SEBI and Shell Companies in India

The Securities and Exchange Board of India has issued an ‘extraordinary’ direction on 7th august evening to stock exchanges to effectively freeze trading in 331 suspected “shell” companies. What this means is that the securities in this group will be allowed to trade only on first Monday of every month on a trade-to-trade basis and with 200% margin from buyer, which will be retained with the exchange for a period of five months. Moreover, the upside move has been capped to previously traded price. The promoters and directors of these companies shall not be allowed to transact in these securities, except buy them, unless credentials/fundamentals of the company are verified by the exchange. For the verification, an independent auditor will be appointed to audit and, if necessary, a forensic audit too might be done. After verification, if the exchange does not find appropriate credential/fundamentals of these companies, they will be delisted.

The markets regulator issued a second communique to the exchanges, asking them to look at the tax returns and financials of the companies for the past three years. Exchanges were directed to seek documents from the companies and hear them out.

“If the verification does not throw up red flags, exchanges will report the same to SEBI. If the financials throw up concerns, then the companies will undergo an audit and other steps mentioned in 7 August circular,” said a source in SEBI to press.

SEBI second circular came, after some of the 331 companies—162 of which were actively traded and 169 had already been suspended—protested against the regulator’s move, pointing to their operating and dividend-paying track record.

The National Stock Exchange said it has started collecting information about the 48 firms that are listed on its platform, out of the 331 suspected shell companies referred by markets regulator Sebi. The leading bourse would report to the SEBI about the 48 companies after collecting the information. Out of the 48 firms, ten entities had already been suspended before the SEBI’s directive.

Also some market participants expressed concern about outsourcing of “forensic audit” by exchanges. As expected some of the companies have approached Securities Appellate tribunal [SAT]. It had provided relief to some eight companies. The ground was that SEBI passed its impugned order without investigation. Shares of both J Kumar and Prakash—part of the banned companies but later given relief by SAT– hit the 20 per cent lower circuit in the week ending Friday’s trade. Interestingly some of these shell companies have Goldman Sachs, BNP Paribas, Black Rock Global Funds, Fidelity securities etc. as shareholders

This move has generated lot of criticisms from market participants. Under Indian laws shell companies are not well defined. This move by SEBI is not against the so called thick shell outside– core empty type of companies– London and New York are familiar.

In the western markets a shell company is one that is listed on an exchange but doesn’t really have any activities other than that listing. No, substantial at least, business exists inside the corporate wrapping of listing. It is possible for a company which wishes to become a listed company to reverse into that shell. It’s a well-known, well understood and rather regulated process.

But the action in India it seems is to curb tax evasion and money laundering.

Prime Minister in his Independence Day address on 15th August mentioned the following.

“Data mining has showed that 3 lakh companies were shell companies and during the last one year, the government’s anti-corruption steps led to the closure of 1.75 lakh shell companies, which were run by black money operators There have been instances where 400 shell companies where running from a single location. Eighteen lakh people have been identified where their assets are more than their known source of income. Of this 4.50 lakh people have accepted their fault. Interestingly, 1 lakh had never heard about income tax”.

Demonetization of Rs500 and Rs1000 notes were done in November 2016 and this step against Shell companies seems to be continuation of that effort. He also mentioned that Rs3 trillion has come back to the banks after demonetization. More than Rs1.75 trillion under scrutiny;  and estimated Rs2 trillion in black money has reached banks.

At the time of writing—RBI has not released the exact information on the returned notes post-demonetization—One can use PM’s suggested estimates.

Reports suggest that Investigation agencies have specially identified more than 13000 shell companies post demonetization. The Income Tax Department, Enforcement Directorate, the Central Bureau of Investigation and the Serious Fraud of Investigation Office had sent their individual lists to the Financial Intelligence Unit (FIU) which had compiled them. It seems that this list was made before SEBI’s ban halting trading in 331 ‘shell companies’.

As many as 145 out of Sebi’s list of 331 shell companies are registered in Kolkata, a city which has historically been the ‘Mecca of parallel banking’. Hence this is not the shell companies known in the west.

This list of companies was apparently forwarded to SEBI by the Ministry of Corporate Affairs (MCA) almost 2 months back, which, in turn, drew the list based on inputs from the income-tax department, the Serious Fraud Investigation Office (SFIO) and other agencies

One thing is clear. Current Government seems to be serious in dealing with tax evasion and money laundering using “dummy” companies and plans to clean up the market.

Hence Demonetization followed by Benami Holding Act followed by attack on “shell” Companies. All directed in tackling tax evasion and black money. One can expect strong action on the illicit money kept abroad as next step.

This seems to be a long drawn battle



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