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Illiquid options for money laundering: Crackdown may net a windfall

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The crackdown against use of illiquid stock options for money laundering could boost the cash reserve of the Securities and Exchange Board of India (Sebi). The regulatory probe involves over 9,000 entities including brokers, wealthy investors and promoters of several small companies and is expected to fetch over Rs 600 crore for the market regulator in fines. This is among the biggest crackdowns undertaken by Sebi since its inception, said two people privy to the development.

Sebi has already served over 2,000 show cause notices to various investors while another 1,000 are expected before the end of the current fiscal. Sebi is planning to initiate regulatory action against others by November, said a source cited above.

It has also passed final orders in about 90 such cases and in most of them the regulator has levied minimum fine in the range of Rs 5 lakh to Rs 10 lakh.

The investigation pertains to use of stocks where options are thinly traded in the market to launder money. These investigations pertain to the period between 2015 and 2016 when the low volumes in derivatives of a stock exchange were exploited by investors. The investigations started when Rajeev Agrawal, erstwhile wholetime member (WTM) of Sebi, issued an ex-parte order against 59 entities in 2015 for misusing the stock exchange platform. This order had paved way for more investigations into such trading patterns.

Consider an investor ‘A’ who has incurred significant capital gains in a year. In order to offset these gains, they use illiquid stock options to book losses. The counterparty to these contracts, say investor ‘B’, books profit in these options. B already has an arrangement with A wherein he retains around 10-15 per cent of the profits made and transfers rest of the money to ‘A’ through non-banking channels.

In some of the cases, the regulator also suspects that investors placed synchronized buy and sell orders in the same options within seconds from each other and also reversed their positions very fast creating artificial volumes in the scrip.

However, some of the lawyers feel that these cases are increasing the work burden on Sebi and instead should be resolved through settlement process. The new consent rules allow the regulator to settle even the cases involving serious market violations such as insider trading and fraudulent trade practices. The idea of allowing serious cases to be settled through consent was to dispose smaller violations so that the regulator can focus on the bigger crimes.

“In most of the cases, a minimum penalty of Rs 5 lakh is being levied,” said Tomu Francis, partner, Khaitan & Co. “Instead, Sebi perhaps should consider specifying a settlement scheme as permitted under the new regulations for such cases as it may significantly reduce the administrative burden.”

Lawyers told ET that most of the entities who have been fined by the regulator are choosing not to challenge the orders further since the amount of fine imposed is minimal compared to the gains made by them. Further, the income tax department is said to be investigation the probe separately.

“Some of the investor accounts being probed are suspected to be mule accounts and tracing the actual culprit could become tricky,” said another source. “Although the matters pertain to fraudulent trade practices, the quantum of unlawful gains is very small in most of the cases and hence are being subject to minimum penalty.”

Source: Economic Times