Sebi on the backfoot on the LTCG scam?

Last Monday, June 19, a courtroom at the Securities Appellate Tribunal (SAT) in Mumbai was witness to a constellation of top senior counsel. There was Iqbal Chagla and Janak Dwarkadas, two of the topmost counsel in Mumbai. Another top lawyer Rafique Dada, supported by senior counsel Vikram Nankani and Mustafa Doctor, was appearing for the Securities and Exchange Board of India (Sebi). More than 60 matters relating to long-term capital gains (LTCG) were listed on that day. The hearing lasted over six hours. What they were arguing over was price manipulation to book long-term capital gains (LTCG) tax, a scam which the government is keen to end but over which Sebi has been taking strange positions. After hearing both sides, the SAT bench directed Sebi to place all its documents on the LTCG scam, on record. This is the first time SAT has taken a serious interest in the issue. Sebi will have its work cut out in trying to explain itself. 

To understand why, let’s recount how this scam works and what Sebi’s actions have been so far. Black money holders who wish to convert their cash into tax-free long-term capital gains (beneficiaries) work with market operators to identify listed dormant companies. Once the beneficiaries buy the shares of such companies, the operator starts ramping up the share prices. After a year, the operator tells the beneficiaries to arrange the cash to be laundered. Various small players convert this cash into cheque and transfer it to an account of the dummy buyer of ramped-up shares. The beneficiary offloads the shares and gets a cheque from his broker. The capital gain comes to him tax-free since it is out of long-term investment.

The Central government has been taking a series of steps to curb this. The Directorate of Investigation (DIT) of the Income-Tax department, Kolkata, did a detailed investigation, with written confessions from various entities involved, named many brokers involved in the scam, and passed on the report to Sebi for action. But the market regulator dithered. During demonetisation and the campaign against black money, on December 29, 2016, Sebi prepared an Information Memorandum (IM), which mainly attempted to discredit the DIT’s work. It said “no documentary/independent evidence in support of the statements of the operators were provided…the statements provided by DIT may not be sufficient to establish connection between” the various players. “Moreover, charges made on the basis of the statements of operators/stock brokers/front entities of operators etc., provided by DIT may not stand the test of legal scrutiny”.

Sebi argued that it “is primarily concerned with violation of securities laws… these cases are mainly resulting in evasion of tax”. However, if there is price manipulation, Sebi will act. The IM was signed by two whole-time members, and top- and middle-level officials of the legal, surveillance and investigation departments and the then chairman, UK Sinha. The note recorded that 145 cases were being investigated. Of those, in 55 cases investigation had been completed. Sebi passed no orders against the beneficiaries in 43 cases despite completing investigations. However, Sebi had passed interim orders against 12 other cases on similar facts. Can Sebi act selectively? This was the crux of the argument in SAT last Monday.

What happens now that SAT has asked for all the documents — the basis for Sebi’s debatable decisions on the LTCG scam — to be placed before it? Sebi will find it hard to explain why it has acted against 12 entities and not against 43 others. It appears that it has now completed investigations into more than 100 of the 145 cases. If SAT really gets into this issue, it will realise Sebi’s odd stance on this in early March, when one of the 12 cases involving price manipulation and LTCG evasion came up for hearing before SAT. Then, Sebi gave an affidavit saying that it will “obtain the approval of the competent authority for clarification of the intention and object of the Information Memorandum”. Experts wondered which “competent authority” above the chairman had signed the IM. Astonishingly, on Monday, Sebi counsel argued that the IM, signed by the chairman and two whole-time members, did not represent the view of the Board. Clearly, SAT has a lot to ask and Sebi has a lot to answer.

Another, and bigger, issue is why Sebi is so lenient with the weakest link in the whole chain, namely, the stockbrokers of the buyer’s side who are a party to laundering cash into cheques, and that go out as tax-free capital gains to the beneficiaries? Brokers are responsible to know their customers. The least Sebi can do is work with the I-T department and nail the brokers who are helping launder money. Unlike the previous chairmen who messed with the LTCG scam issue, despite a keen focus of the ministry of finance, maybe the new chairman and the revenue secretary will want to know — as much as SAT does.
 

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers