Black Money: Sebi Busts Gains Through Losses


Mumbai: As it steps up its crackdown on tax evasion and laundering of black money through stock markets, capital market regulator Securities and Exchange Board of India (Sebi) has busted an ‘innovative’ scheme wherein HNIs (high net worth individuals) were incurring ‘bogus losses’ to offset tax liabilities.

The probe, which has resulted in an interim ban on 59 entities, including HNIs and their shell companies, found that more than half of these individuals and firms showed notional losses totaling Rs 338.3 crore through trading in illiquid stock options.

At the same time, the remaining entities generated ‘bogus profits’ to the tune of Rs 406.9 crore, which were largely done to show artificial increase in the net worth of a private company or individuals, the probe found.

The ‘bogus losses’ were also shown for the purpose of tax evasion by offsetting the capital gains tax on business profits.

While a total of 34 entities showed having generated losses, the other 25 were found to be generating profits. Further probe is continuing in the matter and the case has also been referred to the Income Tax Department for necessary action at their end.

Sebi has also referred the matter to the Financial Intelligence Unit and the Enforcement Directorate for necessary action on their parts.

Under its stepped-up surveillance mechanism, Sebi has come across several instances and internal alerts wherein a set of entities were consistently making loss by their trading in options on individual stocks.

Trading of these entities appeared abnormal because they were consistently seen making significant loss by their trades which were reversed with the same counterparties either on the same day or the next day.

In its interim order in the latest case, Sebi said its analysis of the stock options segment of bourse BSE for the fiscal year 2014-15 showed that there were several entities who consistently made significant loss and others who consistently made significant profit by executing reversal trades in stock options on the exchange.

In its probe, Sebi first identified the top entities making significant loss or profit by buying and selling equal units of stock options of a scrip.

It then checked whether trades happened at unreasonably low or high price or they were out of sync with the underlying price. Sebi also examined contribution of trades of the entities to total traded volume in the contract on those days and identified the quantum of such reversal transactions. The entities which made a loss or profit of more than Rs 5 crore in the stock option segment on account of reversal transactions were shortlisted.

It was found that the loss-making entities were trading mainly in options on individual stocks which were thinly traded. The trades by these loss-making entities, in many cases, contributed to 70-100 per cent of total traded volume for the contracts on those days.

On majority of occasions, the quantity of stock options bought and sold by the lossmaking entities for a contract was identical. However, there was a significant difference in the sell value and buy value of the transactions resulting into significant loss to the loss-making entities.

Also, a substantial number of transactions were squared up and a major percentage of transactions thereof were trade reversals, that is if the stock options were sold first to an entity, they would be bought back in exact quantity from the same entity or vice versa.

In respect of 15 out of the total 25 profit-making entities, the time difference between placement of client orders and counterparty orders for reversal transactions is less than 60 seconds.

All these reversal transactions were carried out through a screen-based trading platform on a segment with hundreds of different contracts.

The placement of orders repeatedly within a time span of less than 60 seconds and a significantly high percentage of matching of these orders, however, appeared to be practically impossible unless there was a prior understanding or a premeditated plan between the two entities executing them.

Further probe revealed that majority of the profit-making entities had opened specific accounts for exclusively executing transactions in such illiquid stock options.

The trading accounts were opened and operated by these entities merely to facilitate the loss making entities execute their motive.

The trading by the loss-making entities and the profit-making entities also sprung up significantly during the last quarter of financial year 2014-2015.

Sebi found that loss-making entities were deliberately and repeatedly making losses, without any economic sense, and profit-making entities were facilitating them by becoming their counterparties with a common objective of executing these suspicious and non-genuine trades.

“The reasons for executing such trades by these entities could be showing artificial volume and trading interest in these instruments or tax evasion or portraying artificial increase in net worth of a private company/individual.”

“Be as it may, it is amply clear to me that the rationale for such transactions is not genuine and legitimate as the behaviour exhibited by these entities defies the logic and basic economic sense,” Sebi said.

“No reasonable and rational investor will keep making repeated losses and still continue its trading endeavours. On the other hand, an entity/scheme may not forever be able to make only profit and become equivalent to an assured profit maker/scheme.”

Sebi whole-time member Rajeev Kumar Agarwal said in his order that it appeared to be “a possible case of tax evasion or portrayal of artificial net worth to certain entities”.

Besides, it was also “a fraud on the securities market inasmuch as it involves non-genuine or manipulative transactions in securities and misuse of the securities market”.


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