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Public issues, private fixers

The IPO mechanism is clearly in need of drastic overhaul to prevent more IPO scams, writes Ravi Srinivasan.

india Updated: Jan 18, 2007 15:27 IST

The National Stock Exchange has formally acquired a foreign investor. Asia’s oldest Exchange (the BSE actually pre-dates the Tokyo Stock Exchange by three years) looks likely to follow suit. The Sensex is back to stratospheric heights. The India Growth Story is selling like hot cakes.

And some old, familiar rats are once again crawling out of the woodwork.

Like IPO (initial public offering) scams, for instance. Does anybody remember Roopalben Panchal? In case you have forgotten, here’s a quick reminder: an investigation by the Securities and Exchange Board of India (SEBI) into multiple identities being used to corner the "small investor" quota in IPOs eventually led to bans, suspensions and fines on depository participants.

It also led to "know your customer" norms actually being implemented by market intermediaries (thanks to threats of stern action by SEBI and RBI), which in turn has resulted in over 40 lakh depository accounts being frozen, because the account-holders have failed to so far provide basic documentation about themselves.

The case of the lady who used tens of thousands of fake depository accounts to run one of the largest IPO rackets detected in recent times sounded the first note of warning that something was badly amiss with the “new, improved” IPO mechanism, especially with the way a new issue is priced, and who gets to buy how much in such issues.

The Cairn Energy IPO disaster and its aftermath has only served to strengthen my growing sense of unease that what is currently happening may only be the tip of the iceberg. And by the time the authorities get around to fixing the problem, a lot of genuine small investors may get badly burnt.

So how exactly is the price of an IPO determined? In the bad old days before reform, ministry mandarins decided which company got to issue stock, when it would be allowed to place equity in the market and even at what price it could sell its shares.

This led to many distortions in the market process. Lobbyists and 'fixers' became as much a fixture in ministry corridors as the ubiquitous peon. And corporates suffered, since they could not, with any degree of certainty, predict when and how they could raise capital.

These issues should have disappeared after the pricing mechanism was into the market. Merchant bankers took over the role of evaluating what would be a reasonable price range for an IPO, and fixed the 'price band'. The actual price was then determined by market prices, with the equilibrium point between demand and supply ending up as the issue price.

Which sounds great on paper, but has failed repeatedly in practice. If an IPO's price was indeed truly market-determined, a Roopalben Panchal would not have happened. There would be no 'grey market' premium for yet-to-be-listed shares, nor would there be thriving off-market trade in such stock.

But all of this is happening. And there is enough margin of profit to allow scamsters to actually run thriving businesses focussed entirely on this. The IPO mechanism is clearly in need of drastic overhaul.

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First Published: Jan 18, 2007 15:27 IST