Creating A Real IPO Market

Last week SEBI punished seven companies for malpractices committed during their IPO process. It also took action against the merchant bankers who had managed the issues. These companies have all had their IPOs in recent months. The malpractices took the shape of diversion of the IPO funds. The theme that runs through all these IPOs that they were substantially fraudulent. The promoters fabricated (or hid) information in the prospectuses and they diverted the funds raised for a variety of purposes.

SEBI has barred these companies from accessing the securities markets again and also barred the merchant bankers from taking further business. Hopefully, the action won’t stop at just this much. If someone has swindled the public then not being allowed to swindle again does not sound like enough punishment. SEBI has said that other aspects of the cases have been handed over to other enforcement agencies. SEBI chairman UK Sinha has also indicated that investigations are being carried out into many more IPOs. From an investor’s perspective, the main problem is that a great deal of relevant information was concealed in these IPOs. Of course, it is another matter that if that information was not concealed then the IPOs wouldn’t have been feasible at all.

It seems self-evident that such actions will go a long way in protecting investors. However, that actually comes later. To my mind, if SEBI sustains such action and carries it to its logical end, then that will result in no less than the real creation of an IPO market for smaller companies in India. There’s no point hiding from the truth—such a market effectively doesn’t exist in India outside a fairly small set of large and mid-to-large companies.

I know a number of business-owners who are growing their businesses while facing all sorts of funding constraints but are simply unwilling to get into the IPO mess. There are others who have gone public, are running perfectly good businesses with solid growth and profitability but who are suffering because they are unwilling or unable to ‘manage their stock price’. Once an IPO’ing business gets into managing its stock price, then that opens the field for those whose primary (or only) business is to bring in managed IPOs and manage their stock price, which is what this lot which has just been caught by SEBI was doing. As in all financial markets, the bad quickly pushes out the good and at the small end of the primary market, there’s hardly any room left for anyone who actually wants to raise money for business in a straightforward manner.

The very definition of capital markets in any text book is that it’s a mechanism for raising capital that will be invested in businesses. The trading is about price discovery and exits, the primary function is raising fresh capital that will be invested in business. This part is dysfunctional. It’s notable that the government’s large public sector issues, both past and present, are not for investment into the businesses. They are offers for sale and thus basically nothing more than trading.

One can always hear a great deal of lament from all directions about the refusal of the small investor to participate in the primary markets. The likely reason for this is the small investor is now too smart. He can see that at the small end, the IPO market is widely rigged and the information flow is terrible. At the large end, practically every single IPO is priced with a ruthless, take-no-prisoners approach. The retail investors’ absence from the markets is a result of valid reasons and will stay till those reasons are there.

It’s encouraging to see this kind of action being initiated against fraudulent IPOs. I hope this is the beginning of a sustained effort that may eventually result in the creation of a real IPO market.