SP Tulsian's take on shell companies' list: 'No smoke without fire'

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SP Tulsian

This was “shelling” of a new kind, leaving all on Dalal Street “shell shocked!”

Securities and Exchange Board of India (SEBI) left everyone bewildered when on August 7, 2017, doing its duty as watchdog, it acted on the letter issued on June 9, 2017 by the Ministry of Corporate Affairs (MCA). MCA spelled out a list of 331 companies, in a letter sent to SEBI, which in turn directed the stock exchanges to move these to  Stage VI of Graded Surveillance Measures. These companies were identified as “shell companies” and trading got suspended. Of these 331, 107 were unlisted and only 48 were listed on the NSE, and even out of the 48 listed ones, 10 had already been suspended much earlier on the orders of the NSE.

The Companies Act, 2013 has not provided a definition for a “Shell company”.

Webster's New World College Dictionary has defined a shell company as, “A company existing as a legal entity but having no assets, independent business operations, etc., often owned or controlled by another company and used for various, often illegal, purposes.”

These 331 companies were identified by MCA on the basis of common directors, common addresses and more importantly, saw huge cash deposits during demonetisation and even had links with some politicians. It may be noted that SFIO, I.Tax, ED, FEMA, MCA and PMLA have found in their independent and concerted investigations that thousands of multi-layered companies are formed, largely for round tripping of money, for conversion of black money and hawala operations, making it very difficult to track the trail of funds. A majority of these multi-layered companies are seen having its origin in Kolkata where newly-incorporated companies were seen issuing shares of FV (face value) of Rs 10 at a hefty premium of Rs 490 with such companies having got income tax assessment done for the first year, and with no records seen available thereafter with any of the authorities. Beneficiaries of such issue were then seen using this money, which was converted to Black money, being used perpetually. FM Arun Jaitley in Parliament on Friday has also said that the government will nab the beneficiaries of this fund, who have used and enjoyed these shell companies, at the last point of this round tripping and fund trail; these might have been received by some of these so called shell companies at some point of this round tripping.

In common commercial parlance, accepting “Cash Credit” or “Entry” is seen rampant, where loan is given by one company to another, on receiving cash from the receiving company or its beneficiary, while in reality, it is an accommodation or a sham transaction, as no actual flow of amount, fund or loan has happened, but only name is lent by the lender for the loan amount. It is also quite a common thing to see that few companies, to shore up their financials, show fictitious sales or commissions in their name. By doing this, such companies by showing higher income, either avail working capital from the banks or adjust income against their brought forward losses, which are about to get lapsed, or to meet eligibility criterion of threshold to participate in large government contracts or to jack up its share price on bourses by showing higher profits. A few of these shell companies that have been banned do have a genuine business, have their own large manufacturing facility, paying a huge amount as Excise, VAT and Income Tax, etc. like Prakash Industries, J Kumar Infra, Parsvnath Developers, Gallantt Metal, Lotus Eye Hospital, Adhunik Industries. Despite the fundamentals of these companies, there is no doubt that there cannot be smoke without fire. It is quite a certainty that many of these might have availed some cash credit or got some fictitious income in lieu of cash, having been given by them at some point of time, to some other shell companies.

Capital market, taxation and legal experts are now arguing, whether SEBI’s move was harsh or whether it went against natural justice?  It may seem so, but it is still certain that all 331 companies will not come forward to prove their bona fides, while many may get caught on irregular and illegal financial transactions, which might be covered under Benami, Prevention of Money Laundering, Hawala, Income Tax evasion or defrauding banks as well.

BSE is seen having 3,909 companies available for Trade in Equity, while 2,667 companies are seen traded now, excluding these 331 (224 on BSE) shell companies. It is most likely that hundreds of companies may also get covered in a subsequent list to be released by MCA  and enforced by SEBI thereafter. Stock exchanges have already started investigations into the affairs and financials of these shell companies, which NSE might finish at the earliest since it needs to look into only 38 companies, while it might take much longer for BSE to do so. MCA may wait to see the findings and investigation outcome of the exchanges, before taking a call on the subsequent list of such shell companies.

The trading ban on shell companies has triggered off margin calls at brokers' end, as stocks of many of these companies were given as margin to the broker, by their clients, being shareholders in these shell companies. Prominent amongst them are Prakash Industries, J Kumar Infra, Pincon Spirit, Parsvnath Developers and SQS India; the amount estimated for margin funding having been provided for, is estimated at over Rs 800 crore. This has led to the liquidation of open trading positions of their clients by the brokers in the last week, which, now seems to have been resolved either on account of receiving matching alternative security or margin exposure getting reduced with the liquidation of open positions.

However, SAT has lifted the trading ban on Prakash Industries, J Kumar Infra, Parsvnath Developers, Signet Industries, Pincon Spirit, Kavit Industries, SQS India and Kkalpana Industries. SAT has also stated that this order shall not come in the way of SEBI as well as the stock exchanges to investigate the case of these companies and initiate proceedings it deemed fit.

So, is this just an interim relief, in common parlance, or actually it is seen just an interim relief only, in legal parlance?

MCA in the recent past had also de-registered 1,62,618 companies till 12-7-17 under section 248 of Companies Act,2013. These were seen as dormant, not complied with the filing of Balance Sheet and Annual Returns with MCA; there was also fear of same being used as sham companies in future for illegal activities. MCA as at 31-5-17 had 16,59,965 companies seen as registered and with de-registration of these 1.62 lakh companies, compliance ratio has improved, giving a better rating in the eyes of the global investors as well. It may be noted that notices are issued to about 4 lakh companies for de-registration and hence, second round may also see de-registration of close to 1 lakh more companies.

This move of shell companies trading ban may optically be viewed as quite harsh for the retail investors, but if few companies having genuine commercial existence, do get off the trading ban and instead get penalised under Income Tax Act for accepting fictitious loans or taking other benefits under law, it will actually go a long way in capital market and our economy, seen and making it quite healthy, giving it more depth, while sending a very stern message to the tax evaders.

If we want CORRUPTION FREE INDIA, this is a baby step in that direction.

Mera BHARAT Mahan. Happy Independence Day.

(The author is CEO & Editor www.sptulsian.com)