The clock is being set back. With weak institutional memory of why India did the things she did in 1991, measures that are directly contrary to the policy intent of the 1991 reform agenda are now being introduced. Two recent announcements from the Securities and Exchange Board of India (“SEBI”) underline this point emphatically.
SEBI sought public comments on a discussion paper titled “Mandatory Safety Net Mechanism” proposing to make the provision of a “safety net” mandatory for all initial public offerings of shares. SEBI also issued, without seeking public comments, a “general order” titled the SEBI (Framework for Rejection of Draft Offer Documents) Order, 2012 (“Rejection Order”) stating that SEBI would now start rejecting securities offerings on grounds of the issue quality being poor.
Each of these measures will throw the securities regulatory policy back to a regime that pre-dated the institution of SEBI. In 1991, SEBI was given statutory powers with utmost urgency, through a Presidential Ordinance to abolish the office of the Controller of Capital Issues (“CCI”). The CCI essentially controlled who could access the capital markets, the amount that could be raised, the price at which securities ought to be priced, and thereby attempted to ensure a good quality of securities offerings. Convincing the CCI used to be an important skill-set. The paternalistic wisdom of the CCI was a key ingredient of investor protection. The quality of disclosures did not matter because Big Daddy decided who was kosher for the market.
Capital formation in the country became very weak and businesses were starved for capital. When we were on the brink of economic collapse, the CCI was abolished and a disclosure-based regime overseen by SEBI was introduced. The markets regulator would set the rules of disclosure and ensured that everything material was disclosed, leaving it to markets to accept or reject a securities offering. In the 1990s, SEBI chairmen would be asked how they could countenance an issuer chaired by a murder suspect accessing the capital markets. They would respond that they would only ensure that the issuer discloses it has a murder suspect at the helm. If investors believed that it did not matter, then so be it.
The Securities and Exchange Board of India would give “comments” and intervene in the form of moulding the quality of disclosures, but would never sit in judgement about whether an issue ought to be access the market.
Indeed, wherever SEBI believed any person was unfit to access the capital markets, it could always pass reasoned orders under Sections 11 and 11B of the SEBI Act, and subject itself to appellate scrutiny by the Securities Appellate Tribunal. The concept of free-pricing was progressed further logically – over time, book-building was introduced to give a platform for negotiated securities pricing. Whatever the shortcomings in the book-building framework, directionally, SEBI stayed clear of controlling price and issue quality – at least, on paper.
Some SEBI officials indeed used to enforce unwritten self-made law by holding up comments on draft offer documents where they had judged the issue to be of a poor quality. That way, the hard work of writing a restraint order and facing appellate review was obviated. Clearing offer documents after years was not uncommon. Verbal directions to withdraw the offer document are also common.
Now, through the Rejection Order, SEBI has publicly said that it would sit in subjective judgement over the quality of a securities offering. For example, SEBI may reject an offering if “the business model of an issuer is exaggerated, complex or misleading and the investors may not be able to assess the risks associated with such business models”. Another anomaly is that SEBI may reject an offer document if there is no discernible promoter – directly contrary to its own regulations which, on paper, permit issuers without a discernible promoter to access the market.
SEBI is also giving a “one-time” opportunity to withdraw any offer document already pending with SEBI, within a month. Clearly, the signal is: “come to markets, if you dare.”
SEBI could have shot itself in the foot with this regime. When SEBI does not reject an offer document, it would only be logical to assume (regardless of the disclaimers it may write) that SEBI has been adequately satisfied that the issuer’s business model is not exaggerated, complex or misleading, and that investors are able to assess it well.
Likewise, the proposal to introduce a mandatory safety net “to reinforce investor confidence in capital markets and discipline issuers and market intermediaries” is also a throwback to the pre-1991 era.
If in three months from listing, the volume-weighted average market price of a newly listed share were to fall by more than 20%, adjusted for movement of an appropriate securities index, the promoter would have to buy shares from resident individual investors who had invested Rs. 50,000 or less, if they are unhappy and want an exit. His outlay would be capped at 5% of the issue size.
If this budget is inadequate to buy the shares sought to be sold to him, he would have to buy them out in proportion – a classic micro-engineered and detailed rationing architecture involving a lot of administration. Most importantly, such a safety net will cause long term damage by weakening the capacity of investors to understand equity shares as risky investments. No one can quarrel with the regulator using its powers to restrain a securities offering when a fraud is detected. However, to sit in judgement about whether a business model is of a good quality is a very different. It heralds a marked shift from a disclosure-based “regulatory regime” to a quality-judged “control regime”. The most laudable of objectives cannot justify an ill-fitting regulatory measure. Each of these measures represents a foundational change in our regulatory policy, taking us precisely the direction we abandoned in 1991.
(The author is a partner of JSA, Advocates & solicitors. The views expressed herein are his own.) somasekhar@jsalaw.com
