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Market manipulation: how FIIs play the game

P Vaidyanathan Iyer & Subhomoy Bhattacharjee

Foreign institutional investors have exploited their status in India by carrying out stock market transactions for anonymous foreign clients- individuals and body corporates- who are otherwise not allowed to trade in Indian scrips, according to the Securities and Exchange Board of India.

Not only this, by routing transactions of foreign individuals and body corporates, the Mauritius-incorporated FIIs with sub-accounts in India have allowed foreign clients to claim undue tax benefits under the Mauritius Double Taxation Avoidance Treaty.

While there are no exact figures available on the quantum of transactions FIIs carried out for foreign clients, it could be substantial given the fact that FIIs' gross purchase and sale transactions in the last 18 months were a whopping Rs 1,470 billion.

Sebi, in its interim report, noted that the trading data of FIIs show that they misused their investment and automatic repatriation facility by issuing "participatory notes" to entities which perhaps wanted to hide their identity or were otherwise not eligible for registration as a FII in India, by enabling them to purchase and sell shares in the country.

The mechanism of "participatory notes" works out thus: any US-based pension fund wanting to open a sub-account in India sets up an investment subsidiary in Mauritius to take advantage of the double tax avoidance treaty.

A foreign entity which intends to buy shares of Indian companies approaches the sub-account which issues the entity a "participatory note."

A foreign broking house executes the order for the FII's sub-account, which is actually for the benefit of the foreign client.

Sebi, in as many words, says that these entities, hidden or anonymous, which were provided access by FIIs to the Indian markets had ample opportunities to indulge in stock price manipulation.

This could have resulted in foreign exchange drain by repatriation of profits (without payment of any taxes), achieved through price rigging.

The market regulator's investigation also revealed that FIIs including Credit Suisse First Boston, Deutsche International Trust, Credit Agricole Lazard and RP &C International predominantly transacted in scrips like HFCL, Zee Telefilms, DSQ Software and Silverline with broking entities of Ketan Parekh.

Sebi's report reveals that Mauritius-based CAL FP and DBMGOF, the sub-accounts of Credit Agricole Lazard and Deutsche International respectively have transacted by and large only in HFCL, DSQ Software, Silverline, Zee, Global Tele-Systems, Global Trust Bank, Aftek Infosys, Mascon Global and Lupin Laboratories.

While the transactions of Coral Reef (the sub-account of RP&C) in Ketan Parekh scrips accounted for about 71.54 per cent of its total trades of Rs 919.55 billion during the period January 1999 to March 2001, that of CAL FP accounted for 95 per cent or Rs 170.49 billion, that of DBMGOF accounted for 64 per cent or Rs 197.04 billion and that of CSFB's sub-account Kallar Kahar Investment accounted for 50 per cent of Rs 454.48 billion.

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