Depositories used for money laundering

Written by Sucheta Dalal | Mumbai, March 22 | Updated: Mar 23 2006, 06:13am hrs
The income tax department has cracked down on a massive racket of laundering black money through the secondary market. I-T authorities have detected tax evasion of over Rs 100 crore and hidden income of over Rs 400 crore. They are looking at nearly 40 other companies whose shares have been manipulated.

The investigation wing of the department found that the large-scale ramping up of penny stocks provided a convenient cover for tax evaders. The modus operandi is as follows:

A group prepares the ground by ramping up shares of scores of companies that were traded at just a few rupees each or sometimes less than a rupee. For instance, if X wants to launder Rs 1,000, the racketeers would give him 10 physical shares of a company quoting on the bourses at around Rs 100. This would be accompanied by a back-dated contract note, showing the sale at around Rs one per share for a cash consideration. Since shares cannot be sold in physical form, the buyer sends the shares to the depository to be dematerialised and converted into electronic form. He sells the dematerialised shares on the secondary market at the artificially ramped up price of Rs 100 plus and pockets a cheque payment, converting his black money into white.

Depending on how far the receipt was back-dated, he walks away by paying either zero or 10 % capital gains tax. It may be recalled that capital gains dropped to 10% since April 2000 and the fraud has been in operation ever since.

In one case the price was ramped up from a few paise to Rs 4.80 and in another case a one rupee face value stock was ramped up to Rs 85 .

The IT department found that the fraudsters were brazen enough to recycle the same set of shares several times over. For instance, the shares of one company, with a paid up capital of Rs 7.3 crore showed Rs 20 crore worth of rematerialisation/dematerialisation in the last two years (this is conversion from physical share certificates to electronic entries and vice versa). Considering that floating stock of a company on an average is just around 50% to 60 % of the capital, the entire capital has been put through the demat-remat process several times in a single year, without attracting the attention of the depositories.

This shocking disclosure, close on the heels of the multiple account scandal raises further questions about the quality of systems and processes at India's two depositories and their level of alertness and market intelligence. In a compulsory demat environment, large scale rematerialisation of fairly liquid shares ought to have triggered a loud alarm at least because the manipulation of penny stocks has been making headlines all of last year.

In the last few weeks IT officials have conducted massive raids all over Maharashtra including Pune and Jalna . So far, they have targeted 24 groups of assessees in Mumbai, four in Pune and one in Jalna who have benefited through such laundering. They have 80 others on their radars.

The companies whose shares have been manipulated and used in this fraud include Database Finance, Fast Track Entertainment, IFSL Limited (also under SEBI's scanner for price manipulation), G-Tech Info-Training Ltd. Additionally, the Assessment Wing of the Income Tax Department smelt a rat in its scrutiny process and tipped the Investigation Wing about manipulation of three other company shares Mantra Online, Herald Commerce and Rashel Agro.

IT sources say that while thousands of persons dematerialised shares and laundered their illegal income, the applicants for rematerialisation in each case were only a handful of individuals. This fact has opened the door to IT officials to quickly scale up the investigation and bring more scrips under their scrutiny. In most cases, there is no record of the back-dated bills in the books of the brokers, who obviously operated under the assumption that they would never be caught.

Given that hundreds of penny stocks have been brazenly manipulated, IT officials have good reason to believe that unaccounted wealth that got laundered though the secondary market could well run into several thousand crores of rupees.