Investor protection? It’s time Sebi woke up

In the IPO scam, the Reserve Bank of India (RBI) has imposed fines varying between Rs 5 lakh and Rs 20 lakh on banks which had aided the scam by allowing multiple demat accounts to be opened (using which applicants manipulated the process to improve their chances of allotment). Banks also helped scamsters by crediting cheques in other names (which, after the Harshad Mehta scam, has been disallowed by the RBI). This is so mild a punishment that it will not deter a future scam. All regulators, including Sebi and RBI, must, if they are serious about investor protection, punish culprits so severely that it sets an example to others. This sort of mild penalty, amounting to no more than a rap on the knuckles, is not sending any signal about serious intent to protect investors. Nor has Sebi taken any steps to penalise Roopalben Panchal, or intermediaries like Karvy, who are involved. She should be penalised financially by a multiple of the purported gain.

Investment bankers quote low (sometimes zero) fees to get IPO mandates. Obviously, since they are commercial houses and not charities, they make money elsewhere. Two areas in which they do are discretionary allotments and IPO funding. When making discretionary allotments, they can favour some institutional clients and make up in brokerage what they lose in fees for the mandate.

In IPO funding, they find a safe way to lend with good margins. Banks and depository participants also benefit from multiple applications; the former from interest income earned and the latter from demat account charges.

Some have suggested that there should be no categorisation of IPO investors into QIB (qualified institutional buyers), HNW (high net worth) and retail. All should be given proportional allotment. This, however, would result in far too many investors for the company to service. Servicing investors costs money; each shareholder has to be sent copies of annual reports (which can cost more than the stock itself), notices, etc.

So if we are to think of proportional allotment, we must simultaneously think of removing the requirement to service small investors, sending notices and reports only to those holding a minimum number of shares. Many small investors sell annual reports by weight; there is, in fact, a market  for them in Mumbai, with some available for as much as Rs 10 a copy. Why not make investors bear half the cost of a printed annual report?

In the IPO process, Sebi also needs to look at the risks investors are asked to unnecessarily take. Take, for example, the use of a brand. At the time of the Jet Airways IPO, a lot of questions were raised about the brand which belonged to the promoter but was being sold to the airline at a price to be decided later by external valuers. This became a needless risk factor. And since the brand is being transferred from one pocket of the promoter to another, one does not understand the logic of postponing the valuation for an external agency to determine.

At IPO meets, when queries are raised, managements and lead managers hide behind Sebi on the pretext that they are not allowed to clarify things until the issue is over. More recently, in the GVK Power and Infrastructure issue, the use of the GVK brand (owned by the promoter) has been licensed, on terms to be fixed later, to the company. Why later? Why should Sebi accept that investors should merely be informed of this as a risk factor, instead of it being decided prior to the issue? Wake up, Sebi!

Sebi also needs to look at valuations in the case of mergers and amalgamations (M&As) as, increasingly, M&A activity will take place and swap ratios will become the crucial determinant.  These ratios are worked out by consultants, usually chartered accountancy firms. Often, though, the terms of reference result in a different valuation. In one infamous example, the instruction given was to value a firm being sold on an ‘ongoing concern basis’, under which, past the five or seven years’ profits are simply capitalised at an assumed rate of return.  The same firm, were it valued on a ‘break-up value basis’ would have thrown up a vastly higher valuation, as it owned valuable real estate that was not giving any profit, to be capitalised.

Shareholders of Kochi Refinery are complaining that the valuation ratio of nine shares of Kochi for four shares of BPCL is unfair to them. In terms of earnings per share, return on net worth and operating profit margins, Kochi is better largely because BPCL has to bear the burden of subsidy that belongs to the government, not to it. Individual shareholders would not be able to get legal relief; it would be far too expensive. Sebi must look into the ways in which the determination of a merger ratio can be made fairer.

In corporate news, Reliance has gargantuan plans. Its subsidiary, Reliance Petroleum, is to make an IPO of nearly Rs 6,000 crore to fund a 27 million tonnes per annum (tpa) export-oriented refinery near Jamnagar and a one million tpa polypropylene plant.

It also plans to set up special economic zones (SEZs) in a big way, with a planned investment of Rs 100,000 crore! It is entering into a joint venture with Bechtel for infrastructure projects.

Other large IPOs in the offing include Jet Airways’ $ 900 million one in the international market, and a $850 million one by Vedanta Resources. Pantaloon Retail is to invest Rs 2,500 crore to set up malls in 29 cities and ONGC is setting up a Rs 8,000 crore refinery. With investment demand set to grow, money will start becoming dearer; the RBI signalled this by raising its repo and reverse repo rates by 25 basis points.

Corporate results are, by and large, encouraging. Steel companies, hit by higher input costs, showed lower profits, including Tata Steel and JSW Steel. There is global consolidation happening, with Lakshmi Mittal making a $ 22.7 billion bid to acquire Arcelor, the world’s No 2 steelmaker. The Sensex gained 363 points, going up from 9,520 to end the week at 9,883, led mainly by ICICI Bank and Infosys. The uptrend should continue in the coming week and the Sensex should soon hit five figures! Cheers!

Comments on this column could be sent to jmulraj@gmail.com