My confusion on the subject lead me to Mr. Viren Shah, the expert on portfolio and cross border investments. “Under the extant regulations, SEBI is relatively powerless in identifying the ultimate beneficiaries of PNs,” he opined as we settled for a cup of hot coffee at the local club. Viren got the import of my raised eyebrows and added, “Narada, you may recall that in connection with the investigations pertaining to the May 2004 crash, SEBI was clearly put of by the “stonewalling tactics” adopted by UBS, an FII, in furnishing crucial details with regards to downstream investors. The needle of suspicion since then has been on PNs.”
“What is the Government’s response on this,” I asked agitatedly. “As is its wont it had set up a high power committee on the issue of encouraging FII flows and checking vulnerability of our capital markets to speculative flows. The key issue is RBI’s negative view on PNs in the course of its response in the above committee. In fact, it had handed out a dissent note to this committee’s view to allow PNs.” “What was bothering RBI?” I asked Viren. Viren opened the copy of the report in his laptop and read out the crux of RBI’s arguments against the continuation of the PNs - “Trading of these PNs will lead to multi-layering, which will make it difficult to identify the ultimate holder of PNs.” “You mean to say that there is no regulator in this country that can trace out the ultimate beneficiaries of the PNs issued?” I asked in complete disbelief. Viren lowered his voice and quipped, “There are two alternatives. First the government can invoke Benami laws. Second, the IT Authorities (AOs) can use the provisions of S 68 of the IT Act – if the FII is not providing the necessary details and tax the PNs as unexplained credit. Of course you know Narada that the IT Act provides sweeping power to the AOs to investigate any financial transaction so that they do not escape from the long arms of law.” I recalled the provisions of S 68 rather well. Years back my friend could not provide the details of a mere Rs 50,000 loan taken to an AO. The AO proposed to add it to his income as “unexplained credit.” In the alternative he threatened expropriation of this amount using Benami laws. My friend immediately fell in line and furnished the relevant details. I asked Viren the obvious question –“If SEBI is not satisfied with the details provided and RBI is not amused with the extant regulations, why is the Government not using the provisions of IT Act and the Benami Act to expose the ultimate beneficiaries of the PNs.” Viren looked at me with scorn and added “Look Narada, it is an open secret that many big wigs of our polity are the ultimate beneficiaries of the PNs. That would explain why PNs are there to stay.” I was shocked. “You mean to say that this is an open secret and despite being well in the know of things Government is reluctant to act?” I said in a raised voice. “Narada, understand for obvious reasons, it is not that the Government can’t, but it won’t. It is a case of markets failing government and the government failing markets.” Viren said firmly. I went cold. So did my coffee.