Cracking the shells

But the principle of natural justice should not be ignored

The government has intensified its crackdown on shell companies — while some 210,000 companies have been deregistered and their bank accounts frozen, pending further investigations, over 100,000 individuals who held directorships in these organisations have been disqualified. Professionals such as company secretaries and chartered accountants suspected of having enabled tax evasion have been placed under watch. The authorities have also threatened to apply penal provisions to any person who has attempted to siphon money from accounts of shell companies. This follows close on the heels of the decision by the capital markets regulator, the Securities and Exchange Board of India, to freeze trading in many listed companies on the ground that these entities were used for the purposes of money laundering and tax evasion. 

The intention behind these concerted actions is laudable. The decision to turn attention towards shell companies cannot be faulted, for it is widely known that lax regulations allowed many errant promoters to list companies with no operations and these were used as a conduit for money laundering. Plugging such loopholes in the corporate system should eventually result in a cleaner financial environment where there are fewer cases of tax dodging and other illegal activities. 

However, the government should guard against taking unilateral actions against corporate entities and individuals on mere suspicion of such acts as this could end up hurting the innocent. This is particularly important to erase the perception that provisions such as Section 164 of the Companies Act, 2013, pertaining to disqualification of directors, can be applied selectively to harass political opponents of the current dispensation.  Second, and this is more serious, the innocent may suffer in the case of precipitate actions and blanket bans. For example, Sebi had banned trading in the shares of many companies without giving the entities in question a chance to respond to the allegations. In fact, that incident proved embarrassing. The Sebi action set off a mini-crash in the market, affecting the prices of multiple shares and leading to the destruction of wealth of many financial institutions and individual investors. Sebi subsequently rescinded the trading ban on many of those companies, tacitly admitting that the charges against them held no water. But the damage to corporate reputations and to the net worth of investors was considerable. 

Similarly, there could be some individuals amidst that vast list of debarred directors who had nothing to do with the activities of these firms and, indeed, there may be firms that are subsequently exonerated of the charges laid against them. Such persons or entities will suffer an unnecessary loss of reputation. The government should definitely proceed against companies where there is credible evidence that attempts have been made to launder money and dodge taxes, but given that such organisations and individuals are already on the watch-list, the authorities should ensure that while banning institutions and individuals, the fundamental principle of natural justice is not given the short shrift. That is a prerequisite for a healthy corporate environment. The other problem is that the Companies Act has not defined what a “shell company” is and what kind of activities would lead to a company being termed a “shell”. This gives rise to a lot of loose interpretations about the definition of a shell company. This also needs to be rectified through suitable amendments in the law.