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Money Laundering and Software Companies in India

When income-tax authorities busted a Delhi-based software company that was doing business with a blue chip IT company, they found to their horror that there were no computers in the office premises. The ones that were there were still packed. The son of the software company owner told one investigator, “My father does not even know what a mouse of a computer is, let alone the meaning of software.” Shell-shocked investigators realised that this Delhi-based company had already transacted business worth Rs 500 crore with the blue chip company. It was only later that they discovered no business had been transacted; only money had been rolled over to improve valuation. When the income tax officials took up the matter with finance ministry officials, they were told to keep quiet as it could hurt India’s image as an IT destination.

This is a representative story of many such shell software companies which have minted money in the share markets. Even today after the big burst of the Dotcom bubble almost "EVERY" investor dreams of owning stocks of technology companies looking at  their high growth potential and fantastic returns they provide. Since, many of the infotech stocks are out of reach of the small investor considering their phenomenal prices; they rush for the smaller and the relatively cheap infotech stocks. But every company is not TCS or Infosys.Some of them are the shell companies which have the only business of laundering the money.
Many techies have started investing in the shares and they look for the attractive growth prospects. How do such companies operate and show decent earnings is the main question? There seems to be a kind of nexus between the export earnings of some  technology companies and money laundering transactions.

Many of these so-called software companies were known to be using the Hawala route in order to show income from software exports. Getting the knowledge about these transactions was not a big deal. It is provided to these companies by the CA's,Lawyers and other professionals who knows the transactional loopholes.

 A Hawala transaction simply means that you pay rupees over here in India and in return get dollars abroad. For instance, if you want to do a Hawala transaction from Mumbai to USA, then by paying Rs 1 lac in Mumbai, you can transfer $2500 in USA. 

How it happens ?
Let us take a simple example to prove our case. Assume there is an existing BSE-listed company, which is closed and is not trading at all. Today, there are over 7000 companies listed on the BSE, of which more than 4500 companies are in the B2 category and are hardly traded. Many of these companies may have even closed down and are mostly based in places like Ahmedabad, Chennai and Hyderabad. It can happen that two or three people get together and take over such a company changing its name to an infotech company. Its even possible that the existing promoters of the company simply change the name of their company to a software company. By installing a few computers, modems, data transmission lines and other equipment, a software company is born.

Some computer literate staff is also hired to show some kind of activity present in the office. Such companies do not even be having the requisite infrastructure or the requisite personnel required running a software company forget aside the any export orders. The next step is to set up a subsidiary abroad by renting a place or just even employing a person to conduct the operations. Most of the exports are done to duty free ports such as Hong Kong, Singapore or Dubai where the money can be remitted back. After that, the promoters conduct Hawala transactions by paying cash over here and getting dollars from abroad through the subsidiary. The same dollars transferred from abroad are shown as software exports in the company's books. In this way the company is able to report decent sales figures in its balance sheet by the way of export income.

The next step is to catch a flamboyant market operator through whom rumours about the company can be floated in the market. The share broker or the operator then spreads stories such as the company has got big software development orders or tie-ups and is going to report excellent profits. Naturally, the bogus export income drives up the net profit reflecting a healthy Earnings Per Share for the company. Since, the P/E of the company appears to be quite low in comparison with the industry standards; the stock appears to be an excellent buy.

The market operators start providing liquidity in the counter and consequently the volumes in the counter start rising. Many of the deals take place between two or three operators itself who start creating a demand for the stock. The stock price of the company is jacked up touching three to five upper circuits in succession. The promoters taking advantage of this situation start dumping their own stock to the small investors who in turn enter to buy. In the end we have the small investors who are left holding the stock which they have purchased at the high prices.

Thus the promoters are able to benefit in two ways. Firstly they are able to get a good price for the dead stocks of their company, which were not being traded at all and secondly are able to convert their cash into official export income at a low premium without paying any income tax. 

However, the question which authority is responsible to check whether the companies are actually engaged in and whether their exports are genuine or not? If no one is then some body or authority has to be appointed who can monitor the activities of these companies. This is necessary so that the investors can be more enlightened about such companies before putting their hard-earned money into them.
This is the magic of technology !

Mayur S.Joshi*

Author is promoter of Indiaforensic Research Foundation and also the winner of the prestigious global ACFE award. Author can be reached at mayur@indiaforensic.com