT THE SIT TOLD SEBI

• Have an effective monitoring mechanism to study unusual rise in stock prices
• Generate red flags, including on trading volumes, entities contributing to trading volume and financial background of firms through annual returns
• Share such information with CBDT and FIU
• Barring entities misused for taking LTCG benefits not enough; prosecution should be launched under Sebi Act
• Form regulations to pinpoint ‘final beneficial owner’ of P-notes
• Information on P-note holder shouldn’t be the name of company, but that of the individual whose KYC details are available
• Have information on promoters or directors who exercise effective control over the companies holding P-notes
• Examine if provision of allowing transfer of P-notes is  beneficial to easing foreign investment

Sources said Sebi had sent a list of violations by companies in the small and medium enterprise platform to the income tax department, adding the investigative agency had already started a probe against these entities. As of now, Sebi is examining 100 additional companies, for which interim orders would be passed. Here, overall illicit gains could be to the tune of Rs 50,000 crore, regulatory sources said.

Though Sebi is considered to be heading a multi-agency probe on black money creation in domestic markets, the regulator has been criticised for not intervening in these cases on time. This, too, was highlighted in the SIT report. “We believe with effective and timely monitoring by Sebi, a significant number of such instances can be checked in time,” the report said.

The SIT advised Sebi to red-flag instances pertaining to trading volumes, entities contributing to trading volume and financial backgrounds of firms through annual returns.

On P-notes, the SIT questioned the opacity of these instruments in identifying the beneficial owners. Based on data provided by Sebi, it said a major chunk of outstanding offshore derivative instruments invested in India were from the Cayman Islands (31 per cent). “This translates to about Rs 85,006 crore. In 2010, the Cayman Islands had a population of 54,397, according to Wikipedia. It does not seem conceivable that a jurisdiction with a population of less than 55,000 could invest Rs 5,000 crore in a single country,” the report said. “Sebi needs to examine the issue raised and come up with regulations through which the ‘final beneficial owner’ of P-notes/ offshore derivative instruments is determined.”

According to SIT, information with Sebi on ‘beneficial owners’ should be on individuals. “In no case should the information end with name of a company,” it said. The regulator has been tasked with keeping information on promoters or directors who exercise effective control over the company holding these derivative instruments.