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Mainstream, VOL 62 No 10, March 9, 2024

Mule accounts malpractices impede booming IPOs growth: SEBI to curb misdemeanor | Nand L. Dhameja, Manish Dhameja, Ridhi Khatter

Saturday 9 March 2024



Initial public offer (IPO) is a process which allows a company to raise funds from public for its growth and expansion. As the term stands it is the initial process of raising funds from the public as before this process the company would have been dependent upon promoters’ or private funds.

As such, companies having grown by relying on the resources provided by the founders, their friends and families and relatives; but still need more funds to get bigger, they undertake a process of issuing of scripts or shares to general public.

The origin of IPO dates back to 1602 when Dutch East India Company, the then the biggest commercial enterprise in the world, invited every resident of the Netherlands to buy shares to help finance its trade in spices and other commodities.

In the U.S., the biggest IPO was that of Bank of the United States in July 1791. Thereafter, many familiar American companies built their businesses with the help of IPOs, and changed the U.S. economy in the process. These included, in 1906 Sears, Roebuck & Co went public with the help of Goldman, Sachs & Co; Ford Motor Co. went public in 1956, the then biggest IPO in American financial history, selling $643 million worth of shares and immediately vaulting to No. 3 on the Fortune 500 list of the biggest public companies; the other In the years that followed, Apple, Pepsi, Kraft Foods and MetLife insurance to AT&T are the other big American businesses raised capital through IPOs.

IPOs in addition to providing young entrepreneur an opportunity to grow big and tap the vast capital market potential, it opens up the way to reward the founders and early investors with the substantial increase in the values of their ownership. In addition, the employees, which did not have big salaries, are rewarded with attractive stock options.

Further, costs of IPOs are substantially lower that the public offers in the form of expert-services cost.

As an IPO process, the number of shareholders in a company increases manifold, and the company informally is known as going public, the number of shareholders increases multi-fold, and shareholders are allowed to market their shareholding, or to market and sell their shares; with this initial offering, a company’s share becomes eligible for a stock exchange listing.

In India, IPO system is not new, it has undergone a massive changes and developments over the years. Reliance Textile Industries’ IPO in 1977 created history by introducing the equity cult in India; the issue was oversubscribed seven times, it was listed on BSE on January 23, 1978. The Reliance was the first large private company that had gone public, and it attracted a large number of retail investors that broaden the base of the Indian stock market.

The establishment of the Securities and Exchange Board of India (SEBI) in 1988 was a watershed moment in the development of the Indian IPO market; it focused on transparency and investor protection and played a pivotal role in enhancing the credibility and integrity of the IPO process.

The 1992 Harshad Mehta securities scam exposed vulnerabilities in the IPO system and that led to important reforms and automation of trading systems.

The dot-com boom and the rise of the IT sector in the late 1990s witnessed a flurry of IPOs and many companies raised record amounts of capital; Swiggy and Walmart-owned Flipkart have planned their IPOs. SEBI has introduced regulatory changes to streamline the IPO process and safeguard investor interests; further digital transformation has revolutionized the IPO landscape, making it more efficient and accessible. As a result, IPO market has become more vibrant and sophisticated with growing individual and institutional investors participation.

The SEBI has initiated steps to regulate the IPO process in India. The IPO process in India is a complex and time-consuming one. With the objective to safeguard the interests of the investors and the IPOs are successful in the capital market, companies are required to provide factual information, to meet the regulatory requirements and to maintain good corporate governance practices. Investment banker is required to be appointed to help the company in the IPO process thorough analysis of the company’s financial statements - risks and opportunities- to prepare the IPO prospectus; to determine the offer price of shares; to underwrite the shares; to examine legal and regulatory framework; to prepare prospectus for the approval of SEBI; and listing of shares on stock exchange. Two main ways to set the price for the IPO include fixed price method and book building method. It may be mentioned that IPOs in many cases come with a lock-in period that may require the investors to hold on to the stock for a fixed period of time.

Performance of IPOs is measured based on the price movement on the listing date. IPOs issued and the amount raised during the last four years are as under

IPOs in India

Factors for the growth of IPOs market reflecting attraction and valuation among investors include:

strong profits and revenues of companies despite Covid-19 pandemic;

low-interest rates and stimulus measures by central banks around the world would have boosted availability of funds, and investors would have found the higher return in the emerging market attractive;

foreign investors specially from the US were also attracted in the IPOs market;

Further, according to the Ernst & Young (EY) Global IPO report, the year 2021 was the best IPO year in terms of number and the proceeds, for the last 20 years. The year had some of the best performances in the Indian IPO market with new-age tech companies leading the way, and also a number of diversified and industrial products, consumer products and retail sectors.

Investor sentiment remained upbeat as 2021 comes to a close with strong domestic and global demand and significant momentum going into 2022.

