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Indian capital market regulator makes investor protection orders

The Securities and Exchange Board of India (Sebi), India's capital market regulator, has recently barred seven listed companies and their promoters from accessing the capital market. This was done on grounds of misappropriation of initial public offering (IPO) monies, inadequate disclosures and other irregularities. All the companies made IPOs in 2011, and on listing their shares prices became volatile.

After investigations, Sebi concluded that the disclosures made in offer documents by the companies were false or incomplete, undisclosed related party transactions were carried out and funds were routed through various intermediate companies for purposes other than those disclosed in offer documents.

Sebi also took action against the merchant bankers involved in the IPOs on the grounds of failure to carry out proper due diligence exercises. Sebi has barred the bankers from dealing with any fresh IPOs.

Through these orders, Sebi has highlighted several issues relating to the role of merchant banks while conducting IPO due diligence. It appears that in many instances the banks had failed to adhere to due diligence requirements.

A key issue as a result of these orders is the nature of the role played by merchant banks while managing IPOs, especially the extent of their diligence at the time of verifying the information provided by the company. The issue is whether the merchant bank can rely on the information being provided to it by the company and its promoters or as regards each aspect, engage in detailed inspection of each piece information. In other words, just like auditors, are they supposed to be a watchdog or a bloodhound?

In fact, carrying out due diligence cannot be equated with carrying out an audit. While a merchant bank is expected to carry out the due diligence in a meaningful manner, would that mean a detailed inspection of each and every document? For example, a review of the audited balance sheet of a company is ordinarily sufficient for purposes of a merchant bank. However, if the audited balance sheet is itself cooked up, but not in a way which is evident, then is the merchant bank to be faulted?

Sebi has also passed orders against the independent directors of the companies concerned. The orders effectively prohibit them from acting as directors of companies accessing the capital markets. The order against them is on the ground that they failed to fulfill their responsibilities towards the company. It could be asked whether this is a case of taking corporate governance too far.

On the whole, it is seems commendable that Sebi has adopted a broad-based approach in tackling the issue of manipulation in relation to IPOs. That it has sought to lay responsibility at the doors of merchant banks and even independent directors results in raising the stakes for such parties. Whether these actions undertaken by Sebi will actually help protect the interest of investors in the future remains to be seen.

Nitu Agarwal and Arunabh Choudhary

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