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The Securities and Exchange Board of India (Sebi) has published guidelines for capital market intermediaries to ensure compliance with the Prevention of Money Laundering Act, 2002. The controversial law, although passed in 2002, was given life last year.

Every person registered with Sebi as an intermediary has obligations under the Prevention of Money Laundering Act. Therefore, this will cover every single foreign institutional investor, mutual fund, broker, sub-broker, portfolio manager, and every other person who requires registration with Sebi for conduct of its business.

Section 12 of the Act requires every intermediary to verify information relating to identity of clients, maintain a record of transactions in the parameters prescribed by the government, and to furnish such information to the designated authority.

Such information has to be maintained for 10 years, and if any person is seen to be entering into transactions of a value just below the threshold prescribed, such transactions too ought to be recorded and reported.

The central government has prescribed rules under the law, which requires intermediaries to record information of all cash transactions of a value of more than Rs 10 lakh, any series of cash transactions in a month, integrally connected to one another, aggregating to a value of Rs 10 lakh within a calendar month, and every suspicious transaction even if not in cash.

In other words, suspicious transactions in securities, movement of shares from one account to another, and even movement of funds through the banking channels, if found suspicious, ought to be recorded and reported.

Sebi has now published guidelines to provide its view of what intermediaries ought to do in order to be compliant with the Act. Essentially, every intermediary is now required to publish a statement of policy and procedures for dealing with money laundering, adopt customer acceptance policies, undertake due diligence before taking on a customer and ensure that all the staff are sensitive to the objects of the Act.

Specifically, the Sebi guidelines require an intermediary to identify the persons who beneficially own securities transacted by the intermediary. If it is apparent that the securities are beneficially owned by a person other than a client, the party should be identified using client identification and verification procedures.

Sebi guidelines add that the beneficial owner is the natural person who ultimately controls, owns or influences a client, or the persons on whose behalf a transaction is conducted.

A concept of "clients of special category" has also been introduced by Sebi. This concept includes non-resident clients, high net worth clients, trusts and charities, family-owned companies, politicians, clients with publicly-known suspicious background, and clients from perceivably lax jurisdictions.

These guidelines bring back into focus the entire debate over the know-your-client requirements that are at the core of the controversy over the issuance of offshore derivative instruments in respect of underlying transactions in Indian securities. Every foreign institutional investor is an intermediary, and will be required to know the ultimate natural person who beneficially owns the securities in respect of which such instruments have been issued.

Sebi has left the formulation of policy and procedures for identifying the ultimate client to the respective intermediaries, asking them to bear in mind the principles of "know-your-client" and bearing in mind the intent behind the Act.

Considering that the entire legal interpretation laid down by the Securities Appellate Tribunal in the UBS case has been stayed by the Supreme Court, Sebi's guidelines in relation to the Act once again raises the interesting debate over what FIIs ought to put in place to ensure compliance with the law.

There should be no issue if the regulators are conscious that often the ultimate investor in an offshore derivative instrument is an institution, which does not issue units or shares on the basis of any single transaction or a series of transactions executed in India by an FII.

For instance, if a mutual fund invests in a participatory note issued by an FII, it would be completely wrong to contend that the general units issued by such a mutual fund are back-to-back derivative instruments that map the transactions executed by the FII.

Unless such an investor actually issues instruments that map individual transactions underlying the instrument, it would be wrong to ask the FII to know the identity of every natural person who has invested in the mutual fund.

The crucial difference is the distinction between the beneficial ownership of the underlying securities and the beneficial ownership of the overall wide pool of resources aggregated by a mutual fund investor.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed are personal)