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SEBI Directions on 331 “Shell Companies” – Misguided Enthusiasm

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Many issues crop up from the Securities and Exchange Board of India (SEBI) letter dated August 7, 2017 (the Directions) to the BSE Limited, the National Stock Exchange of India Limited and the Metropolitan Stock Exchange of India Limited (collectively, the Stock Exchanges) instructing the Stock Exchanges to immediately:

  1. move 331 companies (the Companies) to Stage VI of the Graded Surveillance Measures (GSM);
  2. restrict trading in securities of these companies to once a month (with stringent conditions);
  3. direct a forensic audit of each Company; and
  4. initiate a compulsory delisting of the Companies failing the forensic audit.

The Directions can be challenged on the following grounds:

  • The Directions blatantly violate Principles of Natural Justice as:
    1. No Company was given a right of fair hearing or making a representation.
    2. SEBI, Stock Exchanges and Ministry of Corporate Affairs (MCA) sent no notice or warnings to the Companies but unilaterally decided to wipe out liquidity.
    3. Directions to stop trading should have been issued, if at all, for Companies failing a forensic audit rather than first taking drastic action against all the Companies and directing a forensic audit later.
  • SEBI’s powers are subject to statutory and equitable limitations. All listed companies and shareholders have a legitimate expectation of due process being followed before being penalized.
  • There is no basis for directing a forensic audit for Companies that are already under the insolvency process/debt restructuring. This move of wiping out liquidity is contradictory to the principle of getting these companies back on track.
  • The Directions are arbitrary and abuse of power as:
      1. No criteria for determining Shell Companies is available.
      2. There is no reference to the source of SEBI’s powers to issue the Directions.
      3. The Directions are not reasoned – the only rationale is a receipt of 2 month old letter from MCA (which is not available in the public domain).
      4. There is acknowledgement that the Directions have been issued merely based on suspicion only. The Directions should have issued only against Companies flagrantly violating SEBI regulations/ market abuse.
      5. The Directions are against the interest of minority shareholders- they destroy value of equity shares.
      6. SEBI has used a “one-size-fits all” approach with no regard to the different financial background of the Shell Companies. Some of the Companies are operating, have booked profits, declared dividends and filed tax returns.
      7. Requiring compulsory delisting penalizes a minority shareholders as exit price is determined by a valuer instead of price discovery in the market.
      8. In any event, the SEBI (Delisting of Equity Shares) Regulations, 2009 and the Securities Contracts Regulations Act, 1956 don’t allow compulsory delisting in these situations.
  • There is no material basis for putting the Companies back in the normal segment following a successful forensic audit.
  • Requiring a 5-month deposit of 200% of trade value by the buyer is contrary to the GSM Stage VI norms.
  • GSM norms require a stage-wise progression- moving to GSM Stage VI straightaway is not justified.
Author: Gautam Gandotra and Ravi Kumar
©Cyril Amarchand Mangaldas

Cyril Amarchand Mangaldas was founded in May 2015 to continue the legacy of the 97-year old Amarchand & Mangaldas & Suresh A. Shroff & Co., whose pre-eminence, experience and reputation of almost a century has been unparalleled in the Indian legal fraternity. With a long and illustrious history that began in 1917, the Firm is the largest full-service law firm in India, with over 600 lawyers, including 91 partners, and offices in Mumbai, New Delhi, Bengaluru, Hyderabad, Ahmedabad and Chennai. Several of our professionals are cited as leading practitioners by global publications like Chambers and Partners, International Financial Law Review, Asia Legal 500 and Euromoney.


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