Public Offering of Securities: Liability of Investment Bank

In order to ensure accuracy of disclosures in offering documents pertaining to public issue of securities, regulators tend to impose liabilities for misstatements on issuers as well as intermediaries. The intermediaries, referred to as “gatekeepers” perform an important role in the securities markets. In his book, Gatekeepers: The Professions and Corporate Governance, Professor John Coffee notes (on pp. 1-2):

What Are Gatekeepers? The term ‘gatekeeper’ has been used in many different settings across the social sciences usually in ways that are more metaphorical than precise. Typically, the term connotes some form of outside or independent watchdog or monitor—someone who screens out flaws or defects or who verifies compliance with standards or procedures.

Within the corporate context, the prior academic commentary has usually used the term ‘gatekeeper’ to mean an independent professional who plays one of two distinct roles, which tend to overlap in practice. First, the gatekeeper may be a professional who is positioned so as to be able to prevent wrongdoing by withholding necessary cooperation or consent. For example, an investment banking firm can refuse to underwrite the issuer’s securities if it finds that the issuer’s disclosures are materially deficient; similarly, an auditor or an attorney who discovers a serious problem with a corporate client’s financial statements or disclosures can prevent a merger from closing by declining to deliver an opinion that is a necessary precondition for that transaction in this first sense, the gatekeeper is a private policeman who has been structured into the process to prevent wrongdoing. By withholding its approval, it closes the gate, typically denying the issuer access to the capital markets. …

However, defining gatekeepers simply in terms of their capacity to veto or withhold consent misses what is most distinctive about the professionals who serve investors in the corporate context. Inherently, they are repeat players who provide certification or verification services to investors, vouching for someone else who has a greater incentive than they to deceive. Thus, a second and superior definition of the gatekeeper is an agent who acts as a reputational intermediary to assure investors as to the quality of the ‘signal’ sent by the corporate issuer. The reputational intermediary does so by lending or ‘pledging’ its reputational capital to the corporation, thus enabling investors or the market to rely on the corporation’s own disclosures or assurances where they otherwise might not. The gatekeeper has such reputational capital because it is a repeat player who has served many clients over many years. …

Consistent with theory, SEBI imposes liability for violation of securities laws directly on the issuers on the one hand, and also on various intermediaries (or gatekeepers) on the other hand. Among these intermediaries, investment banks are subject to immediate oversight by SEBI as they are registered with SEBI. In the context of public offering of shares, investment banks have a duty to conduct due diligence in order to ensure accuracy of disclosures in the offering document.

In this background, SEBI has recently issued an adjudication order imposing a penalty of Rs. 25,00,000/- on Enam Securities Pvt. Ltd., an investment bank, primarily in connection with the IPO of Yes Bank. The bone of contention of contention relates to whether the offering document should have disclosed Rabobank International Holding B.V. as the promoter of Yes Bank. The adjudicating officer found that the investment bank was in breach of its due diligence obligations in not disclosing Rabobank as the promoter in the offering document.

While the order is representative of SEBI’s initiatives in imposing liability on intermediaries as a means to ensure adequate disclosure, it also highlights difficulties in certain matters of interpretation under the disclosure guidelines. More specifically, the term ‘promoter’ has hitherto been defined differently in various regulations of SEBI (such as those relating to disclosures in offer documents, takeover regulations, etc.), although efforts have been made more recently to streamline those definitions. Nevertheless, this case highlights difficulties in nailing down entities as promoters for the purposes of offer documents.

On a separate note, SEBI’s efforts to impose liability on intermediaries are not confined to those registered with it. It has previously sought to exercise jurisdiction on auditors in the Satyam case, which approach has received concurrence of the Bombay High Court.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.


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