Since December, 2014, SEBI has passed four orders restricting over 300 entities from accessing the capital markets. SEBI has found these entities to have misused the stock exchange system to generate fictitious long term capital gains in order to convert their unaccounted income into accounted income and avail of a tax exemption. Under the existing tax laws, if the equity shares of a listed company are held for more than twelve months, the long term gain arising from the sale of such equity shares is exempt from income tax. To avail of this exemption and evade tax, the entities employed a scheme, plan, device and/or artifice which resulted in the creation of artificial volume and manipulation of the price of the scrip.
The companies involved in the said scheme allegedly allotted equity shares to certain known entities on preferential basis with a lock in period of one year in accordance with the ICDR Regulations. SEBI examined the financial history of the said companies and noted that the companies garnered large investments through preferential allotment, despite their unimpressive track record. SEBI held that such investments would not have been made unless there was prior arrangement between the management of the company and the allottees.
SEBI observed that two groups of entities were involved in the execution of the scheme. One group increased the price of the scrip during the lock in period and the other acted as buyers after the expiry of the lock in period to provide exit to the allottees. It was also observed that the funds bought in by way of preferential allotment were utilized for purposes other than those disclosed and, in some cases, were forwarded to various connected entities through informal arrangements. Funds were also provided to entities who acted as buyers for purchasing the shares from the allottees through layering of fund transfers. This resulted in the creation of artificial volume and considerable increase in the price of the scrip. For instance, the price of one of the scrips involved jumped from Rs. 5/- to Rs. 263/- within 115 trading days.
After the examination of the schemes, SEBI observed that there was no change in the beneficial ownership of the traded shares as the buyers and sellers were both part of a common group. The schemes were employed to avoid taxes and to legitimize the sources of income. The allottees allegedly made large gains (for instance, in one case, the allottees made a collective profit of over Rs. 3 billion on their investment of Rs. 130 million). SEBI held that the schemes were fraudulent in nature and thereby in violation of PFUTP Regulations and had the potential to harm gullible and genuine investors.