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THE ADDITIONAL CHECKS proposed by the Securities and Exchange Board of India on the use of the preferential allotment route by companies must be welcomed. SEBI's Primary Markets Advisory Committee wants promoters not to sell any shares six months before and after they make a preferential allotment of equity to themselves. This must quickly be made an integral part of the primary market regulatory framework.

Over the last six months, there have been numerous instances of promoters selling their stake to institutional investors — especially foreign institutional investors — at or slightly below the market price. This is done because the FIIs are reluctant to pick up preferential allotments as regulation stipulates a one-year lock-in. If the FIIs are able to get a sizeable lot from the promoters that can be liquidated when they want, the attractiveness of the stock gets enhanced. Thus, promoters have been issuing shares to themselves through the preferential allotment route to protect their stake in the company after selling a part to the FIIs. The abuse can be stopped only if the SEBI proposals are incorporated into the regulatory framework. Such a step would also remove the price manipulation that now happens in the homestretch to a preferential allotment. When a preferential offer is proposed for promoters and associates, the stock's price tends to fall on selling engineered to limit the outgo for promoters as the offer price is benchmarked to prices over the preceding six months. However, if the preferential offer is intended for institutional investors or foreign partners, prices tend to get ramped up to ensure that the offer is priced attractively from the company's point of view. In this context, SEBI must modify the rules to let FIIs pick up a sizeable stake without requiring promoters to go through the charade of selling their shares, and then resorting to a preferential allotment. SEBI should allow transfer of shares among institutional investors (those qualifying as buyers in a book-building offer) even if the one-year lock-in period from the date of preferential allotment is yet to lapse. This would create a healthy market in such shares, without institutional investors suffering price manipulation which is what happens when fresh equity is issued on a preferential basis.

The six-month time frame prescribed by the Committee also takes care of pricing-related issues and removes the scope for abuse on this score. The time limit is also reasonable so as to not affect genuine capital mobilisation plans of the corporate sector. Another welcome step is the proposal that requires promoters to hold their stake in the dematerialised form to ensure it is frozen during the lock-in period. This would enable effective implementation of the regulation. The exemption for preferential allotment of equity made as part of a corporate debt-restructuring package should ensure that the regulatory framework does not impede any genuine attempt to nurse a company to health.

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