May 07, 2007

ipo scams & sebi's horn swaggling

Lead managers (big investment banking firms like Kotak Mahindra Capital, Citibank, DSP Merrill Lynch and so on) appear to be going scot free in the primary market IPO (initial public offer) scams cases of the last 2 years. This and more in a story I wrote for Outlook (main weekly), where I am presently working, around two months back.

Here goes that story:


The stock market watchdog, Sebi (Securities and Exchange Board of India), continues to bark in the matter of scams pertaining to IPOs (initial public offers), as it has been doing so since the one and a half year. It has dealt out 10-15 interim orders in this time. But like the bite is missing from a barking dog so are the final orders from Sebi!

On April 26, in its latest IPO-related interim order, Sebi uncovered what it says is a listing-day "manipulation of order book (on the trading system of NSE and BSE) to
create artificiality in the market" on the first day of listing of six IPOs this year. Six day-traders and one broker would place large buy orders at price much lower than prevailing and cancel their orders as the trading day progressed with a miniscule fraction getting converted into trades (all Sebi orders are put up on their website).

A few days later, in its law-making role, amended IPO norms to make grading of all IPOs mandatory. Companies, tapping public money for the first time, will now compulsorily have to get one or more of four credit rating companies—Crisil, Care, Icra and Fitch—to assess its fundamentals vis-a-vie existing listed companies in the same sector. They will be graded from 1 to 5 with a lower number representing weaker fundamentals. 

But Sebi chairman, M. Damodaran, has time and again elaborated that the grading will not indicate the investment worthiness of the IPO at the issue price or book-building price range. The unstated implication is that of investors not necessarily benefiting from a grade 5 IPO if the issue price has more than factored in the strong fundamentals.

Inversely, weak fundamentals due to lack of track record, will not always hurt investors if
the issue price is kept low enough to warrant the risks involved. Grading idea has been around for exactly a year emanating as it did from a perceived lack of some kind of guidance on IPOs and Sebi, in April '06, permitting IPO issuers to voluntarily seek rating. By the end of last year no one came forward and Sebi started resorting to unofficial force on IPO issuers to seek rating. One of them, Celestial Labs, had mentioned in its Sebi-filed prospectus that it had not opted for grading. But, through BSE, Sebi made it go for grading and the company filed a revised prospectus later.

But investors, particularly cautious ones, are more or less capable of sifting the chaff from the wheat. What is required for a control on the abuse of the allotment of shares and authenticity of disclosures in prospectuses and post-IPO corporate announcements.

Jayshree Dhabaria, a young retail investor from Bombay, says: "Allotment in reasonably

fundamentals-sound IPOs doesn't really happen and you have to block very high

application money to get a little allotment."

Sebi has still not framed final charges against around 110 operators (including 85

financiers and 25 executants) who rigged 21 IPOs in 2005 to corner higher allotment

through the use of over 45,000 benami applications backed by corresponding number of

benami demat and bank accounts. Interim orders were issued by Sebi last year against

DPs and depositories for failure to follow 'know your client' norms. Lead managers to the

IPOs have been let off even though they failed to weed out multiple application bids as

required by Sebi's IPO norms.

Which is probably why barefaced manipulation persisted into one more year manifesting

itself in the 2006 IPOs. And Sebi was forced to sit up and take notice when the price of

one IPO issue of Rs 64.50 crore (Rs 4.3 crore capital and Rs 60.2 crore premium),

Atlanta, shot up from its early September issue price of Rs 150 and a first day listing high

of Rs 208 to Rs 1,446 in mid-January. Amounting to an almost 10 times rise in price it

represented an extreme case given that in the same timeframe Sensex had risen by just

1.2 times.

Sebi started investigating the Atlanta case in January and issued an interim order on

February 22. The prima facie findings by Sebi laid bare a stark picture of a sleazy

operation involving promoters and their associates, market operators and mutual funds

and FIIs.

