Stripping intent drew in the cash for equity funds

The gusher of cash that flowed into equity schemes in December last year could have been triggered by mutual funds and their distributors who tipped off bulk clients and high net-worth investors about impending dividends "" to be declared in March this year.

Armed with such advance information, these investors have beaten the 90-day lock-in norm and can exit after the record date, thus booking capital losses.

"The inflows you hear about are mostly dividend stripping money," said an industry insider.

The new tax rule says that investors entering equity schemes 90 days before the record date have to stay locked-in for at least three months from that date and can book capital losses only nine months later. But the rule does not say anything about investments made more than 90 days before the record date.

So investors who entered into equity schemes in December 2004 would be getting more than 90 days if the dividends are declared in March and can thus safely strip dividends.

Dividend stripping refers to the process whereby an investor enters the scheme before the declaration of dividend and sells immediately after it at a lower price to book capital losses which can be set-off against capital gains elsewhere.

The marketing head of a leading mutual fund said, "I know this is unethical but we did keep our big-ticket investors informed about expected dividends in equity schemes."

Compliance officers with asset management companies, who have the mandate to ensure that the fund is complying with all the Securities and Exchange Board of India (Sebi) regulations, are left squirming.

"This is tantamount to insider trading," said a mutual fund insider, pointing out that his compliance officer was uncomfortable about the whole situation but had been told by the sales head to look the other way.

In fact, the head of a mutual fund said, "I know we should not be doing this, but if this is the way to bring in the investors, then we have no other option."

One big fund house reported a single investor bringing in around Rs 200 crore into an equity scheme with a corpus of more than Rs 1,000 crore.

Sebi officials, when contacted on the issue, said, "We know it is happening, but it all verbal and there is nothing written down. Such kind of things do not leave an audit trail. Any evidence we can collect will be merely circumstantial and we cannot prove that the inflows happened due to deliberate inside information."