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SEBI’s directions regarding alleged shell companies

Finsec Law Advisors

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In a recent communication issued to BSE and NSE, SEBI has forwarded a list of 331 companies, identified as “shell companies” by the Ministry of Corporate Affairs. SEBI has asked the Exchanges to shift these companies to Stage VI of the Graded Surveillance Mechanism (GSM) and restricted trading in securities of such companies by its directors and promoters.

GSM is a pre-emptive surveillance mechanism formed by SEBI to enhance market integrity and safeguard the interests of investors. While it contains six stages, Stage VI is the strictest of all wherein trading in securities is permitted only once a month under the trade-to-trade category and no upward movement in the price of the security is allowed. Further, buyers have to pay an additional surveillance deposit to the tune of 200% of the trade value.

Thereafter, SEBI’s communication was challenged by few of the companies before the Securities Appellate Tribunal. The Tribunal observed that the letter sent by MCA provided a list of “suspected shell companies” and opined that SEBI could not have presumed them to be shell companies without making an independent investigation of its own. Moreover, the Tribunal noted that the communication was in effect a quasi-judicial order having serious civil consequences, but was issued by SEBI as an administrative order erroneously under section 11(1) of the SEBI Act, 1992, a provision which allows SEBI to take administrative action for safeguarding the interests of the securities markets. As a result, the Tribunal issued a stay on the communication, a rare occurrence in their history.

It is pertinent to note that no law in the country has defined or prescribed any criteria to identify “shell” companies. Furthermore, even if any company is “shell”, it is not implied anywhere that it can be penalized for being so. It is surprising that SEBI decided to take such actions which will have a grave impact on the securities market, without providing a hearing or passing a reasoned order in the matter. In the light of other recent actions, such as issue of order penalizing the Exclusively Listed Companies, it seems that SEBI has set a dangerous precedent of undertaking quasi-judicial actions in the garb of its administrative powers.