During Q4 2021 there were twenty IPOs, as against Q4 2020 and nineteen IPOs in Q3 2021; this represents an increase of 50 per cent compared to Q4 2020, and an increase of 5 per cent compared to Q3 2021. As regards to SME markets, there were 16 IPOs in Q4 2021 versus nine and 14 IPOs in Q4 2020 and Q3 2021, respectively, representing an increase of 78 per cent and 14 per cent as compared to Q4 2020 and Q3 2021, respectively.

Goldman Sachs Research report highlighted that based on the recent announcement of ‘new economy’ IPO pipeline in India is expected to remain robust over the next 12-24 months;

least 150 private firms could potentially list over the next 2-3 years;

approximately $400 billion of market capitalisation could be added from new IPOs over the next 2-3 years;

India’s market capitalisation could increase from $3.5 trillion currently to over $5 trillion by 2024, making it the 5th largest market by capitalisation.

Supportive regulatory environment led to spurt in retail investors; SEBI, the capital markets regulator halved in August the timeline for listing of shares on stock exchanges after the closure of IPOs to three days (T+3) from six days (T+6). The reduction in timelines for listing and trading of shares would benefit both issuers as well as investors. The new listing timeframe will be voluntary for all public issues opening on or after September 1 and mandatory for all issues after December 1, 2023.

SEBI has updated the IPO norms, reducing the listing timeline from T+6 to T+3 days. Companies are given the option to follow the new rule voluntarily as of September 1st, 2023. From December 1st, 2023, it will become mandatory for all companies issuing IPOs to list their shares in T+3 days.

The changed rules would benefit both issuers and investors. It would reduce the time for issuers to be able to access the funds raised from the IPO, whereas investors would also receive the shares in a shorter period of time. Investors who were not allotted the shares would receive the money back quickly.

Thus, timeline under the new norms is summarised as under:

SEBI’s new norms have brought in changes to safeguard the interest of retail investors as under:

IPO-bound companies are required to make their targets clear in the prospectus to help investors make informed decisions. As per the new norms, companies planning to raise funds for their inorganic growth must specify their targets and where they intend to spend the money. In case the companies fail to qualify the target, the fund reserved for investment and acquisitions would not exceed 25 percent of the total IPO capital. Unless companies make their targets clear, their IPO permission would not be granted;

Lock-in period for anchor investors has been extended and they can sell:

a). 50 percent of their investments after the expiration of 30-day lock-in; and

b). the remaining 50 percent after a 90-day lock-in period. 

In this respect, anchor investors are large investors or Qualified Institutional Buyers (QIB) who place bids of a minimum of ₹1 crore in mainboard IPOs and ₹1 crore and more in SME IPOs in the book-building process. It may be mentioned that the IPO bidding window for anchor investors usually opens before it opens for retail investors. 

Earlier prior to new norms, anchor investors could exit the market after 30 days, realising a significant profit from the initial bull run; and it resulted in a deep decline in the share price for retail investors;

Exit route earlier available to promoters and stakeholders has been restricted under the new rule as:

shareholders with more than 20 percent holdings in the company can offload only 50 percent of their shares, whereas small stakeholders with less than 20 percent stakes can sell up to 10 percent of their shareholding.

In short, SEBI’s objective is to make the market more stable and transparent to safeguard the interests of new investors has strengthened the IPOs market.

Moreover, certain malpractices have been observed in high subscription numbers in IPOs; there are hundreds of crores of applications with multiple PAN Card details, knowing well that these applications will get rejected.; and this whole process is done to inflate the subscription. Several mule accounts are used to put in IPO applications in a manner that subscription numbers look good but they get rejected.

It may be mentioned that a mule account is basically a trading account maintained with a stock broker or a dematerialized account or bank account linked with such trading account in the name of a person, where the account is effectively controlled by another person, whether or not the consideration for transactions in the account are paid by such other person. Mule accounts are created in two ways as:

accounts belonging to legitimate customers who have allowed criminals to use their account for illegitimate reasons;

accounts created by criminals using stolen or synthetic identities. The criminals use legitimate or a blend of legitimate and fake customer information to commit new account fraud, opening new accounts for illegal purposes that they have complete control over and that cannot be traced back to them. They can use these to transfer their funds between them, to ‘clean’ the money and/or to raise credit scores on the accounts before withdrawing up to the credit limits with no intention of paying the money back to the bank.

SEBI has observed such malpractices in IPOs and are on its radar. Moreover, “IPO market is a market of traders more than investors", as about 68 percent of non- institutional investors or high net worth individuals and 43 percent of retail investors flip their trades in the first week of IPO listing. SEBI plans to improve the IPO documents processing and is examining whether in-principle approval can be given from its side in cases approvals from other regulators or facing judicial delays are awaited. Further, to ward against risk, long-term investors should look for price discovery becomes more stable.

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(Authors: Dr. Nand L. Dhameja Professor Emeritus, MRIIS, Faridabad
Manish Dhameja, Senior Banker having experience in South Asia, Africa and Middle East;
Ridhi Khatter, Associate Professor, MRIIS, Faridabad )

Note: Views expressed are of the authors and not the organisations to which they belong

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