Aug. 8: Sebi, the market regulator, has sent a shock wave through corporate boardrooms and stock markets after identifying 331 companies as suspected "shell companies" - a term that has never been defined in the Companies Act, 2013 - and slapped severe trading restrictions on them.

The move was announced late on Monday but Sebi did not say what kind of illegal activities these companies had engaged in.

The Sebi move was apparently orchestrated by the ministry of corporate affairs but the cloak of secrecy over the entire operation raised fears of a witch-hunt by the Narendra Modi government against companies that may be closely allied to its political rivals.

The list contained the names of 140 companies and entities registered in Bengal. Some names on the list caused consternation among several businessmen based in Calcutta.

The big surprise was to see Nicco Corporation and Pincon Spirit, a liquor maker with revenues of Rs 1,420.05 crore in 2016-17 and a net profit of Rs 43.04 crore, on that list. Tea plantation owner and oil explorer Assam Company India Ltd also figured among the identified entities.

The market regulator sent out the notice after receiving a communication from the ministry of corporate affairs (MCA), which identified the 331 companies as suspected shell firms. The MCA is reported to have cancelled registrations of more than 1.62 lakh firms for failing to file their annual financial statements for two previous years.

A cursory look at the list of these companies showed that most of the entities have been referred to the MCA by the income tax department and the serious fraud investigation office (SFIO).

"There is no probe against Nicco Corp," said Rajive Kaul, director of Nicco Corporation, who was mystified by Sebi's decision. "Never has been one. Unless they begin one in future, which I think is very unlikely." Nicco's name had been referred by the SFIO.

The Bombay Stock Exchange said in a note that these companies would be placed under Stage VI of the Graded Surveillance Measure (GSM) - which means that "trading in these identified securities shall be permitted only once a month".

Securities placed in Stage VI fall in what is called the trade-to-trade category where a buyer must take delivery of the shares he bought, which effectively means no speculation can take place. Delivery of shares usually hovers between 20 and 40 per cent of the traded volume in most trading counters.

That is not all: the shares of "shell companies" will not be permitted to rise above the last traded price.

The exchange will also collect an "additional surveillance deposit of 200 per cent of the trade value" from the buyers of these shares that will be retained by the exchanges for a period of five months.

The market regulator asked stock exchanges to verify the credentials of these listed firms and appoint an independent auditor to carry out a forensic audit.

The sudden clampdown meant that trading in legitimate companies like J. Kumar Infraprojects Ltd and integrated steel and power company Prakash Industries would only be allowed next on September 4.

JK Infraprojects Ltd, which counts HDFC Mutual Fund, Goldman Sachs and American Insurance Funds as its shareholder, said in a filing with the BSE that it "is not a shell company and the suspicion is uncalled for".

The company, which is currently working on the Delhi and the Mumbai Metro projects and claims to have an order book of Rs 9,334.81 crore, said it was seeking legal advice and had decided to approach the regulator and "request it to recall its direction qua us".

Prakash Industries, in which well-known investor Rakesh Jhunjhunwala has a 1.01 per cent stake (or over 15 lakh shares), said: "We are not a shell company... we are a healthy profit-making company having an annual turnover of over Rs 2,400 crore and a profit of Rs 78 crore last year."

The company claimed that it had 52,000 shareholders and the average daily volume of transactions on the stock markets was over 2 million shares.

Others in the list included north Indian real estate company Parsvnath Developers in which the US-based Fidelity group has a 4.17 per cent stake, and SQS BFSI (earlier known as Thinksoft Global) whose promoters had sold their stake to SQS of Germany.

"Pincon Spirit Ltd has been a dividend paying company and we do not have any pending complaints pertaining to dividend payments or investor complaints. We pay excise duties running into crores of rupees.... We, therefore, find it quite surprising that the company has been placed under the surveillance list of shell companies. We are ready to provide all necessary information and extend all co-operation to the regulators to resolve the issue so that the name of the company is excluded from the shell companies list at the earliest," Pincon Spirit director and CFO Arup Thakur said in a letter.

"We are surprised by this inclusion and were not expecting to be a part of this list. We will write to the concerned authorities seeking an explanation," said Ankit Patni, managing director of Ankit Metal and Power.

Officials from Assam Company (India) Ltd, said the company would write to the market regulator to review the decision. ACIL, which has tea plantation and oil exploration business in Assam, recorded a Rs 70.79 crore loss on a turnover of Rs 216.48 crore in the last fiscal.

What is a shell company?

The Organisation for Economic Co-operation and Development (OECD), which has been at the forefront of a worldwide initiative to combat money laundering and terrorist financing, had described shell companies in its 2001 report titled Behind the Corporate Veil as "entities established not to pursue any legitimate business activity but solely to obscure the identity of their beneficial owners and controllers. They constitute a substantial proportion of the corporate vehicles established in some offshore financial centres (OFCs)."

The Financial Action Task Force (FATF) - an inter-governmental body established in 1989 to set regulatory standards to combat money laundering - says shell companies are frequently used to facilitate bribery.

The development is bad news for investors, particularly the small shareholder who may have bought shares in these companies. While they will be stuck with these securities at least till the first Monday of next month, they face the prospect of losses on account of the expected slump in the value of these shares when trading resumes.

However, some market experts feel that investors should not panic as the market regulator may take some names off the list once they establish they are not shell companies. Stockbrokers expect some clarification from Sebi over the next few days.

"The Sebi order has taken industry and investors by surprise. If it is later found that some of these entities were not shell companies, it would not matter as it would have rung the death knell for them. It is not clear whether any of them received showcause notices prior to the Sebi announcement. There are a lot of good names there and consumer interests should have been paramount," said Rajesh Narain Gupta, managing partner of SNG & Partners.