Black to White: Income Tax dept starts action against penny stock operators after SEBI fails to check them
Moneylife Digital Team 09 March 2017
The Income Tax (I-T) department has initiated criminal prosecution against shell companies, stock brokers, beneficiaries and operators involved in laundering over Rs10,000 crore in Mumbai alone by manipulating listed penny stocks to claim bogus long term capital gain (LTCG), says a report.
According to a report from Indian Express, first such criminal case has been filed on 28 February 2017 against Mukesh Ruia, promoter of Shekhawati Poly-Yarn Ltd, a listed entity. "The I-T has alleged that Ruia laundered over Rs 17 crore between 2012 and 2014 through Unno Industries Ltd, a listed penny stock and availed tax exemption by showing fake long term capital gains," the report says.
Earlier on 24 January 2017, the Central Board of Direct Taxes (CBDT) had issued guiding principles for determination of Place of Effective Management (POEM) of a company with an intention to target shell companies and companies, which are created for retaining income outside India although real control and management of affairs is located within the country.
Coming back to the action by the I-T Department, penny stocks are scrips of companies that trade at very cheap price and have lower market capitalisation. In the case against Ruia, the Department had alleged that he laundered over Rs17 crore between 2012 and 2014 through Unno Industries Ltd, a listed penny stock and availed tax exemption by showing fake long term capital gains, the newspaper report says.
As per the I-T Act, long term gain (holding period more than 12 months) from sale of equity shares on stock exchange is exempt from tax.
Citing a filing in the Court, the report from Indian Express says, " the I-T department has sought seven years of rigorous imprisonment under sections 276C (1), 278 of the I-T Act and sections 120 B and 420 of the Indian Penal Code for Ruia and six others — a Mumbai-based chartered accountant, three partners of a brokerage firm and two 'dummy' directors of four shell companies — who assisted Ruia in converting black money into white."
The report quoting court filing says, a Kolkata-based brokerage firm, Intellect Stock Broking Pvt Ltd, allegedly helped Ruia buy 41.71 lakh shares of Unno Industries in 2011 at Rs1.79 a piece through preferential allotment. The court filings state that in the next two years, the owners of the brokerage, through Kolkata-based shell companies Nimbus Vincom Pvt Ltd, Viewlink Dealer Pvt Ltd, Vedant Commodeal Pvt Ltd and Touchwin Dealcomm Pvt Ltd, rigged the share prices of Unno Industries through circular trading (buyers and sellers are connected) in its shares. As a result, in 2013 share price of Unno Industries touched about Rs38 a piece with Ruia’s stake valued at about Rs17 crore. Ruia then funded the same shell companies, allegedly bringing in the black money into these shell firms, which subsequently bought Ruia’s stake in Unno Industries, the court filings state.
Ruia then claimed tax exemption citing LTCG for the Rs17 crore he earned through trading in the penny stock. 
According to Indian Express, investigation agencies have identified close to 30.000 shell companies in Kolkata alone and most of them share the same office address and employ dummy directors — typically 'people of no means' to act as fronts for the main operators.
LTCG Scam: A Failure of SEBI's Surveillance System
Over the past seven years, Moneylife has been publishing reports of one case of market manipulation in every issue. These cases do not require much effort to unearth. We can start looking at the listed companies, alphabetically, and easily find cases of illiquid, closely-held stocks, with no business to speak of, that are rigged a few hundred percent. In other words, price-rigging for booking bogus long-term capital gains is widespread and continuing with impunity. 
Our objective has to be to prevent such manipulation. But, from 2001, when the Joint Parliamentary Committee (JPC) was enquiring into the Ketan Parekh scam, up to 2015, when the Special Investigation Team (SIT) of the Supreme Court on black money flagged this off, SEBI has been found lagging far behind the curve in catching price-rigging. 
