Two recent documents from the Securities and Exchange Board of India, or Sebi, suggest that the market regulator is acting at cross purposes with its brief. The first, a discussion paper on a “mandatory safety net mechanism”, outlines a buyback mechanism to protect retail individual investors, if the price of a recently listed share falls below the issue price. The second, an order entitled “Framework for the rejection of draft offer documents” lists wide-ranging, vaguely defined discretionary criteria for the same. If these measures are implemented, they will have an entirely negative effect. On the one hand, they would make initial public offers less attractive for issuers. On the other, they would offer much scope for officers of Sebi to exercise discretionary power in undesirable ways.
The buyback mechanism proposes to compare the normalised performance of newly listed shares with the performance of a benchmark index like the CNX500. The trigger level would be 20 percentage points less than the relative index performance. For example, if, at the end of three months of listing, the price of a share falls, say, 30 per cent below the issue price whereas the index falls, say, 10 per cent in the same period, the buyback will begin. The promoter would have to buy back shares offered by retail individual investors at the issue price. The buyback would be capped at five per cent of issue size with a proportionate formula if retail allotment runs above this limit. This is contrary to any definition of risk capital and of the principle of caveat emptor. Investors accept an explicit risk of capital depreciation when they buy equity. Assuming Sebi has done its due diligence and ensured that the offer documents present a fair and transparent picture of the financials and the business model, it must be up to the investors to decide if they will buy a given business at the offered price band. Comparisons to indices are frequently useless in any case. A given business may be counter-cyclical with low index correlation. Or it may be a long-gestation project where the price performance in 90 days cannot be meaningfully compared to a broad benchmark.
The grounds for rejection of offer documents also appear to be ill-defined and wrong-headed. For example, draft offer documents may be rejected “where the object of the issue is vague”; or it is proposed to use the capital for purposes “which do not create any tangible asset such as expenses towards brand-building, advertisement”; or is “such where the time gap between raising the funds and proposed utilisation is unreasonably long”. Rejection may also occur where the business model “is exaggerated, complex or misleading and the investors may not be able to assess the risks associated”. Markets exist because one person’s definition of “vague” or “unreasonably long” or “exaggerated, complex or misleading business models” is liable to differ sharply from another person’s definition of the same. The market decides who is right. Regulators are also scarcely infallible judges of the utility of expenses. A glance at the advertisement and brand-building budgets of Hindustan Unilever, Maruti, Airtel and HDFC might suggest that these are not unimportant in certain businesses. It is not the market regulator’s job to remove risk, or define what expenses are “useful”, or determine whether a business model is “vague” or “complex”. It is to ensure a level playing field by setting transparent norms for disclosures and to mandate simple, easily understood market processes that cannot be gamed. Sadly, these documents suggest that Sebi has lost sight of its basic objective.