Small Issues: Well-warranted caution  

April 25, 2005

IPO history tells us that caution about small issues is indeed well warranted.

Small companies: Well-warranted caution

By Sucheta Dalal

Last week, the Consumer Education Consumer  Education and Research Centre (CERC) of Ahmedabad (with which I am connected), put out a press release calling attention to the need to look  at  the  phenomenon  of `vanishing  companies' which have "comfortably  and  conveniently escaped  fiduciary  liability," when investors  have  lost  their lifetime savings.

The concern is timely.  For several months now, the Securities and Exchange Board of India (SEBI) has been stalling the clearance of Initial Public Offerings (IPOs) where the issue size is too small or the promoters are unknown. And where there was no specific project and the funds were being used to retire high cost debt or general corporate purposes.

Market circles allege that there was a clear bias against smaller companies and they were invariably stalled. All this seems to have ended in the last couple of weeks under SEBI’s new chairman M.Damodaran.

Suddenly a spate of issues has been cleared, many of them small and medium companies and this has given rise to a lot of unease among those who have been fighting the phenomenon of vanished companies.

Does this mean there is a bias against small companies? Certainly not. Although market intermediaries would like to brand such concerns as a ‘phobia’ against smaller companies, the truth is vastly different.

The concerns arise from past experience where smaller companies found it a lot easier to siphon off public money and squander it away on luxury cars, fancy housing and foreign holidays.

In fact, there are several reasons why these concerns are valid. Firstly, the largest number of vanished companies is from this segments and it is valid to argue, on behalf of investors, that mistakes of the past must be avoided this time.

Secondly, these promoters are always more difficult to trace. Many of those who cheated investors during the primary market mania of the 1990s have even vanished abroad.

Thirdly, SEBI’s disclosure based clearance mechanism is a problem. A lot of serious risks are hidden away or obfuscated through the turgid prose in bulky prospectuses. And it is a clear recipe for another round of cheating.

Why is it so difficult for market intermediaries and the regulators to understand that these companies could do with some special attention? We are not arguing that all small companies are bad. In fact, the best companies have started small and even an iconic company like Infosys Technologies found it difficult to find subscribers when it first went public. Does that mean that investors were foolish for not recognising that Infosys was an uncut and unpolished diamond?

That would be ridiculous. What Infosys is today is all about the special qualities of its promoters. And there was no way anyone could have known that a bunch of professional engineers would be able to build such a phenomenally successful, global enterprise.

So those who took a risk on Infosys are millionaires today (if they held on to the stock) and those who came in later have been rewarded even after paying a higher price. That is how the market works and there is nothing foolish about being careful about small and unknown start up companies.

Another anti-investor myth is that SEBI’s stricter norms are keeping out the shady issuers. In fact, dubious companies stayed away only because the primary market was dead for 10 years. And even after it began to revive with the Public Sector disinvestments issues of 2004, the subscriptions were restricted to large, well-known companies.

Proof of this is in the list of 18 companies that have been forced or ‘persuaded’ by SEBI to withdraw their prospectuses after January 2003. Their names are : Ken Software Technologies, Subhtex (India), Indowind Energy, HFCL Infotel, Zylog Systems, Qpro Infotech, Himadri Industreis, A to Z Superstore.com, Epsilon Industries,  Proalgen Biotech, Speical Blasts, Plus Paper Foodpac, SPS Steels Roling Mills, ARS Systems & Communications, Mardia Sons Holdings, Software Horizon (India), Alang Shipbreakers, Kolar Biotech.

Further proof of promoters trickery and devious strategies to cheat retail investors is in the rampant issue of preferential shares by industrialists to themselves and the manner in which they are raising money through Foreign Currency Convertible bonds or GDR issues when they have no project in sight and would probably deploy the money into the stock market.

The next question is, should small and mid-cap companies be kept out of the market? Again, the answer is no. These companies need to be handled differently and in fact suffer in many ways on account of being lumped with the large companies.

One the one hand, there is certainly a case for closer scrutiny of these issues and on the other hand, there is a case for the regulator to find a way to lower compliance and advertising costs. Or, to create an active alternative platform (the Indonext is an example) from which they can quickly and smoothly graduate to the main board of the Bombay Stock Exchange and the National Stock Exchange when they grow and need more funds.

This aspect to the small company issue needs to be discussed nationally and a proper policy formulated to help small companies list their shares and grow into the Infosys Technologies of the future.

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