Direct listing route needs investor remedy

A company that does not need money may still need a market. A consultation paper on direct listing released by the International Financial Services Centres Authority (IFSCA) proceeds from that insight. In a direct listing, a company’s outstanding shares are admitted to trading on a stock exchange without an IPO. Listing and capital raising, in other words, need not be the same economic event.

The commercial logic is sound. A company built on founders’ capital and successive rounds of institutional investment may have no use for fresh funds yet still want visibility, a market valuation, and an orderly exit for early investors. Direct listing is now a well-established mechanism in jurisdictions with well-developed markets — such as the US, the UK, and Japan — that have permitted it. Spotify’s listing on the New York Stock Exchange in 2018 is a great example of a prominent company using this route to go public.

Given its nature, direct listing rests on a foundation of trust. For investors, a company that has never made a public offer has no history of standardised reporting to fall back on. The information document is effectively the principal issuer-prepared disclosure document available to them at the time of listing. Recognising this limitation, the consultation paper prescribes eligibility conditions, due diligence by a registered investment banker, a valuation-based price, and a special pre-open price discovery session. What it does not do, however, is state what happens when any information provided in such a document turns out to be false or misleading.

The American experience shows why such omission matters. In the case of Slack’s 2019 direct listing, an investor alleged, after the share price subsequently declined, that the registration statement contained material misstatements. The Supreme Court held that a claim under Section 11 of the Securities Act of 1933 required him to prove that the shares he bought were traceable to the defective statement. Since the two classes had become indistinguishable in ordinary trading, that was close to impossible, and the decision made Section 11 claims extremely difficult in such direct-listing circumstances. Slack Technologies, LLC v. Pirani, 598 U.S. 759 (2023), does not dictate the answer for India, but it warns that market innovation can move faster than liability law. The consultation paper falls short of accounting for a domestic version of the same problem.

Although the consultation paper provides that the issuer must file the information document through a registered investment banker, there is no provision that recognises an investor’s right to compensation for any misrepresentation by the company.

The Companies Act, 2013, is built around misstatements in a prospectus and provides criminal liability under Section 34 and civil compensation under Section 35, the latter for those who have subscribed for securities on the basis of a misleading prospectus and suffered loss as a consequence. Section 35, however, may not readily protect a direct-listing purchaser because a purchaser does not subscribe to securities through a prospectus. Investors may buy an existing share from another shareholder through the market. It is unclear whether an information document qualifies as a prospectus, as neither the consultation paper nor the draft circular addresses this. The gap is wider for foreign issuers, to whom the Act may not apply, leaving no clear statutory basis for investor remedies.

The proposed Securities Markets Code, 2025, Bill also does not fully plug this gap and may allow the regulator to use disgorged unlawful gains to compensate identifiable investors. But this depends on regulatory action and is limited to the gain recovered. It does not give a direct-listing purchaser an express right to recover losses.

Hence, IFSCA would be well advised to come up with a definitive remedy to hold companies using the direct listing route accountable for material misstatements, which investors can use to seek compensation. The simplest route is to treat the information document as a prospectus for purposes of civil liability so that the settled law applies to such a document. If that sits awkwardly with a regime run by IFSCA under its own statute and is open to foreign issuers, the alternative is a self-contained remedy in the circular: giving any person who acquires the securities the right to recover the loss attributable to the misstatement.

Two features of such a remedy matter more than the rest. The first is the class of claimants. It should cover buyers in the opening auction and those who buy until, say, the issuer’s first post-listing results, because that is the period when the document is likely to remain the principal source of issuer-specific information. Once continuing disclosure begins, the link between the document and the price weakens and a claim founded on it becomes harder to justify. Defining the class by time of purchase also avoids the trap Slack exposed. Where every share in the market is an existing share, a traceability requirement works not as a filter but as a bar.

Second, liability should attach to those who control the content of the document and those who benefit from the sale of shares that the listing makes possible. The first captures the issuer, its directors, the banker who certifies due diligence, and the auditors, valuers, and other experts whose work the document adopts, each answering only for the portions attributed to them. The second captures selling promoters and controlling shareholders. Everyone other than the issuer should have a due-diligence defence, and fraud should attract stricter consequences.

None of this makes the reform unattractive. Liability that is unlimited, or undefined, will deter issuers and advisers alike. Liability bounded by a defined class, period, and set of defendants will not. A listing without an IPO may be commercially efficient. A listing without an enforceable remedy would not be credible.

Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.