SEBI’s Safety Net Idea is Full of Holes

Sucheta Dalal 03 March 2015

More silly tinkering with IPO rules

Every time the capital market regulator is under pressure to explain why retail investors shun the market, it fishes out the absurd idea of a ‘safety net’ for equity investors. Each time, the safety net has a new name. This time, The Economic Times tells us that its primary market advisory committee (PMAC) will discuss the idea of allowing investors to buy optionally fully convertible debentures (OFCDs) instead of plain vanilla equity.

SEBI (Securities & Exchange Board of India), which celebrated 25 years of its existence with much fanfare in 2014, still does not seem to understand that equity, by its very nature, has to carry a price risk and cannot be converted into a debt-like instrument. Will OFCDs really work? The newspaper reports that OFCDs will have an 18-month tenure and carry bank interest rate (taxable); the money will be kept in an escrow account to meet redemption requirements should they arise. It is not clear if the conversion to equity will be in six months or at the end of 18 months.

If the conversion to equity has to be in six months, who is to say that truly unscrupulous management will not keep the price high for that period? Many companies have managed to do it for significantly longer periods. A recent example would be Helios & Matheson, whose stock price continued to remain high even when it wasn’t able to pay salaries or interest on fixed deposits.

Moreover, what happens if the price falls precipitously after the OFCDs are converted? Will SEBI act against the promoters or will they get away? Surely, the regulator realises that there must be a reason why various kinds of ‘safety nets’ for equity investors have been discussed for over two decades and why they have never worked.

It is worth pondering what kind of companies would need to raise money under such conditions, while running the risk of numerous factors and circumstances that could impact stock price and corporate performance.

SEBI forgets that its job is to ensure that corporate fundamentals are in order, that facts stated in the IPO document are correct and accounts are not doctored. We, investor activists, pushed for an IPO rating on a scale of 1 to 5 to give investors a snapshot of the fundamentals. All they needed to do was to take a call on the price. But SEBI, under pressure from corporate lobbyists, ensured that IPO ratings were scrapped. What helped the case was that SEBI had deliberately weakened the effectiveness of ratings by allowing companies to choose their rating agency, instead using investor protection funds to pay for them and ensure independence.

Remember, it is SEBI that damaged the primary market permanently in the mid-1990s by allowing hundreds of fraudulent, fly-by-night companies to tap the capital market without any checks. A significant number of these companies vanished with investors’ money and there has been no serious effort to track them and recover funds. Many investors who suffered massive losses in the first flush of capital market liberalisation have never come back. India’s investor population has halved and this is affecting the government’s plan to disinvest shares of public sector undertakings (PSUs).

The answer to this situation is not an absurd safety net, but to rebuild investor confidence through sensible pricing of IPOs and more responsible investment banking. PSUs are unlikely to attract investors unless one of two things happen—the offer is at a significant discount to market price, or the government initiates steps to ensure operational autonomy of management with proper accountability and puts in place professional management selected on merit.

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