Government agencies and Sebi have acted in tandem to arrest the malice that has been bogging the markets

For years now circular trading through shell companies has been the norm rather than the exception in Indian stock markets. In rising markets, cats and dogs, as they are known, rose alarmingly as the rising tide lifted all boats. Oblivious to the regulator, punters made their money. But hapless investors following hot tips in small caps often found themselves trapped when the bubble burst. Ever since new Securities Exchange Board of India (Sebi) chief Ajay Tyagi has entered his Bandra Kurla office, he has meant business. Long pending investigations have seen a move on and the shell companies bust is a first. Imagine that rogue and banned stock broker Ketan Parekh was using fronts to trade, bumping up prices of select scrips and Sebi under remained impervious.

 Putting 331-listed companies on graded surveillance measures (GSM) stage – VI, the highest in terms of initiating punitive action, is one rare action in recent times to curb misuse by fraudulent companies. Although Sebi may have erred in some cases where the companies prima facie appear to be legitimate and bonafide unless the regulator has much more evidence and its reaction to the Securities Appellate Tribunal  (SAT) order seems to suggest that.

Most importantly, over 36 lakh small and retail investors funds valued at over Rs 20,000 crore is stuck after Sebi cracked the whip and restricted trading on these scrips to just once a month. Reports suggest that several of these companies managed to rope in retail investors notwithstanding the fact that they have posted losses in the preceding four financial years. Also, these companies’ scrips have witnessed massive volatility in the market which has not been in sync with their valuations, business operations, revenues, price earning ratios etc. Only the other day Financial Chronicle highlighted how some of these company shares were up as much as 657 per cent in recent times.

Competent authorities will have to quickly undertake forensic audit, independent systems analysis and vetting of financial statements made by the promoters of these shell companies to ensure that uncertainty for retail investors ends early. Perhaps, the Sebi will have to find a way to provide relief to small investors whose hard earned money was stuck in these outfits. Perhaps, the investors fund can be used for this purpose. The correction that everyone was looking for has come courtesy this game changing event.

There’s no credence in some analysts’ arguments that Sebi’s directive on shell companies was a knee-jerk reaction. This is a calculated move after having received vital inputs from corporate affairs ministry, serious frauds investigation office (SFIO) and the income tax department.

It’s clear that both government agencies and the market watchdog have acted in tandem to arrest the malice that has been bogging the markets for several years. The crack down seems to be an extension of the campaign against black money, demonetisation drive and operation clean money. More such companies that have primarily been used for market manipulation, accommodation entries and illicit financial activities should be struck down with a heavy hand. It is believed that another round involving 400-odd companies may be impacted in the second tranche. Though Company Law of 2013 does not specify shell companies, such dormant firms, trusts, limited liability companies and partnership firms have been rampantly used by big groups to park the ill-gotten money.

Some companies’ petition before SAT pleading ignorance cannot be shrugged off lightly for they should be given an opportunity to defend themselves particularly if they are running concerns. While punishing the guilty was important, sparing the righteous businesses from whiplash for no fault of theirs was equally significant. Against this backdrop, the government’s decision to deregister over 1.6 lakh companies by taking them off the roster in the last few weeks assumes equal significance.

Also, a separate move to make Aadhaar compulsory for all individuals to make investments in the stock market would go a long way in weeding out bogus investors and benami shareholders. Already, Aadhaar and Pan were being insisted upon to enable mutual funds transactions. Banks have also been linking the accounts with aadhar numbers. Insistence in quoting Aadhaar for market transactions was only an extension of this campaign. So, government must go ahead with this move to link all financial market transactions to Aadhaar numbers. This will also remove the temptation of individuals to hide or understate investments, earnings from the market and then plug the leakage in tax collections.