Sebi's trading, delisting regulations for IBC firms don't help investors

Retail investors owning shares of companies undergoing insolvency proceedings need to watch out. The stock market regulator, the Securities and Exchange Board of India (Sebi), has imposed restrictions on the trading of these stocks. It has also relaxed the norms for their delisting. Many existing investors in these companies could end up getting the short end of the stick owing to these changes.

According to some market experts, the regulations indicate that the regulator wants retail investors to stay away from stocks going through insolvency proceedings, so that they don’t end up losing money. And it’s for a good reason. Brokerages say that clients come to them regularly asking for their views on these companies, and whether they can be an attractive buy. “Some investors hope that the bidder who takes over the indebted company will turn it around, giving them windfall gains. But with complete uncertainty around bankruptcy proceedings, there’s no rationale for retail investors to either invest or hold these stocks,” says Abhimanyu Sofat, head of research, IIFL.

Even after Sebi brought companies admitted to National Company Law Tribunal (NCLT) under surveillance recently, imposing restrictions on their trading, they have moved up unhindered since then. The stock of Alok Industries, for example, is up 56.6 per cent since the beginning of July, Orchid Pharma has gained 28.9 per cent, and Jaypee Infratech is up 11 per cent.

The stock prices of these companies rise and fall with news of the resolution the bidders are offering. Even if investors buy these stocks for the long term, there are chances that the winning bidder may choose to delist the company. That’s why it’s best that retail investors exit their holdings in the cases that are admitted in National Company Law Tribunal (NCLT) if they are getting some value for their stocks. The rationale: An indebted company going to NCLT means that there no value left in the business. Here’s how the two recently-introduced regulations will affect investors. 

Restrictions on trading: While the insolvency proceedings have been going on at NCLT for many months and some resolutions are in  advanced stage of receiving approval, there was lack of clarity from Sebi on trading and delisting of these stocks. The regulator has now offered clarity on these issues. 

To protect retail investors from price rigging and manipulation, the stock market regulator along with exchanges recently put over 109 stocks under surveillance. The list includes even Group A companies like Bombay Dyeing, Dilip Buildcon, Indiabulls Ventures and Rain Industries, and also stocks that are undergoing insolvency proceedings, such as Alok Industries, Amtek Auto, Jaypee Infratech, and so on.

These stocks have been brought under the Additional Surveillance Measures (ASM) framework. Exchanges put stocks under ASM if their prices do not appear to be justifiable, based on parameters such as price variation, price-to-earnings ratio, number of times a stock hits the circuit, and so on. These stocks are reviewed on a bi-monthly basis. Once under ASM, investors will not get any leverage from brokers to invest in these stocks (investor need to give 100 per cent margin). Exchanges have also revised the circuit filter to five per cent. “Price rigging or manipulation happens using leverage. Increasing the margin to 100 per cent will help curb such malpractices,” says Nikhil Kamath, co-founder, Zerodha.

Liquidity issues could arise:

While the regulator wants to avoid price manipulation by imposing restrictions, these measures could cause liquidity issues in the short term. Traders usually use leverage to build positions in stocks. As brokers will now charge 100 per cent margin on these stocks, most traders are likely to stay away. The five per cent circuit filter will act as an additional deterrent. IVRCL, for example, closed at Rs 1.28 a share. For the stock to hit the upper circuit, it needs to gain just six paise (Rs 0.06).

Lack of information makes them speculative:

Market experts suggest that investors should avoid trading in these stocks as even a single adverse development could cause them to tumble. Putting money in stocks under bankruptcy proceeding is mere speculation as investors are not privy to developments. None of the stakeholders are mandated to share information in the public domain.

New delisting rules may not serve investor interest: According to the new delisting norms, a company under the insolvency proceeding is no longer required to follow the reverse book building (RBB) process for price discovery. All the shareholders will have to tender their shares at a fixed price. The offer price for delisting will be the liquidation price minus the dues that need to be paid on a priority basis under IBC.

Investor associations have written to Sebi for a review of these norms, which they say are against minority shareholders. Their reason:

Investors who have stuck with the indebted company will not get to be a part of a possible turnaround under a new management. Recently, Vedanta Star took over Electrosteel Steel by bidding under IBC. While there is a possibility of a turnaround, the bidder has announced that it will delist from the stock exchanges and pay 19 paise (Rs 0.19) a share to minority shareholders. While Vedanta Star is offering some value, according to the prescribed formula, the value can even be negative in certain cases. It means that the winning bidder doesn’t need to pay anything to shareholders. “IBC has been introduced to serve lenders’ interest and they will not compromise. They will demand their pound of flesh,” says Sofat. Whatever money the bidder invests in the indebted company goes first to secured and unsecured creditors, bondholders, and then the government's dues are paid. Only after all these parties have been repaid in full does the shareholders' turn come. But in the current prominent cases, the secured and unsecured creditors are receiving only a part of what the company owes them. Equity investors should, therefore, not expect any value out of these resolutions.