15 Aug 2017 16:22 IST

All you wanted to know about shell companies

There is no clear definition of shell companies in India

Investors were shell shocked last week by SEBI’s sudden directive to stock exchanges to initiate action against 331 suspect shell companies and ban them from trading. Following SEBI’s diktat, BSE and NSE moved 162 and 48 companies, respectively, into Stage-VI of the Graded Surveillance Measure (GSM), implying these stocks would not be available for active trading. With over ₹7,000 crore of public money stuck in them, investors are rankled by the move.

What is it?

Sadly, there is no clear definition of shell companies in India. In the US, however, the Securities Act defines a shell firm as one that has no or nominal operations and assets. The assets must consist mainly of cash and cash equivalents with very little other assets. In other words, a shell company should not have active business operations or assets.

The Centre may be coming down hard on shell companies, but interestingly not all shell companies are illegal. Some were formed to raise funds to promote start-ups. But as they say, even one bad apple can spoil the bunch.

Given the umpteen instances of individuals and corporates abusing shell companies, either to avoid tax or use them as conduit for money laundering, these are generally viewed as dubious and questionable enterprises.

SEBI has asked exchanges to verify credentials / fundamentals of suspect companies by appointing an independent auditor. If exchanges do not find appropriate fundamentals about existence of the company, the stock can be delisted.

Why is it important?

The Centre has been cracking down on shell companies in recent months. The corporate affairs ministry cancelled the registrations of over 1.62 lakh companies for not filing financial statements for the immediate two preceding fiscals. Some of these are shell companies possibly used for money laundering or tax evasion, or other fraudulent activities.

The SEBI’s move to come down hard on suspect shell companies is important to protect investor interest. Companies with financial irregularities, set up by errant promoters for the sole purpose of money laundering, can cause heartburn to investors. In the past, many investors have burnt their fingers with companies that have suddenly vanished without a trace. Many companies that listed during the IPO boom in 1994-95 have vanished since then.

Why should I care?

If you are an honest tax payer, increasing instances of individuals and corporates escaping the tax net by devious means, is bound to exasperate you. The multitude of opportunities for fraud through brass-plate companies is not a good news for the broader economy either.

The need to shield investors from such fraudulent shell companies is also understandable. But since there is no clear cut definition of a shell company put down by law, don’t jump the gun on every news that crops up on such companies.

In the recent incidence too, there is lack of clarity over what prompted SEBI or the corporate affairs ministry to identify 331 companies as suspect shell companies. If you are an investor, stuck with such stocks, don’t panic and resort to fire sales. Your company could well be in the clear and have genuine business operations.

While of the 162 BSE companies, 23 have reported nil net sales for FY17, about a fifth have a notable turnover of around ₹100 crore and above.

The bottomline

Till the shell is cast away, the last word is not out.

(The article first appeared in The Hindu BusinessLine.)

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