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SEBI cracksdown on Shell Firms
Aug 31, 2017

[GS Paper III: (indian economy and issues relating to planning, mobilisation of resources, growth, development and employment)]

The Securities and Exchange Board of India (SEBI) has directed stock exchanges to initiate action against 331 listed firms that the Ministry of Corporate Affairs suspects are shell companies. The Securities Appellate Tribunal (SAT), the statutory body to which appeals against SEBI’s orders lie, has stayed trading restrictions on eight of these companies after they approached the tribunal to seek reprieve terming the order as arbitrary.  

What was the SEBI order?

  • SEBI had directed that shares of 331 companies will be kept in Stage VI of the Graded Surveillance Measures (GSM) with immediate effect. 
  • GSM, which came into effect in March 2017, is a framework of enhanced surveillance of companies to enhance market integrity and safeguard the interests of investors. 
  • Securities which witness an abnormal price rise not commensurate with financial health and fundamentals like Earnings, Book value, Fixed assets, Net worth, P/E [Price/Earnings ratio] multiple, etc. are put under GSM. 
  • Under the GSM framework, monitoring is carried out in six stages, with progressively tighter actions. Stage VI is the highest stage of surveillance.

How does the SEBI order impact these companies?

  • After this order, the shares of these companies have stopped trading on the bourses, and will be allowed to be traded only once (the first Monday) every month. 
  • The companies will be subject to independent audit, and to a forensic audit of their financials. 
  • After the completion of the audits, if the exchanges find evidence that these companies did not exist, they will be delisted. 

What is a shell company? 

  • An incorporated company with no significant operations, established for the sole purpose of holding or transferring funds, often for money laundering purposes. Shell companies have only a name, address, and bank accounts and are made to look like real businesses by maintaining fake financial records.
  • A shell company is per se not illegal — as long as it is not used for an illegal act, such as manipulation of share prices, evading taxes, or financial fraud.
  • The term “shell company” is not defined under the Companies Act, 2013. 

Why did SEBI move against these companies?

  • These 331 companies are allegedly being investigated for tax evasion and corporate fraud. 
  • As part of its efforts to stamp out black money, the Ministry has already cancelled the registration of more than 1.62 lakh companies that have not carried out business activities for long. 
  • In July 2015, the Special Investigation Team (SIT) on black money had recommended proactive mining of the Registrar of Companies (RoC) database to weed out shell companies. The SIT found that these shell companies were being used to launder black money. 

What is the significance of the SEBI directive?

  • This is probably the first time that SEBI has issued a circular naming so many companies as suspected shell companies. The regulator has in the past asked the stock exchanges to suspend trading in companies and initiate penal action for violations of its norms.
  • This move by SEBI will help to protect the interests of small investors. 
  • SEBI’s preventive measure may have a temporary negative impact on the stock markets but will help weed out companies which do not have genuine business operations.
  • SEBI’s circular is in the direction of expanding the role of stock exchanges which are the frontline regulators that ensure compliance and keep a watch over economic offences and money laundering. 

Way Forward

  • The government’s resolve to act against dodgy companies by bringing business practices under the purview of the law is indeed warranted. 
  • At the same time, a sound business environment also requires that the government adhere to the basic rules of justice at all times. Handing out extremely harsh punishment on suspect companies without giving them an adequate chance to explain their positions goes against the principles of natural justice. 
  • To restore confidence of investors and the companies, SEBI and the government must act transparently and also explain the rationale behind their actions.


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