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Investors ‘shell’ shocked over SEBI order

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Diktat puts at risk shareholder wealth of ₹13,000 crore though consultants say action was needed to protect larger interests

A recent order from markets regulator SEBI brought to a halt trading in more than 170 actively traded stocks on the stock exchanges. These firms formed part of a larger group of 331 ‘shell’ companies whose names the Minsitry of Corporate Affairs (MCA) shared with the regulator for initiating action.

The order issued by the Securities and Exchange Board of India (SEBI) last week put at risk investor wealth amounting to almost ₹13,000 crore.

A look at the financials of the companies show that most of them reported at least some income in the last financial year with a few even reporting a positive bottom line.

There are seven companies that reported a net profit of more than ₹20 crore in the financial year ended March 31, 2017. One of them — J Kumar Infraprojects – registered a profit of ₹105.51 crore in FY17.

Further, there are 25 entities that reported a total income of more than ₹100 crore in FY17 with Prakash Industries, Kkalpana Industries, J Kumar Infraprojects and Pincon Spirit reporting incomes of between ₹1,400 crore and ₹2,500 crore.

From purely a stock price perspective, there are at least 20 companies with a market capitalisation of more than ₹100 crore each with the biggest three — J Kumar Infraprojects, Prakash Industries and Parsvnath Developers — having a market capitalisation of more than ₹1,000 crore each.

Interestingly, eight entities, including the biggest three ‘shell companies,’ have already managed to obtain a stay on the trading restrictions by way of interim relief from the Securities Appellate Tribunal (SAT), that observed in clear terms that the capital market watchdog passed the diktat without an iota of investigation.

“… it is apparent that SEBI passed the impugned order without any investigation… we are prima facie of the opinion, that the impugned communication issued by SEBI on the basis that the appellants are ‘suspected shell companies’ deserves to be stayed,” said SAT.

However, though many companies may not appear as shell firms purely based on numbers, the list prepared by MCA was based on inputs received from various agencies, including the Income

Tax department and the Serious Fraud Investigation Office (SFIO), the details of which are not in the public domain.

“I do not think that SEBI operation on shell companies is over with the SAT order,” said Sumit Agrawal, partner, Suvan Law Advisors and a former SEBI law officer.

“There may be thorough examination through brokers, investor associations and registrar and transfer agents (RTAs).

The challenge would be to delist those really non-operational companies or to penalise the brains behind them. My hope is that it does not affect overall sentiment for investment,” added Mr. Agrawal.

Verification of entities

Incidentally, stock exchanges have already asked their member brokers to verify if any of the unlisted entities, that were part of the MCA list, were registered as their clients.

The brokers will have to verify the credentials of such entities and submit a report to the exchanges by August 31.

A lot of companies, directors and promoters are going to go to SAT as this order will create an ineligibility for many other things such as directorships in other companies and fund raising, said Mr. Agrawal.

While the capital market regulator has begun hearing the companies on an individual basis, the proceedings and an order — even in the form of an interim relief — might take time due to the sheer number of companies and the lengthy verification process.

‘Larger interest at stake’

J.N. Gupta, managing director, Stakeholders Empowerment Services, a proxy advisory firm, said he felt that while one may debate as to whether SEBI could have managed the whole issue better, the larger interest of shareholders was at stake and an immediate action was required.

“This is a preventive order by SEBI and companies can approach the regulator with proper credentials,” he said adding that the MCA list was not only about shell companies but also those that might have a link with a shell entity.”

‘Not genuine’

The order assumes significance as the government, in April, had said that during the last three financial years, ie, from 2013-14 to 2015-16, investigations by the Income Tax department led to the detection of more than 1,155 shell companies used as conduits by more than 22,000 beneficiaries.

The amount involved in non-genuine transactions by such beneficiaries was more than ₹13,300 crore, it had said.

According to Mr. Gupta, companies that have got interim relief at SAT should be told to submit an affidavit stating that they do not have any connection with a shell company and that they have not violated any rules related to disclosures in their balance sheet.

Meanwhile, there was a clear impact of the regulatory action on the stock market. While there was an overall negative trend due to disappointing quarterly numbers and global geopolitical concerns, the mid- cap and small-cap universe bore the maximum brunt.

Indices decline

On Tuesday — a day after the diktat — the BSE MidCap and BSE SmallCap indices lost more than 1% each even as the benchmark Sensex declined only 0.8%. Well-known stocks that made to the MCA list were locked at the lower circuit level as investors frantically tried to offload their positions as trading restrictions were being imposed.

The restrictions include allowing the shares to be the traded only once a month and not allowing any upward price movement beyond the last traded price. Further, an additional margin of 200% of the trade value is to be collected from the buyers.

SEBI has also advised the exchanges to appoint an independent auditor to audit such listed firms and if necessary, even conduct a forensic audit to verify the business credentials of such firms. If the exchanges are not able to to find appropriate credentials, they can initiate delisting proceedings against the company, as per the order.