Sebi versus merchant bankers

Written by Sandeep Parekh | Updated: Sep 28 2010, 15:01pm hrs
Business dailies flashed news of a tongue-lashing of merchant bankers by the Sebi chairman last week. He was quoted as criticising merchant banks for not leaving money on the table for investors in initial public offerings.

I could not disagree more. I find the statement asking merchant bankers to leave money on the table (a call to deliberately under-price an issue) disturbing for several reasons. On a philosophical level, it goes back to babu raj of the Controller of Capital Issues where a babu would decide the price and amount of money a company could raise, often after due supplications were offered to this god of Indian capital. We have moved a long way from there, where neither the company nor babus decide the price or quantum of IPOs. It really is a matter of millions of investors deciding to accept or reject the price set by a company with the advice of merchant bankers. We have moved to an era of full disclosure, and to hark back to the babu raj will be a terrible idea because it supports the wisdom of one group of bureaucrats/regulators over the wisdom of millions of investors. Such a retrograde suggestion even if only stated in a conference rather than in a regulatory fiat assumes not only investors are foolish, but that merchant bankers are crooks. Neither is the implicit statement sound. The pricing of an IPO is offered by a company and investors have the option to buy or not to buy the securities at that price.

Second, there is no god-given right to make free money. Issues must be rightly pricedand economics (however faulty it may be, is the best we will have) will dictate that over-priced issues must fail and under-priced ones shift wealth from productive companies to speculators. Clearly, there will be many cases of over-pricing and under-pricing given the price discovery made on exchangesa price discovered in hind-sight. From a big picture, too, this push is disturbing as there seems to be an attempt to push money from productive use of a working company (where IPO money goes) to speculators and flippers (those who buy in an IPO and sell immediately on listing). Clearly, investors with a time horizon of 1 to 5 years will not and should not be affected by listing gainswhich is free money for neither any work done nor for any capital investment made (holding of a week to sell on listing date can hardly be called investing). While there is nothing wrong with being a speculator, it is hardly appropriate for a regulator to push money from productive capital use by companies to speculators.

Third, the implicit charge that merchant bankers are being crooked or greedy is incorrect. It is in the economic interest of merchant bankers to under-price an issue. If an underwritten issue fails, the merchant bankers who are also the underwriters must shell out money from their own pockets and fill the gap. So, it is in the interest of the merchant bankers to keep the offer price as low as possiblehurting the interests of the issuer. This conflict of interest between the issuer and the merchant banker is contained in any standard textbook on the subject. If the merchant bankers had their way and their economic interests in mind but for competition, they would price all issues at the lowest possible level. In other words, merchant bankers can be accused of being too investor friendly rather than too little because it is in their economic interest to be so.

While the statement is sure to drum up populist support for Sebi, it is wrong for a regulator (as opposed to a controller) to give a view on pricing, and even less acceptable to allege that an industry is conspiring to loot the investors when it is incentivised to do the oppositeespecially given that the costs would be borne by a productive company and the benefits of the homily would be enjoyed by the shortest-term speculators.

The author is the founder of Finsec Law Advisors and former ED of Sebi