First, within a week of listing on September 25, MFs/FIIs who were allotted 20.5 lakh

shares of the 43 lakh shares issued in the IPO, sold off 19.4 lakh shares. Sebi doesn't

reveal their names but a look at the bulk deals data on NSE and BSE (shares traded

during a day by any investor exceeds 0.5% of the share capital gets reported as bulk

deals) reveal the sales by four FIIs—ABN Amro Bank N.V London (1.96 lakh shares),

Credit Suisse Singapore (1.61 lakh), Marshall Wace A/c Kuvera (1.31 lakh) and

Somerset India Fund Rhode (1.31 lakh)—and one domestic MF, Prudential ICICI (1.85


All these 8.05 lakh shares sold by these five were on the first day of listing itself at prices

ranging between Rs 188 and Rs 202. Interestingly, the first two FIIs are among the top 15

P-note issuing FIIs in the country.

Sebi found that the major net purchasers in Atlanta from listing day till end of December

were five groups of investors. The largest among them was controlled jointly by Manish

Marwah and Dilip Nabera through 16 entities and they cornered Atlanta's shares from the

market pumping up the market price and jacking up their holding in Atlanta from 3.5%

on September 30 to 6.3% on October 31 and further up to 7.3% as of December 31. Since

they didn't disclose their crossing of 5% they violated Sebi's takeover norms.

Then Sebi found that Atlanta's reported rise of sales (139%) and net profit (1788%) for

the quarter ended December 31 were not backed up by proper evidence of revenue

receipts and accounting records. Atlanta also failed in using a project-earmarked Rs 42.5

crore of IPO proceeds for the project. Its promoters diverted Rs 20.9 crore of it to pay for

preferentially issued convertible warrants to themselves in December which would entitle

them to 18 lakh shares after 18 months. In the same preferential issue warrants worth 9

lakh shares were issued by Atlanta to Marwah/Nabera group.

Sebi's interim order in Atlanta case prohibited further dealings by company promoters,

officials and associates and by the entities of Marwah/Nabera. But it kept quiet on the

motives of FIIs/MFs in selling 95% of their allotment in a week after listing. Market

sources say there is a pre-IPO arrangement between promoters and the funds in such

cases whereby the funds are promised exit on listing day at a profit of 20-100% over the

listing price.

Interestingly, the bulk deals data for this year also reveal that two P-note issuing FIIs,

Deutsche Securities Mauritius and BSMA, were purchasers – Deutsche buying 0.85 lakh

shares at Rs 1030 on January 5 and another 1.5 lakh shares at Rs 231 on April 4, and

BSMA buying one lakh shares at Rs 1265 on January 25. According to a broker, who did

not wish to be named, "operators like Marwah and Nabera are known to indirectly fund

large purchases by FIIs in stocks like Atlanta to maintain the price level." With regard to

Furthermore, Sebi's order lists details of cornering of Atlanta shares by another group

headed by Atul Shah through seven entities. No prohibition was issued on them and as a

result at least 1.09 lakh shares have been sold by one of their entities, Rajshah

Enterprises, through a bulk deal on April 18 at a price of Rs 395.

Market sources say that there are at least 5-10 more IPO cases similar to that of Atlanta

involving same operators. Sebi has so far not reported any action taken in those cases.

The horror stories continue to haunt investors in IPOs. Says Dhabaria: "Using these

revelations as a yardstick I don't think I will ever invest in an IPO for fear of being taken

for a ride. Investors like me will want to push the panic button."

But the next Sebi move might very well be introduction of price bands on the first day of

listing of an IPO given the findings of order book manipulation in its April 26 interim

order. But, again, in this newest expose Sebi has failed to connect the bloated but

unexecuted orders with their actual impact on executed trades.

Moreover, the trading price on listing day itself was 20-80% higher than the issue price

and so orders at 30-100% lower than those traded prices were actually closer to the issue

price. For instance, Pochiraju Industries, whose issue price was Rs 30, was traded

between Rs 46 and Rs 60 on the listing day, February 9. Four of the Sebi-targeted

operators who put large orders in this stock did so at a range of Rs 25 to Rs 30, very close

to the issue price.

None of the brokers Outlook spoke wanted to go on record with their views on Sebi's

conclusions but the general impression was that Sebi should make up it minds whether it

wants to encourage or discourage inflated prices on first day of listing or leave it to

market forces. Said one: "Sebi is barking up the wrong tree by going after orders at close

to issue price; instead it should take stringent action in Atlanta-type cases which are

ruining the integrity of the market."

The IPO juggernaut rolls on and the investors continue to be taken for a ride.

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