Market regulator Sebi asks auditors to tread with caution with SMEs

WTM Ashwani Bhatia says preferential allotments used to benefit promoters

Whole-time member of the Securities and Exchange Board of India (Sebi) Ashwani Bhatia on Friday sounded a cautionary note on listings and fundraising by small and medium enterprises (SMEs), amid instances of manipulation and fraudulent practices.

Speaking at a conference held by the Institute of Chartered Accountants of India (ICAI), Bhatia stressed that such cases could have been prevented with diligent auditing.

His comments came after Sebi’s recent actions against several SMEs for flouting norms, manipulating financials, and engaging in fraudulent activities. The regulator has also found instances of the use of mule accounts to inflate IPO subscriptions and pricing.

The most recent order on Friday against Debock Industries showed fictitious transactions to inflate the balance sheet, and the use of preferential allotment to migrate to the mainboard, as well as siphoning off funds raised through a rights issue. Sebi has barred Debock Industries and its management from the securities market and ordered the impounding of illegal gains of Rs 89 crore.

“We simply do not like layering, we do not like money going to related parties, which a couple of years later you write off. It is very easy to monitor. We have seen transactions flowing on a single day to 10 different entities and coming back to the same company in layers. Be careful and be good partners to the entities you engage with,” Bhatia urged the auditors at the event.

The Sebi WTM also asked them to be vigilant and raise flags if they notice issues with financial numbers.

“Auditors need to be vigilant. There is an inherent conflict of interest in related party transactions — the directors are to manage the interest of the company and the interest of themselves and their friends. Mismanagement of this conflict of interest leads to diversion and siphoning off funds, ultimately benefiting the promoter companies at the cost of erosion of shareholder wealth. Auditors need to ensure that disclosures on RPTs comply with the law and spirit,” he added.

Bhatia also noted that despite easing delisting regulations, companies are not opting to go private due to high valuations. Instead, global firms are attracted to list in India. He added that the mutual fund industry, which currently commands an asset under management of Rs 65 trillion, could surpass the banking industry's size. 

The market regulator has stepped up vigilance against SMEs, with the National Stock Exchange (NSE) tightening eligibility conditions for listing by including positive free cash flow to equity (FCFE) as a criterion. The change will be effective from September 1.

According to a notice issued on Thursday by NSE, SMEs must have a positive FCFE for at least two out of three financial years preceding their application for IPO to be eligible. The change will be effective from September 1. The calculations will also be made on the audited balance sheets.

Earlier, Sebi had extended the short-term additional surveillance measure (ST-ASM) framework to SME stocks which monitors the price and volume volatility. The exchanges have also imposed a 90 per cent cap on the price rise on listing day for SMEs.

The total number of listings on NSE Emerge has crossed 500 as of July with 22 new listings in the month. July saw the highest number of listings in a month with fund mobilisation of Rs 1,030 crore.