Working Capital Schemes: 12 Shell Company Red Flags

By: Sumitra Raghavan
 
A company enjoying a credit limit of $10 million from a bank had turned bad, otherwise known as non-performing assets (NPAs). A preliminary investigation was conducted to understand the genuine reason for the degradation of the loan account. Allegations included the siphoning of funds by the borrower through the shell companies and improper monitoring of the account by the bank. The suspected borrower company was dealing in garments, while the suppliers were traders of animal husbandry products, revealing even more inconsistencies in the trade activities and additional evidence of round-tipping of transactions. 

Upon reviewing the account statements of the suspected borrower, it was found that there was minimal turnover in the account, it was frequently overdrawn, and the entity had only repaid the interest instead of routing of entire sales proceeds in the account. This led to the identification of several red flags that indicated potentially fraudulent activity.  

Red Flags to Identify the Round-Tipping of Transactions Through Shell Companies: 

1. Frequent cyclic transactions with the entities engaged in different lines of activities. 
2. Key persons of the entities remain common. 
3. The shell entities form the major portion of the debtors of the primary entities. 
4. There is no physical presence of the major trade partners. 
5. Transaction between the entities takes place in rounded figures. 
6. The shell entity has less share capital but undertakes to execute a high amount of work orders. 
7. The shell entity remains debt-free to avoid due diligence and scrutiny by the lender. 
8. Account turnover is not commensurate with sales. 
9. Cost of sales remains disproportionate to the revenue. 
10. The production capacity does not match with sales. 
11. Delay in filing returns/ documents with statutory authorities.
12. High volume of non-trade transactions in the account. 

Red flags are the indicators that call for further scrutiny and examination. Even if the conduct otherwise appears to be genuine. In this case, the above red flags were ignored leading to credit risk, erosion of capital and degradation of business.