Jayant M Thakur: A bad idea from Sebi

The proposal to disgorge profits from the IPO scam and to distribute them to the affected investors may appear fair, but is it legal or right.

It was reported recently that Sebi proposes to forfeit the profits made by alleged IPO scamsters and distribute this to those small investors who consequently got lesser shares and, therefore, smaller profits. While, at first sight, this seems to be a fair proposal, on closer examination, it appears that it may do more harm in the long run. Before we examine the pros and cons of this development, let's recap what allegedly happened in the so-called IPO scam.

It was alleged that some persons, in a well organised manner, made multiple applications in IPOs in the "small investors' quota" using fictitious names and other devices. They thus got more shares than they would have got otherwise.

Since, on listing, the price was higher than the issue price, they stood to gain. Sebi, however, took various steps including freezing accounts, issuing prohibitory orders and so on, and even took action against the intermediaries allegedly involved. Some of these orders are said to be in appeal.

Sebi now reportedly proposes to forfeit these gains and pay these to those small investors who would have otherwise got these shares and made profits. On first impression, this may appear to be a fair proposal. However, with due respect, this proposal is setting a wrong precedent, is against the avowed objectives of the whole scheme and, hoping not to sound too uncharitable, is a populist proposal, perhaps illegal also.

To appreciate this, we must first understand why the quota for small investors is made. Firstly, in law, a company is permitted listing only if it has the minimum public shareholding, which is usually 25 per cent. Secondly, one would expect that the more the number of shareholders, the deeper would be the market trading. Hence, it may make sense having a larger number of small investors rather than a few large investors. It was for these and other purposes that reservations were made for small investors.

The reservation for small investors is not like the distribution of goodies or sweets where all should get their fair share. It is not as if Sebi has made a law that companies should come out with a low-priced issue for small investors so that they may profit therefrom. If that was the intention, then it may appear fair that persons who corner an undue share should be made to give it up and be further punished also. The crucial and incorrect assumption thus made is that such IPOs would necessarily result in profits.

The post-listing price can be higher for several reasons. Perhaps the company made a bad judgement and under-priced the issue. Perhaps the markets were very bullish. Whatever the reason, these matters are best left to market forces and this is the approach Sebi consistently takes in other cases.

It is for the company to decide its issue price, howsoever high or low. It is for the investor to decide whether and how much to subscribe for. Sebi's role is limited to ensuring that there is adequate disclosure and compliance. It is not for Sebi to see whether the investors have made a profit or loss unless the disclosure was inadequate.

The matter would be different if, say, a group of scamsters rig the market by systematically and artificially raising the price and then circulate rumours in order to offload to unsuspecting investors. In such a case, the scamsters make a profit and the investors make a loss and it is fair that this is set right.

The same would be the case with open offers or offers for delisting where all should get a chance to participate and gain. But in the case of an IPO, there is no question of distribution of gain. It is a pure risk proposal an investor makes based on his judgement.

What would have happened if the scamsters had made a loss? In such a situation, they would have actually saved the small investors from loss! The point again is that, in these and most other areas where pricing is involved, Sebi has rightly taken a distant stance where it will not interfere with price determination by market forces.

Now, if Sebi takes a stand that IPOs make a profit and that these profits should be distributed, then it is misdirecting itself along the wrong path.

Could Sebi, for example, stop these companies if they had allotted shares directly to such group of persons at the IPO prices? Surely not, so long as the other norms were followed. If that is the case, saying that they made undue gains through the IPO is not right.

One may recollect that just a few years back, many IPOs were not getting their minimum subscription. Hence, unscrupulous promoters used to "arrange" for "investors" who would have a buyback arrangement. They would subscribe for the unsubscribed portion and then these monies would be returned usually to the company itself.

In such cases, the whole objective of Sebi, that there should either be minimum public investment or listing should not be allowed, was frustrated and hence, Sebi's action was justified.

Of course, if what Sebi states to have found is right, there is certainly cause for outrage, particularly if the whole system is subverted, fictitious applications made and accounts opened in false names.

For such cases (which one cannot comment on any more, since some of these matters are in appeal and hence sub-judice), it is submitted with great respect that, the law permitting, severe punishment may be justified. But I respectfully also submit that the disgorgement of funds cannot be justified solely on the populist proposal and ground that it is for distributing to small investors.

Serious questions of law arise. Can Sebi disgorge profits? Were these alleged multiple applications illegal? Does Sebi have the power in law to distribute profits to small investors?

By interfering with the free market forces of price determination, instead of standing aloof and ensuring transparency, Sebi may set a bad precedent and may be forced to continue to do so in many other situations.

To conclude, while the Sebi proposal is with good intentions and good consequence also, it is misguided and can create more long-term harm than short-term benefits.

The writer is a chartered accountant. He can be reached at jmthakur@yahoo.com