Caution, IPO ahead

The capital markets regulator’s order last week laying down a long list of ‘disqualification’ criteria for initial public offers (IPO) is welcome as initiative goes, but is fraught with regulatory challenges. While some of these criteria are objective in nature and can, hence, legitimately form the basis for rejection of offer documents, the rest, being subjective, can lead to litigation. Thus, offers by companies that dress up numbers through related-party transactions, or by those with pending litigations threatening their very survival and projects without critical regulatory clearances, may not pose a challenge, as a summary rejection on any of these grounds can stand the test of judicial scrutiny.

But where the Securities and Exchange Board of India (SEBI) is treading on thin ice is in laying down subjective criteria that, in the event of forming the basis for rejection, can be challenged, thus leading to vexatious litigation. One such ground is if a prospective issuer’s business model is “exaggerated, complex or misleading and investors may not be able to assess risks associated with the business”. How is SEBI to determine ‘complexity’ for the lay investor? Similarly, an “unreasonably long” gap between raising the funds and utilising them is a no-no, but again with no proper definition of ‘unreasonable’! The SEBI order also frowns upon use of IPO proceeds for a purpose that does not create any tangible asset, such as meeting advertising expenses or consulting fees. This condition ignores the fact that many consumer-oriented businesses would possibly create better investor value through brand-building than putting up fixed assets. Moreover, how is SEBI going to clear offers within a reasonable time frame, if it sets out to screen everything from the issuer’s business model to its accounting policies and financing decisions? It is understandable that SEBI, in its efforts to rebuild retail investor interest, should focus on primary market reforms. Investor confidence there has taken a beating in recent years, with many instances of exorbitant pricing, poor disclosures and even sheer manipulation of the bidding process. But given the limited resources at its disposal, SEBI is biting off more than it can chew.

Also, filtering out poor quality IPOs, such as there are, will not revive the primary market anytime soon. The tepid investor response to issues has arisen mainly from unsustainable pricing timed to bullish market conditions. Curbing such practices isn’t easy, unless SEBI plans to go back to an era of ‘pricing’ approvals as was the case in the Controller of Capital Issues regime. SEBI has already done quite a few things to level the field for retail investors by measures such as making the offer/bidding process quite transparent, ending the advantage enjoyed by institutional investors, and cracking down on instances of blatant manipulation. Beyond that, the doctrine of ‘caveat emptor’ should guide its actions.

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