Sebi jumps the gun

Principle of natural justice cannot be ignored

The Securities and Exchange Board of India (Sebi) decided on Monday to suspend trading in 331 listed companies that it suspected were “shell companies” and received suspicious cash deposits in the wake of the demonetisation announcement last November. These deposits are being investigated. Predictably, the action knocked down investor sentiment as trading in the companies under scrutiny will be allowed only once a month under stringent conditions. A deposit of 200 per cent of the trade value must be submitted and this deposit will be held by the exchange concerned for the next five months. At one level, it is laudable that money laundering is being investigated so that the country can move towards a cleaner business environment. Finance Minister Arun Jaitley told Parliament recently that as many as 162,000 shell companies had already been deregistered.

 
But the latest Sebi move raises several questions — the reason why a number of the companies labelled “shell” moved the Securities Appellate Tribunal on Wednesday against the market regulator’s decision. That is because Sebi seems to have acted in haste and has violated some of the basic principles of natural justice. The accused were given no chance to defend themselves before trading was suspended and no show-cause notices were sent to the firms specifying the charges. Sebi’s clarification on Wednesday that it has not concluded that they are shell firms and the action has been taken based on a list forwarded by the ministry of corporate affairs is surprising. The wisdom of the regulator in taking such a drastic measure on mere suspicion and without the criteria being publicly declared is difficult to fathom. Although the finance ministry later clarified that the companies would be given an opportunity to defend themselves, the opacity of the order adversely affected the interests of minority shareholders. Due to the suspension of trading without notice, minority investors did not get a chance to assess the situation and, possibly, exit these stocks in an orderly fashion.

 
The term “shell company” is undefined in the Companies Act but it is being used in public parlance to characterise entities suspected of indulging in, and enabling, tax evasion. Share prices can indeed be manipulated to absorb black money and launder it via circular trades with the connivance of the promoter-broker nexus. For example, a trader may buy a share from a promoter who rigs the price upwards with the connivance of brokers. The share may then be sold back to the promoter (or the cronies) for capital gains, with the trader paying the difference in cash under the table. Or, if the promoter wishes to launder black money, a share may be sold by the promoter and the price rigged down. The buyer will show a capital loss, which can be used to offset profits in other stocks. In this case, the buyer will receive cash under the table from the promoter.

 
There is no doubt that companies engaged in this “laundry system” deserve punishment. But it should always be done in a manner that protects the minority shareholders. That is not the case here. Moreover, the accused have already suffered a loss of market value and they will inevitably suffer a loss of reputation as a result of this action. In the interests of transparency and natural justice, the regulator should make public the specific charges immediately. This is the normal procedure in the case of listed companies and there is no reason why Sebi should deviate from that.