What is Tunneling?

Tunneling is the unethical and illegal practice where a majority shareholder directs assets or
future business to themselves for personal gain

 A controlling shareholder can simply transfer resources from the firm for his/her
own benefit through self-dealing transaction
 The controlling shareholder can increase his/her share of the firm without
transferring any assets through dilutive share issues, minority freeze outs, insider
trading etc.
Tunneling process involves following steps:

 Identify and incentivise a trusted company 'insider', usually in the finance dept, that
will be willing to trample over company compliance and authorisations—and enter
secretly into a loan/loans—with a person 'outside' of the company. 'Granting' a
partial or a full 'security' over some of, or over the assets, or over the entire business
and all of its assets.
 Rapidly run down the cash in the company, usually by buying and holding in
inventory equipment and stock—that is unnecessary at that time.
 At short (sometimes only 24–48 hours) notice, announce that the company is
'insolvent'—and have the company immediately forced into a bankruptcy process.
 The 'only'/'main creditor' is of course the local 'outsider'—and so it is THEY that
dominates a rapidly assembled 'creditors committee'—which similarly rapidly agrees
to sell some or all of the company assets.... to a holding company that THEY already
control.
 Knowing that the original owners are eventually likely to seek justice and also the re-
establishment of ownership of their assets, the 'tunnelers' next typically pay a local
Police Dept officer, to file (knowingly false) 'charges'—against the original owner of
the company—usually by claiming that a 'loan' or 'loans' (which the original owners
were entirely unaware of!) were 'taken, with no intention of repaying them'.
 The 'tunnelers' typically pay a local Local/Regional Court official
What is Money Laundering?

 Money laundering is concealing or disguising the identity of illegally obtained

proceeds so that they appear to have originated from legitimate sources. It is
frequently a component of other, much more serious, crimes such as drug
trafficking, robbery or extortion.
 According to the IMF, global Money Laundering is estimated between 2 to 5% of
World GDP.

How Money Laundering works?

 It involves three steps: placement, layering and integration.
 Placement puts the "dirty money" into the legitimate financial system.
  Layering conceals the source of the money through a series of transactions and
bookkeeping tricks.
 In the case of integration, the now-laundered money is withdrawn from the
legitimate account to be used for criminal activities.
Money Laundering can take several forms, some of them are:

 Structuring also called as Smurfing

 Bulk Cash Smuggling
 Cash intensive Businesses
 Trade based Laundering
 Shell companies
 Round tripping

Economic Impacts:

 Undermines legitimacy of private sector

 Undermines integrity of financial markets
 Loss of control of economic policy
 Economic distortion and instability
 Loss of revenue
 Declines the moral and social position of the society by exposing it to activities such
as drug trafficking, smuggling, corruption and other criminal activities
Political Impacts:
1. Initiates political distrust and instability
2. Criminalisation of politics
Steps Taken by Government of India to Prevent Money Laundering
1. Criminal Law Amendment Ordinance (XXXVIII of 1944): It covers proceeds of only
certain crimes such corruption, breach of trust and cheating and not all the crimes
under the Indian Penal Code.
2. The Smugglers and Foreign Exchange Manipulators (Forfeiture of Property) Act,
1976: It covers penalty of illegally acquired properties of smugglers and foreign
exchange manipulators and for matters connected therewith and incidental thereto.
3. Narcotic Drugs and Psychotropic Substances Act, 1985: It provides for the penalty of
property derived from, or used in illegal traffic in narcotic drugs.
4. Prevention of Money-Laundering Act, 2002 (PMLA)
It forms the core of the legal framework put in place by India to combat Money Laundering.
The provisions of this act are applicable to all financial institutions, banks(Including RBI),
mutual funds, insurance companies, and their financial intermediaries.
 How to Deal with Tunneling

 Better board procedures and a better compensation policy

 Insider trading legislation should be strengthened.
 Introduce new auditing procedures.
 Don't invest all of your money into a corporation's shares if you work for one.
Satyam employees earned a significant amount of their pay in the form of stock
options. Some folks even used their retirement assets to increase their stock
portfolio.
 Establish a code of ethics for all publicly traded corporations.
 External Auditor Rotation in Non-Financial Institutions
 If you hold shares in the company, pay attention to the behaviour of the founders
and directors. If they don't own a large portion of the firm or are actively selling it.
 Establish that the audit committee is totally self-contained.
 Set up a method for reporting wrongdoings.
 Describe what a class action lawsuit is and how it works to employees
 Appointment of Independent directors
 Prevent the collusion between the rating agencies and companies