India's markets need to get used to a new regime of policies and regulation that are proving to be a curious mix of modern motives and medieval methods.
Last year's demonetization exercise, a witch hunt against unaccounted-for cash, is now being dressed up as an enabler of digital money: a modern objective. The recently introduced goods and services tax wears the garb of reform, but its cumbersome design -- and tinkering with rates -- reeks of a moody king's haphazard efforts to maximize revenue.
Even before the GST dust could settle, the Indian market regulator decided this week to banish as many as 331 publicly traded companies to the doghouse. Their shares will be allowed to change hands on only one day per month, with strict controls on insider activity, until fresh audits can convince the Securities and Exchange Board of India, or SEBI, that they aren't "shell companies."
The move took investors by surprise. Between them, the firms boast millions of individual shareholders as well as prominent institutional investors. J Kumar Infraprojects Ltd. and Prakash Industries Ltd. have market capitalization in excess of more than $300 million. SQS India BFSI Ltd., a dividend-paying affiliate of Cologne-based SQS Software Quality Systems AG, has 14 million hours of software testing behind it. Some of the affected parties have challenged the order, prompting the appellate authority to inquire on Thursday why the regulator didn't give the firms a hearing first.
One of the ways a publicly traded firm is used as a conduit for tax evasion was chronicled by Sugata Ghosh in the Economic Times, based on an investigation by authorities last year. Suppose you have a suitcase full of cash. To wash it, you connive with the controlling shareholder of a smallish company and buy shares from the market using legitimate cash; prices of thinly traded securities shoot up.
After holding the stock for a year -- so that there's no capital gains tax -- you pocket the profit by selling to an entity close to the company boss. However, to receive a clean check for proceeds, you part with your suitcase. The new buyer of the stock offloads it at inflated prices to a profitable firm so that when the prices eventually fall, the loss provides a nice tax offset; as his reward, the chief of this second company gets that suitcase full of spending money.
But are all 331 companies complicit in this kind of money-laundering? SEBI says it was acting upon a list drawn up by the ministry of corporate affairs, with inputs from the tax department and the serious fraud office.
This is where modernity comes in. Following the demonetization drive in November, New Delhi began using big-data specialists to unearth tax evasion. Armed with a biometric database of a billion-plus people, the government is rolling out Project Insight, which trawls through social media posts and pictures to discover the disconnect between spending patterns and reported incomes.
Investors should be happy that India now has the forensic capability to go after elaborate pump-and-dump schemes. Instead, they're alarmed. The list of 331 is in the public domain, but the algorithm behind it is not.
It's a costly opacity. Even if some firms are allowed to trade normally again, the stigma of being named as a dodgy shell company is bound to have a permanent effect on reputation.
What should worry investors more, however, is that this overzealous enforcement action is not the usual bureaucratic bungling, but part of a new trend of using primitive justice to fashion clean capitalism.
The pursuit started with demonetization; nobody knows where it'll wind up.
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