Last week, investors were shocked when SEBI directed stock exchanges to take action against 331 suspected shell companies and ordered that the affected companies be banned from trading. Following this directive, BSE and NSE moved 162 and 48 companies respectively into stage VI of the Graded Surveillance Measure (GSM). It means that these companies stocks would not be available for trading.
According to a notification from SEBI, the decision was based on a letter from the Ministry of Corporate Affairs (MCA). “These companies were identified by a panel formed by the government of India post-demonetization. The 331 companies saw high investments through layering and fund flows from non-listed shell companies,” reported Mint, citing an unnamed official of the ministry.
The move has riled investors that stuck over 7,000 crores of public funds. But what exactly are shell companies?
Unfortunately, there are no precise definitions for Shell Companies in Indian law books. However, in the US, the Securities Act defines a shell firm as one that has no or nominal operations and assets.
These assets usually consist of cash and cash equivalents with little or no other assets. What it means is that a shell company has no real business operations or property. Most of these shell companies are usually registered in places that are regarded as tax havens with no or little tax.
While the regulatory agencies that are responsible for company formation in India, as well as capital market control, may have hit shell companies real hard, it is worth noting that not all shell companies are illegal. Some shell companies were formed to raise capital to promote start-up businesses.
But even at that, the proliferation of shell firms that usually serve as a significant conduit for money laundering or to avoid taxes have made people to view them as dubious and phoney enterprises. If the auditors so appointed do not find sufficient fundamentals regarding the existence of such companies, the stock of these firms would be delisted.
According to the Chief Operating Officer for Institutional Investor Advisory Services, Hetal Dalal, establishing a shell company cannot imply doing something fraudulent. She urged the regulators of the capital market to apply a more rigorous approach in sifting those shell companies that are genuine from the phony, fraudulent ones.
The challenge, according to capital market experts, lies in data collection on transactions and to discern legitimate business transactions from the nefarious operations. Government agencies responsible for company formation in India must be alive to their duties to protect investors from fraudulent shell companies.
Why is This Necessary?
For several months now, the Centre has launched a massive crackdown on alleged shell companies. The Ministry of Corporate Affairs (MCA) has cancelled about 1.62 lakh companies who had failed to file financial statements for the immediate past two fiscal years. Some of these are shell companies that were established to serve as conduits for money laundering, for tax evasion purposes or several other fraudulent activities.
This move by SEBI to come hard down on these shell companies is significant as it would help to protect the interest of the investors. Shell companies engaging in financial irregularities that are established by people for the sole purpose of money laundering, tax evasion or other nefarious activities can cause innocent and ignorant investors to lose their hard earned money entrusted to their care.
In the past, several investors had invested their money in these fraudulent companies only for the companies to disappear with the money into thin air. Several businesses that were listed in the IPO boom of 1994-1995 have long gone since then.
Why Should I Be Interested?
If you are a hardworking and honest tax payer, incidences of people and corporate organisations evading taxes are sure to rile you up. Also, the tremendous propensity for fraud via these fake companies would massively hurt the economy on a broader scale.
There is also need to protect investors from putting their hard earned money from such fraudulent shell companies. In the recent incidence, the reasons behind SEBI and Ministry of Corporate Affairs clamp down on these 331 alleged shell companies are not stated. And under such circumstances, panic sets in.
If you are an investor in one of the companies that had been listed as an alleged shell company, do not panic. Do not resort to firing sales. The company you invested in may eventually be cleared, and your investments may be safe at the end.
Out of the 162 companies, BSE listed, 23 of them had reported zero net sales for the 2017 financial year. About a fifth of them has a minimum turnover of about 100 crores.
So the final word for investors in these alleged shell companies is to keep o their fingers crossed and not panic. The report of the independent auditors is still awaited. Hopefully, not all may end up as fraudulent companies. The MCA handles all issues related to company formation in India.