On Tuesday, the Securities and Exchange Board of India issued a circular to local stock exchanges to take action against 331 listed companies suspected of being shell companies. Based apparently on a list passed on by the Ministry of Corporate Affairs, the move has rattled the markets. The Sebi circular to stock exchanges says that these companies — 162 of those whose stocks are actively traded — will not be allowed to trade this month in line with the Graded Surveillance Measure introduced by the capital markets regulator earlier this year. The regulator has also told the stock exchanges to carry out a forensic audit to examine the financials of these firms besides an independent audit — indicating that further action such as delisting could follow if there is evidence of wrongdoing.
The latest crackdown on suspected or real shell companies should not come as a surprise given the government’s drive against tax evasion. Last month, Prime Minister Narendra Modi had said that the government had cancelled the registration of over one lakh companies in one fell swoop and that more than 37,000 shell companies had been identified for further action. What is surprising, however, about Tuesday’s action is that neither have the companies, nor investors and other stakeholders been told on what count they have been punished or the laws they have violated. Presumably that will follow. But the question is whether the move of a quasi-judicial authority like Sebi should have been guided more by the principles of natural justice and whether the reasoning is sound given the consequences of this action and the fact that existing laws such as the Companies Act or the Sebi Act do not define a shell company. A public listing facilitates the processing of information by investors who then make investment choices based on that. That’s why it is important for the regulator to demonstrate to the market through its reasoning while launching action against suspected shell companies that curtailing or stopping trading in stocks of such firms and denying trading rights was in the interest of investors.
Failure to do that is bound to lead to a prolonged round of litigation and the risk of a credibility knock of the securities market regulator, negating the gains over the last few years. It may well be worth reminding the regulator and policymakers that at the height of the Satyam accounting fudge, despite calls from many quarters, Sebi never halted trading in that stock. Investors weren’t the losers then, as subsequent events show.