Disclosures do not protect retail investors adequately
One of the first promises made by Prem Gupta after he took over the ministry of company affairs was that he would go after companies that had vanished with investors’ money in the 1990s. To his credit, and that of the finance ministry, there has been more joint action on this issue in the last few months than there was in the previous few years.
After a decade in the dumps, the initial public offering (IPO) market is looking up again. Prithvi Haldea of Prime Database predicts that companies will top the 2004 record this year by raising at least Rs 40,000 crore. At the same time, the government must prepare for a fresh onslaught of dubious companies that hope to pocket public money by cashing in on renewed investor interest.
Sebi is already grappling with the problem of how to reject scores of shady applications. So far, it has delayed clearances by raising endless queries. Having chosen the disclosure route to regulation, it cannot continue to avoid clearing issues of companies prepared to publish a long list of embarrassing disclosures in their prospectus.
If disclosures are properly made, Sebi needs to have some objective reasons for rejecting public issue applications. In a few extreme cases, the regulator recently used its power of suasion to force some companies to withdraw their IPO documents. But such arm-twisting tactics can be used very sparingly.
Some leading investor activists have long argued that IPO clearances cannot be based on disclosures alone and the regulator must bring in an element of subjective evaluation. They point out that many American states continue to insist on a merit rating and clearance criteria which is completely subjective. In India, such powers are liable to be misused.
The question then is, are current disclosures adequate to protect investors? The answer is negative. Ideally, a company is expected to make every conceivable disclosure in its prospectus, so that retail investors can make an informed decision. Ravi Mohan, managing director of the Credit Rating and Information Services of India (Crisil) however says that it is difficult to rate an IPO without personal interaction with management.
• The government must prepare itself for a fresh onslaught of dubious companies
• The IEPF must be asked to commission IPO ratings on an urgent basis
Clearly, investors need help in evaluating issues and IPO ratings, although not very popular around the world, are worth a trial in India. The question is, who will pay for the rating? Investor Associations say ratings paid for by the companies themselves will be less credible, especially if they are also free to choose the rating agency.
However, the government is sitting on a big pool of investors’ money (over Rs 300 crore at last count) in the shape of the Investor Education and Protection Fund (IEPF) which is meant to be used for their benefit. Considering that each rating will cost around Rs 4 lakh, the IEPF must be persuaded to commission IPO ratings on an urgent basis.
Ratings commissioned by the IEPF will have several advantages. First, they will be independent of the company. Second, IEPF has representation from Sebi as well as MCA and this would ensure effective coordination and scrutiny of the process. Third, credit rating agencies will have to stake their reputations on a proper rating that ensures investor protection.
The MCA and the finance ministry will provide investors with an important evaluation tool and they can persuade IEPF to adopt and initiate such a rating process urgently. However, it must be remembered that ratings alone will not absolve regulators from their responsibilities. Past experience suggests that Sebi must prepare for dubious IPOs by ensuring better coordination with the Reserve Bank of India (RBI) to check the role of banks in aiding and abetting unscrupulous promoters.
For instance, during the 1992-94 boom, many banks (including nationalised banks) colluded with companies to cheat the public. They asked defaulting companies to raise public money in order to repay overdue bank loans; they also helped dress up their accounts and lent credibility to their prospectus by lead managing and underwriting the issues. Sometimes the lender was also banker to the issue and simply did not part with the application money. Such investments were doomed from the beginning.
The role of banks and investment bankers was never properly investigated in the 1990s. A coordinated approach and better vigilance could prevent investors from being cheated again.