Sebi's blanket ban on shell firms hurts innocent minority shareholders the most

The Securities and Exchange Board of India's (Sebi's) action of freezing trading in the shares of 331 so-called shell companies has hit minority shareholders hard. It was an action taken on the basis of price-sensitive information received from the MCA. However, the action itself was taken in a way that doesn't give shareholders either pertinent information or a chance to make a rational decision to stay invested or exit.

Investigations into the financials of listed companies and into cases of alleged price manipulation are common enough. The normal procedure is to put the charges into the public domain. The company or companies in question are informed of specific charges, which are also posted through notices at the exchanges. Investors then get a chance to assess the charges and figure out whether they wish to sell out. If the share price drops, contrarians and value-investors get a chance to go bargain hunting.

In this instance, the trading of these shares was frozen with no advance notice and without specific charges being filed against the concerned corporates. After the event, there have been assurances that the concerned companies will be allowed to present a defence, which is a given, anyhow.

Several of the concerned corporates have gone to the Securities Appellate Tribunal (SAT) in appeal. Two of those companies have won a reprieve in the sense that trading is to be resumed in these stocks. This could encourage other companies to make representations at SAT. It remains to be seen if Sebi will now modify the blanket order. The speed of action is also important. There has already been considerable wealth erosion and delays will lead to more wealth destruction.

The list itself is puzzling. if shell companies are defined as entities that do not have any normal business and simply indulge in share price manipulation and money laundering, there are many companies on that list that simply don't fit the description.

Price manipulation and money laundering are typically done in corporates with minimal equity base, low trading volumes, and a large percent of shareholdings held by promoters. Such companies tend to have little or no normal business. This makes it easy to ramp up or depress the share price at will using circular trades. In turn, these manipulated capital gains and losses can be used to launder money with cash passed under the table to compensate for the official loss or gain.

Obviously, one can't comment on unknown charges. However, there are many dividend paying, profitable entities on that list. They have very visible businesses, including government contracts. These companies have large shareholder bases, liquid trading patterns, decent market cap, and large balance sheets. In total, it's estimated that over 3.6 million shareholders have been affected by the freeze and that includes multiple institutions. It's estimated that foreign institutional investors and mutual funds have positions in at least 25 of the affected stocks, along with some government entities and domestic institutions.

Regulators are supposed to punish the guilty without hurting the innocent. In this case, the innocent, meaning minority shareholders with no connection to crooked promoters, have definitely been hurt. So have managements that have taken a hit in terms of reputations, even if they are subsequently cleared of charges. There has been a fallout across the whole market. Sentiment has been affected and so has margin funding. The sooner this situation is cleared up, the better.