Sucheta Dalal :Graded Apathy
Sucheta Dalal

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Graded Apathy  

November 15, 2010

Vested interests in SEBI seem set to torpedo the IPO grading process when dozens of pressing investor issues remain unattended

At Moneylife, we have long discovered that it requires years of persistent writing and advocacy to get regulators, or the government, to initiate pro-investor measures. This is often true even after major financial scandals.

Consider this. Investor activists began to push for better regulation of initial public offerings (IPOs) after the 1993-96 IPO mania when companies took investors' funds and vanished. The need for IPO grading was an idea that took five years to germinate. During that time, it was considered and rejected by the ministry of corporate affairs (MCA) as well as the Securities and Exchange Board of India (SEBI). It was only in 2006 that SEBI finally initiated the grading process, despite persistent pressure by powerful corporate lobbies. But the decision had a crucial twist. Instead of ensuring independence by using investor protection funds to pay for grading (a few hundred crore rupees are available for investor protection with the MCA, as well as the two national bourses and a slightly lesser amount with SEBI), it asked the companies to pay. This immediately turned the process into a business opportunity for rating agencies who extract a high fee.

Less than four years after grading was made mandatory (2007), SEBI officials are busy doing research to establish that IPO grading serves no purpose because the process does not take pricing into account. Are SEBI officials who are conducting the study ignorant of the background of the grading process? Apparently so, since media leaks suggest that they have been allowed to present this 'study' to the SEBI board and to SEBI's primary market advisory committee. IPO grading was never intended to be a tip for the IPO punter, though SEBI's 'study' seems to assume so.

Statistics can be twisted to back any argument. So, some argue that IPOs graded a high '3' and '4' have not provided spectacular post-listing gains, while some with poor grades fared well. If a low-rated IPO does well post-listing, it may well be that the rater was just being cautious in grading a less-known company, or it may simply be a case of post-IPO price manipulation. Those lobbying against grading never get into details.

A data collator says that his firm has found no correlation between post-listing price performance of companies and their grading. Well, why should there be a correlation between grading and the post-listing price performance? Grading is a tool for investors not flippers-so the right time to examine price performance vis-à-vis grading is at least five years after listing, not earlier. It is only then that we will know if companies whose IPOs bagged a high grade have performed better over time and benefited investors, despite the high issue price. A high IPO grading reassures investors that the company won't vanish and that its fundamentals such as project details, technology, key permissions and funding plans are in place. A Moneylife survey of over 674 readers indicates that 65% of them do refer to the IPO grading before making an investment decision (Moneylife recommends that retail investors should avoid IPOs, unless they plan to flip on listing). That should be reason enough for SEBI not to meddle or, at best, make the process more independent. SEBI's study only indicates the power of vested interests who want gradings to go.

Why isn't SEBI more concerned with making investing safer instead of finding ways to disempower investors? One example is the new draft takeover code which has tried to eliminate the reverse-book building process that allowed investors to decide the exit price of companies seeking to delist shares. Powerful corporates and their retainers, such as lawyers and investment bankers, are lobbying for this too. Fortunately for investors, corporate India did not like the open-offer provisions of the draft code and it has not been accepted yet. Another example is that of portfolio management schemes (PMS) run by brokerage firms which have caused massive losses to investors. It is only in November 2010, after persistent exposure of PMS abuses, that SEBI has prescribed rules regarding fees and asked for performance data to be posted on corporate websites.

We at Moneylife have constantly argued that asking companies to publish information (whether it is their annual reports or the performance of PMS schemes) on their websites is only to shirk regulatory responsibility. We have also pointed out that SEBI chairman CB Bhave should appreciate the concept of statutory reporting systems, with clear formats, guidelines and penalties for misreporting. If SEBI were serious about empowering investors, the 200-odd PMS companies would have to report their performance such that investors can compare data before choosing a service provider.

It is exactly the same with reporting financial performance. SEBI, finally, opted to ditch its shoddy electronic reporting system (EDIFAR) for a corporate filing system that is being set up by the two major bourses. It is not a statutory reporting system; which means there cannot be serious consequences to not reporting or mis-reporting. But then, verification of information provided by companies has never been Mr Bhave's strong point. Remember how a controversial SEBI board committee had indicted the National Securities Depository Ltd (NSDL) for failing to detect how DSQ Software had dubiously dematerialised shares in excess of capital and sold them in the market! The issue was buried for years to protect Mr Bhave's image.

Another area where SEBI has prevented investors' access to regulatory and punitive action against companies, promoters, directors and market intermediaries is with regard to consent filings, whereby charges filed against companies are settled by payment without admitting guilt. Moneylife has repeatedly pointed out that consent orders on SEBI's website are scrappy; they do not outline the gravity of the charges and, finally, are not searchable. For instance, in March-April this year, SEBI allowed three top firms, namely, Motilal Oswal Securities, India Infoline Securities and HSBC InvestDirect Securities to file consent orders and pay up fines of Rs5 lakh, Rs25 lakh and Rs40 lakh, respectively, but investors are clueless about the magnitude of their offence.  

The lack of clarity about regulatory actions is not limited to intermediaries. Every few days, we receive letters from readers about the status of stocks in which trading is suspended. Investors are clueless if trading will ever resume and receive no answers from regulators or the bourses. Often, they continue to pay annual fees to hold dud stocks in their demat account. It is yet another issue that Moneylife has highlighted repeatedly where the regulator has not issued any direction to the bourses to turn more investor-friendly. Instead, SEBI was busy hiking up arbitration fees, without even bothering to check that 85% of all arbitrations went against investors.  

Given the number of investor-related issues that remain untouched at the end of chairman CB Bhave's term, wouldn't you agree that SEBI officials, who want a fat raise, would be better employed serving investor interest, instead of meddling with hard-fought and well-settled issues like IPO grading? — Sucheta Dalal

-- Sucheta Dalal