In India, Shell companies haven’t been defined in law, observes Sandeep Parekh, the founder of Finsec law Advisors.
On Monday SEBI, the securities market regulator had directed bourses to initiate action against 331 suspected shell companies that are listed and these scrips will not be available for trading this month. Sebi’ notification said that the decision was based on a letter from the ministry of corporate affairs (MCA) identifying these 331 firms. “These companies were identified by a panel formed by government of India post-demonetization. The 331 companies saw high investments through layering and fund flows from non-listed shell companies,” reported Mint, citing an unidentified ministry official.
In this piece, we explain the meaning of shell companies. Just like a shell, which has a thick outer covering, while the inside is hollow, Shell Company is a corporate entity without active business operations or significant assets. It is interesting to note that that shell corporations are not illegal. They are deliberate financial arrangements created to either avoid taxes or even promote startups. Most of the shell companies are registered in tax havens, where there is nil or low tax. Legally, Securities Act enacted in the USA has defined shell company as follows.
“Securities Act Rule 405 and Exchange Act Rule 12b-2 define a Shell Company as a company, other than an asset-backed issuer, with no or nominal operations; and either:
- no or nominal assets;
- assets consisting of cash and cash equivalents; or
- assets consisting of any amount of cash and cash equivalents and nominal other assets.”
In India, Shell companies haven’t been defined in law, observes Sandeep Parekh, the founder of Finsec law Advisors. Hetal Dalal, chief operating officer, Institutional Investor Advisory Services, a proxy advisory firm, points out that simply having a shell company cannot imply any wrongdoing. She said that the capital markets regulator must consider having a more rigorous approach to discern those (shell companies) that are genuine and those that are being used for money laundering or other nefarious activities. However, experts say that the challenge lies in gathering data on transactions and being able to distinguish between genuine business transactions and transactions that lack substance.
According to Hetal Dalal, regulations could be framed to define shell companies by using operational parameters such as standalone revenues, assets, employee strength, or other operational metrics. “By using measurable operating parameters, regulators can set easily-understood thresholds that define shell companies,” says Dalal.
The regulator’s directive came after the corporate affairs ministry shared a list of 331 listed companies that are suspected to be shell entities and could even face “compulsory delisting”. Stepping up the surveillance measures, these entities would be subject to independent audit and if required, forensic audits could also be initiated to check their credentials.