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Probe thoroughly before calling a firm ‘shell’, Tribunal tells SEBI

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Courts and tribunals are coming down heavily on SEBI for branding companies as ‘shell’ without any investigation and putting trading curbs. Latest is the Securities and Appellate Tribunal (SAT), which set aside SEBI and BSE’s directions against SVC Industries, which was branded as ‘shell’ merely based on the fact that the company had not done any production since 2000.

On June 9, 2017, SEBI had recommended the exchanges to suspend trading in over 300 suspected ‘shell’ companies.

“No investigation has been done to find out as to whether the appellant company (SVC Industries) is a shell company or not. Contention that SEBI and BSE were not required to investigate as to whether the company is a shell company or not is totally erroneous,” SAT said.

Earlier, Gauhati High Court had set aside the SEBI order against Assam Company on related grounds.

A list of suspected firms was shared by the Serious Fraud Investigation Office (SFIO) with SEBI but the regulator did not conduct its own investigation.

Intent good, but…

“The SAT order essentially holds that before branding a company as a shell company, a thorough examination by SEBI and BSE is required, rather than first branding a company as ‘shell’ and collecting evidences subsequently to prove such a decision. While the intent of SEBI is to contain risk in the listed space, the process adopted was found to be questionable,” said Sumit Agrawal, Founder RegStreet Law Advisors and ex-SEBI official.

In the SVC Industries issue, the tribunal observed that it took SEBI two months to issue directions to exchanges to take actions. Such direction to place 331 shell companies under GSM Stage VI (draconian trading segment) without verifying their credentials/ fundamentals was wholly illegal and in violation of the principles of natural justice, SAT observed.

“If there was urgency, SEBI should have reacted immediately when it received the request from MCA dated June 9, 2017. It took SEBI two months to issue a direction. Thus, there was no urgency.

“Consequently, placing the appellant in GSM Stage VI without giving them a notice or an opportunity of hearing was in violation of principles of natural justice.”

SAT further observed that the BSE could not pick holes in the balance sheet of the company nor are they competent to hold whether any expenditure should be a revenue expenditure or a capital expenditure. “If the BSE does not agree with the balance sheet, it was open to the respondent to appoint an independent auditor or even go in for a forensic audit which they have not done,” SAT said.