The vanishing act

1. Portfolio Organizer • September 2002 21
COVER STORY
The Vanishing Act
The US might have given the world, an Enron, WorldCom and Xerox debacles, but India has gone one
step ahead in highlighting the dangers, which its small investors face. Rather than the fraudulent accounting
practices revealed in the WorldCom scandal, or the auditing failures uncovered at Enron, Indian investors
have been hoodwinked by firms, which have simply run off with shareholders’ cash and have vanished
in the air. The article highlights the act of vanishing and, the reason and process of origin of these
companies, their intentions and real functions at the face of small investor benefit.
© ICFAI PRESS. All Rights Reserved.
Prof Tapan K Panda
I
t is an irony on the part of a
developing country like India
where everyday we have stories of
companies vanishing from the scene.
This act of vanishing from the existence
is furthermore painful when the
companies eat up the hard earned
money of the small, marginal traders,
lower middle class and people with
paltry incomes. The lower level of
awareness on the part of the investors,
the lucrative returns promised through
advertisements in the local media and
inefficient role of the administration in
controlling the growth of these
institutions are the major problems for
this financial exploitation. The
attraction of a higher return in the age
of high inflation and promise of
liquidity at ease attracts small investors
to the illegal fold of the vanishing
companies. This is evident in the form
of non-banking financial institutions,
plantation companies, para-banking
institutions. The small and marginal
investors get attracted by the false
promises made in the campaigns by
these firms and then lose their money.
At a higher plateau we have also seen
the growth of organizations with
constant under performance leading
to delisting of their stocks and then
vanishing from investor’s money.
It has also been observed that in
India and West lot of these vanishing
companies are used for laundering
money. These institutions are used for
conversion or transfer of property,
knowing that such property is derived
from serious crime, for the purpose of
concealing or disguising the illicit origin
of the property or assisting any person
who is involved in committing such
crime to evade the legal consequences
of these actions and the concealment
or disguise of the true nature, source,
location, disposition, movement, rights
with respect to or ownership of
property, knowing that such property
is derived from serious crime. Mostly
vanishing companies are used for this
purpose. Since the deposits come from
mafia, real estate owners and corrupt
politicians, companies could bring out
aggressive promotion strategy to woo
the small time investors. The legal
frame work also does help them in this
process. Few years before, you just
have to register a society in India to
start a non-banking company or a chit
fund. There was no mechanism to
evaluate the credibility and authenticity
of these organizations. The role and
capability of Reserve Bank of India was
confined to addressing complaints after
the companies had vanished.
Investor’s awareness in small towns
was also a big advantage for these
kinds of companies. Most of the teak
plantation companies promised a
greater return after a long period of time
by associating the investments with the
life of the teak tree. This made even
matters worse as small investors put a
larger sum in stake compared to the
non-banking companies promising a
higher return in short-term and then
vanishing in few years.
What matters most in a financial
system is how these vanishing
companies manage to launder the
money that they obtain from the real
sources of crime and corruption and
then add on the hard earned money
of the small investors to vanish from
the picture. Although money
laundering talks about property, it is
more about processing of cash from
illegal sources by vanishing companies
to legal sources.
If one deeply analyzes the whole
process of vanishing act, it starts with
placement or insertion—the process of
placing illicit proceeds of income in to
financial institutions with dubious
distinctions through deposits, wire
transfer and purchase of negotiable
instruments. In this process many
relatively small investors transactions

2. Portfolio Organizer • September 200222
COVER STORY
The Vanishing Trend
The capital markets have witnessed a boom during 1993-94 and 1994-1995 after the liberalization and ushering of
economic reforms when many companies had tapped the market and collected funds from the public through issue of
shares/debentures and fixed deposits. Most of such companies have taken advantage of the regulatory loopholes and
defaulted in their commitments while mobilizing the funds and some have even disappeared. SEBI has so far identified
229 listed companies. The narrow technical definition used by SEBI to define the vanishing companies ignored the key
issue—the misuse of the funds. Given the extreme focus to the secondary markets, the role of primary markets is often
ignored. A glance at the list of listed in 1992 on BSE indicates
that nearly 550 companies have since delisted or simply
vanished. Though 550 is the official figure the numbers in
real figures are much higher. There is no trading activity
taking place in nearly 3500 companies with investors losing
a total of nearly Rs. 250 bn. Numerous non-banking finance
companies and plantation companies are now either missing
or unable to repay their debts. Out of 3872 public issues
offered in the market form 1992 to 1996, only 562 are
traded above their issue price, while 205 are not traded at
all on the exchanges.
The companies that got listed during early 1990s didn’t
have any concrete business plans and yet managed to garner
millions of rupees from small investors by the way of several
instruments and IPOs. Except for limited powers under the
Section 11 of Companies Act 1956 to regulate brokers and
the stock markets through listing norms, SEBI does not have
any statutory powers and also has limited search and seizure
powers. It has neither power to attach property nor specific
powers to disgorge the ill-gotten profits. It is only permitted
to impose measly penalties on companies violating listing
agreement under limited circumstances. And in the past
several companies, intermediaries, brokers and stock exchanges have challenged the actions of SEBI to protect the
interests of small investors.
The very first step to revive the primary markets is to identify and punish the companies that have vanished with issue
funds and to avoid any recurrence of such instances a proper regulatory mechanism should be put in place and make
the information disclosure relevant- quality and quantity and format of delivery and ensuring that investors of all classes
get the information at the same time. The regional stock exchanges were being conferred the duty of ensuring compliance
and monitor the working of such companies with the listing agreements. It has been noticed that in the past, a company
rejected by one exchange is accepted by another. So many companies opted for smaller exchanges to avoid closer
pre-issue scrutiny and post market monitoring. With the emergence of BSE, NSE and OTC, investors can trade from
anywhere. So a company should list only in NSE or BSE if its turnover is more than Rs. 10 cr and in OTC if its capital
base is lower. Listing on regional exchange should be made optional and a National Listing Authority called the Central
Listing Authority should be set up to ensure a uniform standard in listing and monitoring.
The Board should be empowered with several provisions under the companies Act to bring back the confidence back
into the market. In fact the capital markets in India are governed by several agencies such as the Central Bureau of
Investigations, the Monopolies and Restrictive Practices Commission, the DCA, the Reserve Bank of India, the Unit Trust
of India Act and various consumer forum. The company Law Board should dilute its powers to bring back discipline
into markets. There should be a consolidated securities law and provisions relating to securities market should
be deleted from the Companies Act and suitably incorporated in the SEBI Act. Since the fate of secondary
markets is closely linked with the primary markets, it is imperative that the latter should be made fraud free,
transparent and investor friendly.
Source: ICFAI PRESS Research Center
Year No of Issues Money Raised (Rs cr)
1989-90 186 2521.97
1990-91 140 1450.20
1991-92 195 1399.85
1992-93 526 5651.38
1993-94 765 10824.04
1994-95 1343 13311.60
1995-96 1423 8881.72
1996-97 740 4671.14
1997-98 58 1131.84
1998-1999 22 504.02
1999-2000 56 2974.71
2000-2001 56 701*.00
Total 5510 54023.47
*Till June, 2000
Source: Prime Database
Public Issue Travails

