Unmasking shell companies: How to tighten the screws

Strong monitoring mechanism, along with other measures, may help prevent abuse of shell firms

Two recent events, though unrelated, could have wide-ranging impact going forward on the abuse of shell companies for money laundering and tax evasion. The first is a provision in the Companies (Amendment) Bill, 2017, that was recently cleared by the Lok Sabha. It proposes to define, for the first time, the term ‘beneficial interest in a share’. It further makes it mandatory to maintain a register of persons with significant beneficial interest in a company. The other event is the Securities and Exchange Board of India (Sebi) setting up a committee on 'fair market conduct', to suggest measures to improve surveillance of the markets. 

The Companies (Amendment) Bill, 2017, gives an extremely wide and inclusive definition of ‘beneficial interest in a share’ that recognises all the 'direct and indirect' rights or entitlement of persons. Apart from the right to receive or participate in any dividend or distribution, the definition requires identification of ‘any’ rights in shares as ‘beneficial interests’,” says Sharad Abhyankar, partner, Khaitan & Co.

Experts point out that till now, 'share' of a company was considered to be an integrated bundle of rights, privileges and obligations that cannot be separated and assigned to different persons. The proposed amendment seeks to give a legal recognition of the fact that for the same shares there could be multiple beneficial interest holders. 

Under Section 90 of the Act, the Bill proposes to make it mandatory to maintain a register of significant beneficial interests in a company. This, say experts, will help to bring transparency about individuals, including trusts and persons not resident in India, who either have significant influence or control over the company. “This is likely to be a serious deterrent for non-disclosure of real interest holders. Further, Section 90 also imposes a very heavy burden of enquiry into beneficial interest holders, which may be difficult to discharge,” says Abhyankar.

How to tighten the screws

Companies (Amendment) Bill, 2017 

• ‘Beneficial interest in a share’ to be defined for the first time to recognise ‘direct and indirect’ rights or entitlement of persons (under Section 89 of the Companies Act) 
• Requires identification of persons who collectively hold beneficial interests 
• Apart from right to receive or participate in any dividend or distribution, the definition requires identification of ‘any’ rights in shares as ‘beneficial interests’ 
• There is a need to maintain a register of significant beneficial interests in a company, including those of individuals, trusts and persons not resident in India 

Sebi Act, 1992 

• Identify shell companies or penny stocks that could be used for manipulation 
• Step-up surveillance and enforcement under Section 12A of the Sebi Act along with the Prohibition of Fraudulent and Unfair Trade Practices regulations 
• The recently-appointed T K Viswanathan Committee on ‘fair market conduct’ could suggest specific measures to improve surveillance of shell companies 

Inder Mohan Singh, partner, Shardul Amarchand Mangaldas & Co, points out that a lot depends on the final rules to make the new definition of 'beneficial interest in a share’ effective in preventing abuse of the provision. “The rules must help identify the ultimate beneficiary,” he says.

Many experts in securities law feel appointment of the T K Viswanathan Committee on ‘fair market conduct’ could not have come at a better time. Most believe there is no need to change the Sebi Act, 1992, to prevent the abuse of shell companies.

“Section 12A of the Sebi Act, read with Prohibition of Fraudulent and Unfair Trade Practices Regulations are wide enough to deal with it,” says Sumit Agrawal, partner, Suvan Law Advisors. He is in favour of the T K Viswanathan Committee suggesting specific steps to improve surveillance of shell companies and penny stocks.

Yogesh Chande, partner, Shardul Amarchand Mangaldas & Co, feels the real issue is supervising and tracking down such companies based on the filings made by them to stock exchanges. “Apart from seamless sharing and exchange of data among various regulators and authorities, a thorough analysis could also be an efficient tool for stock exchanges to track suspected shell companies,” says Chande.

Experts point out that the market regulator's role till now has largely been focused on preventing tax evasion carried out through manipulation on the exchange platform. The best way forward for Sebi is to step up surveillance and enforcement, say experts. The first is to identify shell companies or penny stocks that could be used for manipulation. This would require imposition of strict trading curbs on them to avoid price rigging. The other area is acting against manipulators and companies who are involved in price rigging or colluding with individuals who launder money.

So far, Sebi has identified 145 cases of long-term capital gains evasion. It has completed investigation in 85 cases and shared the report with the Central Board of Direct Taxes to take action in such cases. The market regulator aims to complete investigation in the remaining cases by end of September.