Terror funding through the stock market undermines a basic principle that well-functioning markets guarantee the integrity of price discovery.

The Home Minister’s admission, the other day, at the Interpol’s General Assembly, that terrorist outfits are investing in the Indian stock market is something that had been hinted at — if not explicitly stated in a public forum as now — even in the past. But that doesn’t in any way dilute the seriousness of the situation. Using listed company shares as a conduit for moving cash does undermine a basic principle that well-functioning markets guarantee the integrity of prices discovered in the course of trading among buyers and sellers. The threat to internal security thus becomes two-fold. By threatening to unleash violence, terror undermines the physical well-being of the public. Two, by undermining the capacity of vital economic institutions (stock markets) to function effectively, their economic well-being too is threatened in the process. The Securities and Exchange Board of India should direct the depository participants (DPs) to launch, as a matter of routine, investigations into the demat accounts of clients putting through trades that are unusually high or are inconsistent with their declared financial standing. Similarly, dormant accounts that suddenly spring to life too, ought to be a source of concern. The DPs may even be empowered to freeze further activity in such accounts pending completion of such an investigation. Once the source of funds is proved to be from entities that have, prima facie, links to terrorist organisations, such shares should be sold and money transferred to investor protection funds of exchanges.

Unfortunately, intermediaries have, in the past, been found to be lax in following the procedures laid down under the Prevention of Money Laundering Act, as it affects their business interests. About 110 members of BSE and 68 members of NSE were found non-compliant with the guidelines laid down by SEBI to prevent money laundering and financing terror operations that include collecting the required documents for establishing the identity of the owner of the trading account. Until now, most offenders have been let off with a mild reprimand and a miniscule penalty. Clearly, this is insufficient, given the repercussions of such laxity when it comes to threats against internal security.

The need to step up vigilance in tracking client accounts is equally pressing for foreign institutional investors who invest on behalf of clients based in other countries or issue participatory notes. SEBI has brought out many guidelines for FIIs, including directing FIIs with multi-layered opaque structures to simplify their organisation, directing that P-notes be issued only to regulated entities and improving the reporting requirements for such transactions. While flow of dubious money from overseas has reduced considerably following these checks, SEBI needs to deal with misbehaviour by FIIs equally sternly if the scourge of terror money is to be removed from the bourses.

(This article was published on November 11, 2012)
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