Sucheta Dalal :Time For Transparent Allotment And Distribution Of Issues
Sucheta Dalal

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Time For Transparent Allotment And Distribution Of Issues  

Mar 16, 2004

It makes no sense to imitate western IPO practices, especially when they are questioning their own systems. (March 16,2004)

Time For Transparent Allotment And Distribution Of Issues

Sucheta Dalal

MUMBAI, MARCH 15:  If the fighting that has broken out over allocation of shares is any indicator, then disinvestment minister Arun Shourie’s claim of being able to raise Rs 1,50,000 crore every year through disinvestment of government shareholding may well turn true.

Despite the “computer error” at The Stock Exchange, Mumbai (BSE), which allegedly led to multiple counting of bids, all the six public sector issues have been oversubscribed. This has led to a mad scramble for allotment by qualified institutional buyers (QIBs) for the 50 per cent of each issue that is reserved for them —the remaining is split between retail and non- institutional buyers (NIBs).

Sources in the mutual fund industry say that the underwriting syndicate, which decides on allotment, is arbitrarily distributing large chunks of shares to their friends and business associates. This is in line with the capricious allotment procedures followed in all book-built issues in the US and other developed markets. And it is one of the main reasons why investment bankers find ‘book-built’ issues more attractive than fixed price IPOs.

R Balakrishnan, CEO of First India Asset Management Pvt Ltd, says that in a recently allotted PSU offer, the allotment to institutional investors has varied between two and eight per cent of the shares applied for. Higher allocations were made to larger mutual funds and probably to business associates who probably help bring in business.

Mr Balakrishnan points out that this practice distorts the net asset value (NAV) of mutual funds in a good market; that is because funds with a larger allotment of “hot” IPOs show better NAVs than those who receive tiny allocations.

Clearly, it is misplaced to adopt such unhealthy IPO practices from developed markets when our mutual fund industry is also struggling to woo investors. Instead, the regulator must prevent needless controversy by mandating that the proportionate allotment system be extended to institutional investors. After all, mutual funds (MFs) are investment vehicles for retail investors and their NAVs should not be distorted merely because of arbitrary procedures.

Since the proportionate allotment system already works well for retail and high networth investors, there is no reason not to extend it to institutional investors.

As Mr Balakrishnan explains, “if a large MF applies 10 per cent of its scheme corpus and gets a 30 per cent allocation and a small one also applies for 10 per cent of its scheme corpus and gets only 10 per cent, then the performance of the smaller fund is severely affected in a good market”. Other fund managers also echo these views.

Interestingly, the strongest case of avoiding US practices comes from the Americans themselves. After the deluge of corporate scandals in America and the revelation of IPO excesses after the dotcom bubble, the Securities Exchange Commission (SEC) began to investigate the dubious methods used to distort the market.

The SEC commissioned a report through the IPO advisory committee of the New York Stock Exchange and the NASDAQ. It is an eye opener for us Indians. It’s reading would show the disinvestment minister that the questionable advice that he complained about may be standard market practice. It will also introduce him to a raft of investment bankers’ tricks, each neatly captioned in the May 2003 report with an apt and pithy expression.

The report starts by saying that “public confidence in the integrity of the IPO process has eroded significantly” and that investigations had revealed that underwriters and other participants “engaged in misconduct contrary to the best interests of investors and our markets”. The report says that many of these shady practices described below, “have arisen in the context of the ‘book-building’ of IPOs.

For instance, “spinning” an IPO is to allot shares to directors and executives of potential investment banking clients. Some underwriters rig the post-issue pricing (called aftermarket) of shares by making allotments to those investors who commit to buy more shares in the secondary market after listing. They also impose ‘penalties’ on those who ‘flip’ or sell their allotted shares immediately after listing.

Here too, the treatment is arbitrary. Favoured investors, with potential to bring more business (by way of brokerage or investment banking fees) are encouraged to book profits through ‘flipping’ and they don’t attract any penalties. Certain clients are also given bigger allotments if they promise to direct brokerage fees to the underwriters in unrelated trades.

A much discussed, but shady practice was to pay commissions to analysts for pumping up IPOs by making ‘buy’ recommendations. Although ‘friends and family’ of issuers are generally included in the favoured allottee lists, the issuer companies are often enough as confused about the market potential and pricing as Arun Shourie was before his angry outburst. In most cases, the price movement of their scrips, immediately before and after the IPO, is so erratic that they are never sure if the investment banker has advised them correctly.

The US committee recommends that issuer companies set up a committee of independent directors to decide the pricing, which must force investment advisors/underwriters to give a correct estimate of investment demand at various price points.

The committee describes another form of prohibited market conduct called “IPO laddering”. This involves inducing investors to give orders to rig the aftermarket (post-listing market) at pre-decided prices in exchange for receiving assured IPO allocations.

Another, highly questionable American practice documented by the committee is that of investors being able to return shares (sometimes after listing), on grounds such as mistaken allocations, incomplete information or problems relating to trading and settlement. Fortunately, this has never been adopted in India.

Thanks to the strict control over capital issues (CCI), the mischief making skills of our investment bankers have been concentrated on fixed price issues. The excesses of the 1990s, after CCI was abolished, destroyed the primary market for eight long years, and this is the first time that substantial amounts of public money have been raised from the public. The government must move quickly to put in place an effective and transparent allotment and distribution procedure so that neither retail nor institutional investors end up feeling short-changed.



-- Sucheta Dalal