Here is what the SIT said, in 2015: "SEBI has recently barred more than 250 entities, including individuals and companies, from the securities market for suspected tax evasion and laundering of black money through stock market platforms… There is an urgent need for having effective preventive and punitive action in such matters to prevent recurrence of such instances."
The SIT had recommended, "SEBI needs to have an effective monitoring mechanism to study such unusual rise of stock prices of companies… We believe that with effective and timely monitoring by SEBI a significant number of such instances can be checked in time." This clearly means that SEBI has singularly failed in its job, despite spending over Rs50 crore on installing sophisticated real-time surveillance systems.
The only action SEBI has taken, so far, is banning some entities from the stock market. But SIT says, "Barring such entities from securities market would not be of (sic) strong deterrence. In case it is established that stock platforms have been misused for taking LTCG benefits, prosecution should invariably be launched under relevant Sections of SEBI Act. Section 12A, read with Section 24 of the Securities and Exchange Board of India Act 1992, are predicate offences." SIT went on to suggest that the enforcement directorate should then be informed to take action under Prevention of Money Laundering Act for the predicate offences. It is remarkable that SIT had to tell SEBI what it should do in such cases! 
In 2013, Moneylife wanted to know how many cases of price manipulation, detected by SEBI's integrated market surveillance system (IMSS) and data warehousing business intelligence system (DWBIS), resulted in prosecution, or consent orders, or were dismissed due to lack of evidence or were still pending investigation. In a shocking disclosure, SEBI replied that it did not have information relating to its market surveillance system! 
SEBI has spent crores of rupees on the so-called state-of-the-art surveillance systems, IMSS and the more modern DWBIS. Earlier, SEBI had touted that the DWBIS project will "exploit the power of modern technology in terms of computation and speed of data analysis" and "host pattern recognition algorithms", to crack insider trading. Despite all this hype and the enormous amount of money spent, stock manipulation continues, right under SEBI's nose.
Moneylife had found out, in 2013 that 48 staff members are posted in the integrated surveillance department (ISD) of SEBI, which houses the IMSS and DWBIS. The IMSS contract value was of Rs20.55 crore. Then, SEBI adopted the Rs34.38 crore DWBIS, which became operational in 2010. This is a lot of taxpayers' money and nobody knows how effective the surveillance system is. Or if anybody in SEBI is truly looking at all the cases triggered by the systems or are they doing it selectively. Despite draconian powers and plenty of funds, SEBI is extremely reluctant to act effectively against price manipulation and LTCG scamsters. The Ruia case shows that maybe the revenue secretary has given up on SEBI and has started using income tax team to go after stock manipulators.
You may want to read…
jaideep shirali
5 years ago
If SEBI finds nothing wrong in penny stock manipulation, how is it acting in the investor's interest ? Many investors get caught in the circular trading in these penny stocks, when the operators cash out of the stocks, these investors suffer losses and never return to the capital markets. SEBI must stop behaving like the proverbial three monkeys and act, markets are its domain, if Income Tax has to act, it means SEBI is a watchdog that cannot even bark, leave alone bite.
Suketu Shah
5 years ago
This is why experts say out of 6000 stocks only 200-300 at the very max are worth keeping a track on.
Hemlata Mohan
5 years ago
Sebi is another place where friendly contacts matter both in appointment and in the supervision of companies. What can we expect from such a "watchdog"?
S Santhanam
5 years ago
My wife is a victim of SEBI inaction.. She holds equity shares in Teledata group companies. For the last three years the stocks of Teledata are not traded in the stock exchange. How to approach the it authorities to get me redressal.
Vaibhav Dhoka
5 years ago
SEBI has failed totally in boosting confidence of small investors .SEBI,s action helped culprits to boost their confidence to do WRONG,SEBI was never interested to make capital market healthy,In fact SEBI could have gained praises if it would have taken note of investigation of moneylife write ups i the magazine.Income tax investigation is rap on knuckles for SEBI.
Free Helpline
Legal Credit