Shell companies in a nutshell?

On Independence Day, Prime Minister Narendra Modi mentioned India’s battle against black money and said that more than 1.75 lakh shell companies have been de-registered so far.

Recently, capital markets regulator SEBI (Securities and Exchange Board of India) directed stock exchanges to take action against 331 suspected shell companies that are listed on the bourses. The body restricted trading activities for these companies. Of these, 162 actively traded while 169 were already suspended for various violations of the listing agreements.

Many of these shell companies are being probed for helping wealthy individuals evade taxes through fake long term capital gains. Some of the commodities brokers have been misusing the liberalized remittance scheme under the garb of trading in overseas markets.

According to BSE, trading in all such listed securities shall be placed in Stage VI of the graded surveillance measure (GSM) with immediate effect. If any listed company out of the said list is already identified under any stage of GSM, it shall also be moved to GSM Stage VI directly.

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 ₹7,000crore of public money stuck in them, investors are rankled by the move.

Shell companies

Shell companies are companies without active business operations or significant assets. The assets must consist mainly of cash and cash equivalents with very little other assets. They can be set up by business people for both legitimate and illegitimate purposes.

Illegitimate purposes for registering a shell company include hiding particulars of ownership from the law enforcement, laundering unaccounted money and avoiding tax.

With the shell company as a front, all transactions are shown on paper as legitimate business transactions, thereby turning black money into white. In this process, the business person also avoids paying tax on the laundered money.

However, not all shell companies are illegal. Some were formed to raise funds to promote startups.

Shell companies

1) As per the provisions of the GSM framework, the securities shall not be available for trading. Trading in these securities shall be permitted only once a month (first Monday of the month).

2) Shares held by the promoters and directors in such listed companies shall be allowed to be transferred by depositories only upon verification by the exchange concerned and they shall not be allowed to transact in the security except to buy securities in the said listed company until verification of credentials or fundamentals by the exchanges is completed.

3) Exchanges shall initiate a process of verifying the credentials/fundamentals of such companies. Exchanges shall appoint an independent auditor to conduct audit of such listed companies and, if necessary, even conduct forensic audit of these companies to verify credentials/fundamentals.

4) On verification, if exchanges do not find appropriate credentials/fundamentals about existence of the company, they shall initiate proceedings for compulsory delisting against the company, and the said company will not be permitted to deal in any security on the exchange platform and its holding in any depository account shall be frozen till such delisting process is completed.

5) Out of the list of shell companies, if securities of any of the listed companies are under suspension, the trading in such securities shall be placed under GSM Stage VI directly on revocation of suspension by exchange

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.

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.