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Business News/ Opinion / Online-views/  Investors ‘renting’ out PAN cards
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Investors ‘renting’ out PAN cards

Investors 'renting' out PAN cards

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Call them the ‘Rent-a-PAN-card’ investors.

A flourishing network of investors are emerging in Gujarat, such as in its capital Ahmedabad, who are essentially renting their permanent account numbers, which are required for stock market trades, to brokers in return for a flat, predetermined fee.

This is how the arrangement, dubbed vyaj koshtak or pancard ka bhada, works.

These individual investors apply for shares of an initial public offering (IPO) under the individual investor quota (usually 30% of an offering is set aside for such retail investors) in their own name, using their own PAN cards. But in reality, they are simply acting as a front for a broker who has agreed to pay them a pre-determined flat fee, ranging from Rs1,500 to Rs4,000, depending on the IPO, irrespective of how many shares they are allotted or what happens to the price of the shares once they list. Sometimes that fee, for “renting" the PAN card, is even paid upfront.

The investors then sell their allocated shares on opening day, turning over the profit to the broker, essentially enjoying a risk-free, fixed return for the service provided. Meanwhile, the broker is able to make profits on a significantly larger number of shares than he would get on his own.

Typically, the broker can take a hit if, for some reason, the shares list at lower than the IPO price, somewhat of a rarity in a nation that is obsessed with shares and IPOs, even in recent turbulent times in the markets.

“Since there is a risk of the shares getting listed below the issue price, the broker enters into such arrangement only in those IPOs where there is a high probability of listing at a premium," says one Ahmedabad-based investor who didn’t want his name used.

For instance, the recent successful IPO of rating agency Icra Ltd as well Mindtree Consulting Ltd saw brokers pay Rs3,000 per application made on their behalf. Icra shares rose from Rs525 a share to Rs1,125 a share between 13 April and 17 April. Mindtree shares jumped from Rs575.20 on 7 March to Rs1,021.80 on 15 March.

On Friday, Mint first wrote about the plain vanilla koshtak, the grey market in cities such as Ahmedabad for IPOs, which usually involves one person promising to buy a stock that is to be listed, at a pre-determined premium on the issue price from someone who has applied for the shares. Mint noted the emerging demand under koshtak for shares of DLF Ltd, which is expected to be the largest IPO in India when it debuts on 11 June.

But the more complicated vyaj koshtak kind of deals highlight the way the retail quotas of IPOs can potentially be misused. Since there is nothing illegal about such applications from investors who are, on the face of it, genuine, it has largely escaped scrutiny by the Securities and Exchange Board of India, or Sebi, the nation’s markets regulator.

India has already been through a major stock market scandal in which multiple trading accounts were opened in the name of the same investor. The vyaj koshtak system is different in the sense these are real individual investors and the money is going from their trading accounts along with the IPO application, and shares are allocated to their accounts.

Back in 2005, Sebi’s investigations revealed that in 20 or so IPOs which hit the Indian stock market between 2003 and 2005, thousands of demat accounts were opened by certain large investors who then cornered shares that were meant for genuine individual investors. That sparked off a debate in the industry about the viability of the quota system in IPOs.

The system of subsidizing small investors in the allotment process is the root cause of the IPO abuse, says J.R. Varma, former member of Sebi and a professor at the Indian Institute of Management, Ahmedabad.

According to Prime Database, which tracks the primary market, Rs45,000 crore worth of IPOs are set to hit the Indian market this year alone, with a spate of mega IPOs lined up over the next few months, giving networks such as vyaj koshtak a significant yet under-the-radar role.

Here is how a broker and an investor would work under the vyaj koshtak network.

First, to further avoid any scrutiny, these “rented investors" typically apply for shares worth Rs96,000 as part of the the retail quota. That’s because any application of Rs1 lakh or less is considered a retail application according to Sebi’s IPO rules.

If the amount exceeds that, then an applicant comes under the separate category of high networth investors.

There is usually a gap of around three weeks between the closing date of an IPO and the listing day. Assuming that the rented investor gets an allotment of only Rs15,000 worth of shares, the balance Rs81,000 is refunded to his account. On the listing day, if the Rs15,000 worth of shares appreciate in value to, say, Rs25,000, he earns a “profit" of Rs10,000 on selling the shares as agreed to with the broker.

Out of this “profit," he keeps the predetermined fee—which ranges from Rs1,500 to Rs4,000—and hands the rest to the broker who had rented his PAN card.

A 20-day return of, say Rs1,500, on an investment of about Rs1 lakh roughly translates into an 18% annualized return. If the commission is Rs3,000, then the return goes up to 36%. Even compared with a bank deposit, which is also risk-free, an investor not only has to put aside money for a much longer period to get a 10% or 11% return (on a one-year deposit), but he then would have to pay tax on any interest income of above Rs10,000, which is deducted at source. In vyaj koshtak, the fee for renting the card is paid in cash and is thus tax-free.

“The actual returns can be much higher as these investors constantly rotate their money in one IPO after another," says the Ahmedabad branch manager of a leading brokerage firm who also didn’t want his name mentioned.

While the investor will attract short-term capital gains tax, currently at 10%, people familiar with the vyaj koshtak arrangements say investors don’t end up paying the tax as the broker also works out some arrangements, such as showing losses through sale of some shares before the end of the tax year, thus offsetting the capital gains, and depriving the government of legitimate revenues.

Since capital gains tax is clubbed with overall income, it is also possible to avoid paying taxes by having investors whose incomes are below the threshold level that attracts income tax. For the broker, such an arrangement turns out to be a neat deal because typically, he has a large and growing network of such “for hire" investors.

For instance, if a broker has 10 such investors in his network, he dishes out Rs15,000 as a fixed charge to these investors and ends up retaining the combined profit made by these investors, netting him Rs85,000. Of course, if for some reason the shares list at a discount, then he is out of Rs15,000 and also the difference between the IPO price and the listing price.

Some market participants do not rule out the possibility of connivance between merchant bankers, promoters and brokers in such arrangements.

These kinds of arrangements “existed on a massive scale during the earlier IPO boom of 1994-95 wherein the promoters used to connive with brokers and investors to control the kind of investors who invest in their company," says Prithvi Haldea, managing director of Prime Database. “But I don’t think it’s rampant now."

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Published: 28 May 2007, 06:47 AM IST
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