3. Portfolio Organizer • September 2002 23
COVER STORY
are performed to launder the funds in
batches that fall under regulatory
thresholds. Given the number of
branches that they open for placement
or insertion and the daily number of
retail and business transactions
conducted, the monitoring and
recognition of this first step is an
extremely complex problem.
The second step is that of layering
—the process of separating the
proceeds of this illegal activity from
their origin through the layers of
complex financial transactions. Small
investors are given interim dividends,
loans, events programs are sponsored
for giving a whitewash to the money
flow. The purpose of this step is to
provide the initial disguise as to
ownership of money, disrupt any
attempt at establishing an audit
trial and provide layers of
anonymity over a series of
transactions. The layers are
typically provided by moving
funds between offshore accounts,
the use of bearer shell companies,
stock, commodity and future
trading, fraudulent bills of
exchanges, inflated bills of lading
and false billings.
Integration is the next act, which
ends with vanishing act for the
company at the face of public.
Integration is the process of using an
apparently legitimate transaction to
disguise the illegal proceeds after
layering in to an otherwise legitimate
ownership. The purpose of this step is
to allow the ultimate owner of the illicit
funds to benefit from the use of those
funds in a manner that is legal. The
money is integrated in to legal
economy and assimilated in to all of
the other assets of the system. Once
this process is over, then the company
vanishes overnight. This happens
because the objective of establishing
the company is achieved from the
promoter’s point of view. The poor
small time investor is left stranded in
this issue as he has no clue of the
internal transaction happening within
the system.
So for the promoter, three key
designs should be satisfied, namely
concealment of the origin and true
ownership of the organization and
assets, the maintenance of the assets
as they proceed in the cycle,
conversion of the form of asset in to
legitimate and more portable format.
The vanishing companies take
advantage of the lax enforcement of
the Central Bank and also by the
marginal and distributed customers,
poor level of counterparty identification
process, poor or ineffective system
audit trails, collusion of the employees
within the financial system, volume of
small but legitimate transactions within
which to mask illegitimate transactions,
confusing and/ or conflicting
procedures, regulations and oversight
standards.
As a result, the vanishing
companies that are used for the
purpose can operate at costs far below
market rates, undermining the role of
the Central Bank or even the market
forces. Financial institutions and
financial markets are adversely affected
by changing investor’s perception and
that largely for the equity market in a
country like India. Countries lose
control over economic policy and in
emerging countries like India the range
of money outflow through this process
is a substantial portion of the legitimate
fund circulation in the economy. The
loss of tax revenue leads to higher cost
of tax enforcements. The privatization
and disinvestment to national assets
may land up in wrong hands as these
vanishing company promoters have
an access to illegitimate and
unregulated money.
Though the task of controlling this
vanishing act seems difficult but it is
not impossible. Rules are to be framed
based over few criteria that include
reigning the limits and third party
guarantee level for establishing these
non-banking and para-banking
institutions, constitutions of a separate
board for this purpose, development
of institution rules based on
management’s responsibility to protect
the small investor’s money,
compliance mechanism, and financial
integrity within the organization,
establishment of oversight
responsibility of national and
international industry regulators to
protect the financial system,
intelligence rules based on the
responsibility of international
intelligence and defense agencies to
detect and interrupt these activities at
international level. Unless the issues
are dealt at international level it will be
difficult to handle the mushrooming
growth and speedier vanishing act of
these companies because how many
of these people are caught and how
much of money has gone back to the
small investors is a big question waiting
for an answer. 
Prof Tapan K Panda is Faculty Member
at Indian Institute of Management,
Lucknow.
Questions for discussion
1. What are the measures that the regulatory agencies need to adopt to control the menace of vanishing companies?
2. Discuss the process of origin of companies that are deemed to vanish.
Reference # 6-02-09-02