Less discretion, please

Reports indicate that the Securities and Exchange Board of India (Sebi) is once again thinking of imposing curbs on the discretionary allotment of shares to Qualified Institutional Investors (QIBs) in initial public offerings (IPOs), after complaints by banks and others that they had been unfairly discriminated against in the allotment of shares in recent IPOs.

The issue is by no means a new one. It has long been recognised that since the allotment of shares to QIBs by the book-running lead manager is wholly discretionary, it is open to misuse.

One way of abusing the system is for the lead managers to ask their friends among the QIBs to put in their bids as soon as the issue opens, so that the issue is oversubscribed within minutes.

This magnifies the hype surrounding an IPO, luring retail and high net worth investors to jump into the fray. Sebi attempted to address the problem by stipulating that QIBs could not withdraw their bids, but that hasn't really helped, since an institution can bid for a million shares when the issue opens and can revise the bid to just one share before the issue closes.

Also, since the allotment is discretionary, the lead managers can always not make any allotments to any of their friends who don't really want a share of the issue.

However, during bull markets such as the present one, the opposite is true, with QIBs clamouring for allotment, because those favoured investors who can get their hands on the stocks in an IPO make a killing in the secondary market.

In fact, lead managers can actually create an artificial shortage in the market by distributing the stocks to a chosen few.

Several solutions to the problem have been mooted, some of them by Sebi-appointed committees. Some have called for making QIBs pay their money upfront, just like the high net worth or retail investors have to do.

Others want QIBs to pay margins on the bids made by them. In case bids are revised the margin could be forfeited. Yet another suggestion is that a proportional allotment system should be made applicable to QIBs, in the same manner as for other investors.

On the other hand, supporters of the present system point out that it is an accepted international practice to have discretionary allotment for QIBs.

They say that it helps the issuer gets the best price and allows the lead manager to allocate the shares so as to ensure that short-term players do not corner them.

However, internationally too there have been many cases of abuse of discretionary allotments, perhaps the most notorious one being the shares allotted by Salomon Smith Barney in hot telecom IPOs to Bernie Ebbers, the former chief of WorldCom, who has now been sentenced to 25 years in jail.

In short, there's a good case for a re-look at the allotment process to QIBs, albeit at the same time ensuring that issuing companies continue to get the best possible price for their IPOs.

Ways and means of increasing transparency in the allotment process to QIBs need to be considered. One way forward would be to mandate the parameters for allotment to QIBs rather than leave it to the lead managers to decide these norms.

The issue of having margins to discourage frivolous bids may also be looked into. At the same time, as the Sebi chief has asserted, the issue must be handled in a consultative manner after discussions with all market players.