[Shreya Saswati and Sruti Patra are 4th year B.A.LL.B. (Hons.) students at National Law University, Odisha]
Recently, the Securities and Exchange Board of India (“SEBI”) sent a letter to bankers with a list of 31 advisory points on due diligence pertaining to initial public offerings (“IPO”). The IPO disclosure requirements at present are quite broad and clear. Starting from the preparation of the draft offer document to the subsequent offer document, all material disclosures are needed to be made to enable investors to make informed decisions. Further, in order to broaden the scope, a general prospectus as well as the red-herring prospectus (“RHA”) are required to abide by all such disclosures as prescribed in the Companies Act, 2013 and Part A of Schedule VI of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”). Additionally, the lead managers (“LMs”) are required to exercise due diligence to abide by every aspect of the offer document. They carry the prime responsibility of confirming every piece of information contained in the draft offer document, after which they submit it to SEBI along with the due diligence certificate.
At the outset, this post underscores the additional disclosure requirements necessitated by SEBI and its implications on the pre-existing disclosure framework under the ICDR Regulations while exploring the repercussions SEBI’s move will have on future disclosure mandates.
New Disclosure Requirements for IPOs
Broadly, the additional disclosures pertain to details regarding pre-IPO placements, shareholders, previous agreements and allottees of employee stock option plans (“ESOP”). Under the umbrella of pre-IPO placements, the LMs need to authenticate not only that the ESOP allottees are employees but also ensure proper disclosure of the price and name of the shareholder on the day of allotment. Furthermore, as a step forward, a proper disclosure of names of suppliers and corresponding customers is required if more than 50 percent of supplies or revenue originates from the top 10 suppliers or customers. If the arrangements are with respect to acquisitions, mergers, and slump sales, then information with respect to valuation and any relationship with the promoters or directors needs to be disclosed.
The LMs should have the direct responsibility of ensuring that there is no conflict of interest between suppliers, third-party service providers, and the company or promoters. They need to ensure that all the funds that a company raises between the draft red herring prospectus (“DRHP”) and RHP must be used for general corporate purposes as mentioned in the DRHP.
The Integrity of the ICDR Regulations
It is important to note that SEBI did not unveil these requirements through an official channel such as through circulars, directions or consultations. Rather, SEBI sent a letter to the concerned bankers with a list of these new requirements. As a result, concerns have been raised about the possibility of these informal observations undermining the sanctity of the SEBI ICDR Regulations. These concerns are justified as the new disclosure norms possess the potential to overpower the framework set forth by the ICDR Regulations.
The ICDR Regulations lay down the guidelines and conditions precedent for various kinds of issue of securities. It is a standard practice for not only companies planning to go for IPOs but also LMs, underwriters, legal advisors, auditors, and other stakeholders involved in the securities issuance process to ensure compliance with regulatory requirements. But if SEBI begins a pattern of coming up with so many unofficial and ad-hoc requirements, a parallel set of expectations and requirements that overshadow the formal regulatory framework will emerge.
When these additional norms impose stricter disclosure and verification processes without actually being part of the ICDR Regulations, it would lead to regulatory inconsistencies and confusion. For instance, it is evident that the IPO chapter of the ICDR Regulations specifies the responsibilities of the LM quite clearly. The LM plays a significant role in the drafting and approval of the IPO offer document. But the new disclosure norms require LMs to undertake additional tasks as illustrated previously. These additional requirements alter the scope of LMs’ duties while overshadowing their traditional role defined by the ICDR Regulations. Nevertheless, these concerns can be resolved if SEBI undertakes a formal consultation and formally amends the ICDR Regulations to harmonize any new disclosure requirements with the pre-existing regulatory requirements.
Ramifications of these Disclosure Requirements
Apart from the spontaneous increase in the responsibilities of the LMs, the advisories will also make it difficult for companies and law firms alike by making the offer documents bulkier and considerably increase the IPO timelines. Although there has been a drop in the average time which SEBI takes to clear the DRHP, these additional disclosures will increase the documentation and, thus, the process will revert to the earlier timelines where there used to be a delay in the clearance of the DRHP.
An unintended consequence of SEBI erratically releasing disclosure norms will be the impact on smaller companies who are new to the issue of securities, either by way of IPOs or otherwise. Having fewer resources and comparatively less experience, these complex regulatory requirements which are emerging from time to time, could affect them, apart from the increased compliance costs.
Similarly, with these unofficial additional disclosures, the market will begin losing trust in the regulatory framework of the capital market, finding it unstable and unpredictable, resulting in the reduction of investments in the country. Thus, there would be a negative impact on the capital market efficiency.
Conclusion
There is no doubt that the new advisories reflect SEBI’s efforts to strengthen transparency and accountability in the securities market. While SEBI’s aim with these norms is to prevent companies from concealing material information that typically goes unnoticed during the process of an IPOs, SEBI’s recent approach to the same is misguided. Issuing advisories to bankers without releasing it on a public platform will generate confusion in a process which is critical to companies. Ambiguity on any level cannot be permitted in an IPO. Furthermore, these informal announcements have the potential to set a precedent for SEBI to exercise its discretion to introduce any norm at any time. Can the capital market sustain that?
– Shreya Saswati & Sruti Patra
