Sebi cracks down on inactive companies: Why penny stock investors should be alert

Sebi is working to delist companies with no economic activity from stock exchanges. The move seeks to protect investors from manipulation and pump-and-dump schemes.

In Short

• Sebi aims to delist companies with no economic activity to protect investors
• Penny stocks attract retail investors but can hide serious financial weaknesses
• No timeline or criteria for delisting announced; investors urged to exercise caution

The Securities and Exchange Board of India (Sebi) is working towards removing companies with no economic activity from stock exchanges, in a move aimed at protecting investors from potential market manipulation. The proposed clean-up could be particularly relevant for retail investors who are drawn to penny stocks, where low share prices can sometimes hide serious risks.

Sebi chairman Tuhin Kanta Pandey said on Saturday that several companies continue to remain listed despite having no economic activity. Their presence in the market, he warned, could expose investors to potential risks and make such stocks vulnerable to manipulation.

"These companies pose a potential danger to investors, and therefore, it is necessary to remove them from the listed space. We are making efforts towards their delisting," Pandey said at a programme in Kolkata.

The chairman also pointed to the possibility of these stocks being used in "pump and dump operations" by market manipulators. He said their continued listing could expose more investors to risks, particularly through social media groups that may be used to promote such stocks.

WHY SEBI WANTS TO REMOVE INACTIVE COMPANIES

A company that remains listed on a stock exchange is not necessarily an active or healthy business. Some firms may have little or no meaningful economic activity but continue to have their shares traded in the market.

This can create an opportunity for unscrupulous operators. A stock with limited trading activity, weak business fundamentals and little public information can be easier to influence, particularly when investors are relying on tips circulating on social media rather than checking the company's financial position.

The concern is that manipulators can use such stocks to create an impression of rising demand. They may first buy shares at low prices and then promote the stock through messages, online groups or other channels to attract retail buyers. As more investors enter and the price rises, the operators can sell their holdings. The resulting selling pressure can cause the price to fall sharply, leaving late investors with losses.

This is broadly known as a pump-and-dump operation. The risk is especially high when investors are unable to assess whether a company has a functioning business, a credible earnings outlook or a sound financial position.

Pandey's comments suggest that the regulator wants to address the problem at the level of the listed market itself, rather than only responding after investors have been caught in suspicious trading activity. Removing companies that have no economic activity could help reduce the pool of stocks that manipulators may exploit.

WHY PENNY STOCK INVESTORS NEED TO BE CAREFUL

Penny stocks often attract investors because their share prices are low. A stock trading at Rs 5 or Rs 10 may appear affordable, and investors may believe that even a small rise in its price could deliver large percentage gains.

But a low share price does not automatically make a stock cheap or undervalued. The price of a share has to be assessed alongside the company's business, financial position, earnings, debt and future prospects. A company with no meaningful economic activity may have little underlying business value, even if its shares are available at a seemingly attractive price.

There is also a difference between a low-priced stock and an inactive company. Not every penny stock is a company without economic activity, and Sebi has not said that all penny stocks will be delisted. Its stated focus is on companies that have no economic activity and whose continued presence on exchanges could expose investors to market abuse.

The risk for retail investors is that they may enter such stocks after seeing sharp price movements or messages promising quick returns. If the rise is driven by manipulation rather than an improvement in the company's business, the price can fall just as quickly.

An Economic Times report on November 1 said 10 penny stocks had fallen between 35% and 70% over the preceding three months. Such sharp declines underline the risks involved in chasing stocks purely because they are trading at low prices or have recently surged.

SEBI USING AI TO TRACK SUSPICIOUS ACTIVITY

Alongside the proposed delisting of inactive companies, the regulator is also stepping up its efforts to identify suspicious trading activity.

Pandey said Sebi was using artificial intelligence techniques to track and scrutinise suspicious accounts, along with other measures aimed at preventing retail investors from getting trapped in manipulative trades.

The Economic Times has separately reported that the regulator is looking at an AI-based system to monitor companies with minimal economic activity and generate alerts more quickly. The reported surveillance effort is part of a broader attempt to identify potential risks before they affect more investors.

The use of technology is significant because suspicious activity can involve several accounts and trading patterns. Monitoring such activity can help the regulator identify possible manipulation and examine accounts that may be involved

For investors, the development is a reminder to look beyond a stock's price and recent market performance. Before investing in a small or low-priced company, it is important to understand what the business does, whether it is generating revenue, whether it has reported financial results and whether there are credible disclosures about its operations.

Investors should also be cautious about unsolicited stock tips, social media messages and claims that a particular penny stock is likely to multiply in value. A sudden price surge, especially in a stock with limited information or trading activity, should not be treated as proof of improving business prospects.

It is equally important to distinguish between a company's market price and its underlying financial health. A share trading at Rs 5 is not necessarily cheaper than one trading at Rs 500. The company's fundamentals and valuation matter far more than the absolute price of one share.

NO DELISTING TIMELINE OR CRITERIA ANNOUNCED YET

While the chairman has made Sebi's intention clear, several details of the proposed action are still awaited. The regulator has not publicly specified which companies could face delisting, how it will define the absence of economic activity, or when the process may begin.

The available announcement also does not explain how existing shareholders will be treated if a company is eventually delisted. Investors should therefore not assume that any particular stock will be removed from exchanges or that all low-priced shares are covered by the proposal.

For now, the message from the regulator is that companies with no economic activity should not continue to remain in the listed space if their presence creates risks for investors and market integrity.

For retail investors, the bigger lesson is to avoid treating penny stocks as easy opportunities for quick gains. A low price can look attractive, but without a real business behind it, the investment risk can be substantial.

(Disclaimer: The views, opinions, recommendations, and suggestions expressed by experts/brokerages in this article are their own and do not reflect the views of the India Today Group. It is advisable to consult a qualified broker or financial advisor before making any actual investment or trading choices.)

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