Sebi diktat on 331 'shell' companies: A good move but hurried crackdown will scare innocent investors

The Narendra Modi government has clamped down on 331 companies by directing capital market regulator Securities and exchange board of India (Sebi) to immediately restrict share-trading in these firms. These firms will likely face investigations into alleged tax evasion and other financial irregularities by various government agencies, mainly by income tax authorities.

All of these companies aren’t unknown entities. The list has names like Parsvnath Developers, SQS India, J Kumar Infra and Prakash Industries that have a fairly decent track record on corporate governance. Hence, the Sebi-directive has come as a shocker to these firms and the investors of these companies.



The credibility of these organisations is now facing a big question mark, so is the fate of investments both institutions and individuals have made in them. Some of these firms may move to the regulator to explain their side and may eventually get cleared off the list. But, the short-term damage is inevitable. There are both positives and negatives for the government-Sebi action.
The positives first: It will send a strong signal to the promoters of fraudulent companies that exist only on the paper and who use these entities for tax evasion and other illegal activities.

One should see this in the context of Prime Minister Narendra Modi’s battle call against the tax evaders after the demonetisation of Rs 500 and Rs 1,000 notes in November last year. Just last month, Modi said the government has traced some 37,000 shell companies indulging in tax evasion had been detected and more than 3 lakh firms were under the scanner for suspicious dealings, post the note ban exercise. The government-Sebi action should be seen in that context.

Indeed, this will help to clean up the system and dig out the dirt out. Although investors will face a temporary setback, the government-regulatory action will prevent major losses for them in the future when the illegal activities get exposed. Thus, in the larger context, this is a much needed follow-up action to the note ban since the battle against black money will not be complete without crackdown on benamis. The government has just done that.

Now the negatives: A blanket clampdown on a large number of companies, including some of the reputed ones, without giving them a chance to explain their side, will backfire badly as it will scare the investor community, particularly retail investors. The knee-jerk reaction was visible when the benchmark Sensex slumped 260 points while the Nifty cracked below the crucial 10,000-mark on Tuesday. On Wednesday too, the Sensex continued its slide, but much of it is also due to global cues.

Also, it is not clear what methodology government and Sebi have chosen to prepare the list of ‘shell’ companies. A shell company is typically defined as a company that does no business but exist only on paper as vehicles to carry out illegal activities. Do the bigger, reputed names in the list fall in this category?

There is a possibility that their inclusion in the list is due to absence of furnishing some data or simply some errors, as JN Gupta, former executive director of Sebi says in this interview to ETNow. If that is the case, the question is which authority will compensate the companies for the loss of reputation and investors, their losses. As far as the available details are concerned, there were no warning signals to investors or to the companies — the reason why some of the firms have expressed shock.

The bottomline is this: The crackdown on shell companies is good and goes well with the Modi government’s agenda to take on the parallel economy in the country. But, as a matter of fairness, companies should have been given a chance to explain their side before trading is halted on their shares and retail investors should have been given warnings to make up their mind. Such actions will adversely impact the investor confidence at a time India badly needs it.

Updated Date: Aug 09, 2017 11:57 AM

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