SEBI takes steps to strengthen initial public offerings market

Towards the end of last year, the Securities and Exchange Board of India (SEBI) took some important steps aimed at cleaning up the IPO (new issue) markets. It barred seven companies that were found to have committed malpractices in their recent public offerings from entering the capital market again.

Along with them, six merchant bankers, who had managed their share issues, have also been hauled up. Specific charges against these companies include falsifying or withholding information and diverting the funds for purposes other than what were proposed in the offer documents.

Disclosures in prospectus

Those are serious offenses that strike at the integrity of the IPO process, which is built on proper disclosures in the prospectus. Unfortunately, the sanctity of the prospectus has for long been given a go bye.

Hardly any one, even those intimately connected with the issue process, gets to read it. It is legally necessary document, which, over the years, has become bulky and incomprehensible to all except the experts.

It is common knowledge that even managers to the offer, legal advisers and others who have a vested interest in preparing/vetting the prospectus are often negligent in their duties and do not take their legally mandated roles seriously. For those investors intent on scrutinising the offer documents, they are not accessible. Companies making the public offer want to economise on printing and stationery expenses. What better way than to print and distribute very few copies of bulky documents, which are apparently of no use to any one directly connected with the issue process.

No wonder then that in the issue process, publicity material, conferences and so on have become the prime means of communication with the investors. Although these should not convey messages that are different from what is stated in the prospectus, companies and their merchant bankers are known to violate the rules with impunity.

The allegations against the seven companies are that they illegally diverted the money garnered through the IPOs. Whatever purposes they claimed to have raised the money and so stated in the prospectus were not the real ones. The IPO process has thus become a tool for hoodwinking investors.

It is never easy for SEBI to check such malpractices, which inexorably sap investor confidence in the IPO process.

Like in the phenomenon ‘of vanishing companies', the loss is not confined to investors. Companies with name boards and nothing else floated IPOs. Their promoters just disappeared after collecting the money. Surely, these companies must have complied with all the legal formalities — filing of prospectus, obtaining consent letters from various intermediaries (whose names appear in the offer document) and so on. They would have also mentioned some fictitious purposes for which they are floating shares. With such intentions and planning, is it really possible to stop such unscrupulous promoters in their tracks? Assuming it is possible to identify the culprits, can they be awarded deterrent punishment that would send loud messages to would-be perpetuators? The regulator has promised to look at other cases too but should not stop with merely identifying the fraudulent IPOs and barring the issuers from future issues.

Perhaps, this is all the regulator can do. SEBI has promised to involve other investigative agencies. How far those investigations will go and how soon they will be concluded are matters of juncture at this stage.

Merchant banks, less than stellar role

Rules and regulations governing the IPOs are based on self-regulation and oversight by merchant banks and other intermediaries.

One of the important reform measures that the newly formed SEBI undertook in the 1990s was to license capital market intermediaries, thus bringing them under regulation for the first time. Further, every public issue will have to be managed by one or more merchant bankers. It was hoped that the merchant banks, even more than the actual issuers of capital, will do everything to protect the integrity of the markets. That is because they have a much bigger stake in protecting the integrity of the markets.

At the barest minimum, it was hoped that they would not support dud or fraudulent promoters and their IPOs. But, time and again this assumption has proved to be too simplistic. Crooked promoters too are supported by one merchant bank or the other.

Most commentators think that fraud or perception of fraud is one reason behind the low retail participation in public issues. Obviously, it is necessary to proceed further with institutional reform and at the same time convey to investors that the market environment is in fact improving.

Another vital reform measure is educating investors. Well informed investors can check sharp practices and hopefully counter rampant cynicism in the financial market.

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