IPO rigging: Sebi needs to also punish, not just prevent
November, 21st 2011
Last week, Sebi chairman UK Sinha was quoted in The Economic Times saying the regulator was considering a 10% intra-day circuit filter on listing day, to curb manipulation in initial public offerings (IPOs). Such a mechanism will not allow the stock to rise/fall 10% above/below its issue price on the first day. Currently, shares of newly-listed companies are exempt from intra-day circuit filters on the day of debut, to help price discovery. But this provision is being increasingly misused of late to jack up share prices on listing day, especially of small-sized IPOs.
But imposing circuit filters from day one is hardly the solution to price rigging. Not just that, it sends out a wrong signal on two counts. One, restricting the share price within a band conflicts with the principle of price discovery. Two, placing circuit filters on the first day is no safeguard against manipulation in the coming days. Stock prices are routinely manipulated despite intra-day limits. So what the regulator seems to be indirectly saying is that manipulation is fine as long as it does not happen in the first few days of listing.
Price rigging is more rampant in small-sized IPOs managed by little known merchant banks. Of the 40 IPOs that hit the market this year, 27 are quoting below their issue prices. And the stocks that quote at huge discounts to their issue price are mostly sub-Rs 100 crore IPOs.
Manipulation is not the only reason why stock prices underperform soon after listing. Overpriced IPO, overall weakness in the market and adverse business environment/policies could also hurt stock performance. The broader market has had a bad run this calendar, with stocks sliding amid volatility. So it is not surprising that majority of the IPOs are underwater. But the sharp difference in the highs and lows of many stocks within a short period of their listing indicate manipulation rather than mispricing.
For instance Acropetal Technologies, which listed in March this year, touched a high of Rs 156 and a low of Rs 13. Other IPOs which saw similar sharp swings include Servalakshmi Paper( Rs 49-Rs 4), Shilpi Cable (Rs 85-Rs 12), Bhartiya Global (Rs 81-Rs 11), RDB Rasayan (Rs 93-Rs 10), Brooks Laboratories (Rs 131-Rs 19), Indo Thai Securities (Rs 99-Rs 12), Taksheel Solutions(Rs 185-Rs 20), and Sanghvi Forging(Rs 145-Rs 22), to name a few. These stocks are currently quoting 70-87 percent below their issue price.
It is an open secret in the market that there are quite a few merchant banks which specialise in the sub-Rs 100 crore IPO segment. Companies looking to raise less than Rs 100 crore are not entertained by big merchants, because of the low fee such issues yield. The promoters then turn to merchant banks that can help them raise money. Often, the company has no say in the pricing of the issue. The promoters will get the money they wanted to mobilise, but everything else will be controlled by the merchant bank and the handful of high networth investors/market operators who subscribe to the issue. Brokers familiar with such operations say it is usually the same set of investors who ensure that the issues are fully subscribed.
Post-listing, the stock price is jacked up (which is not too difficult given the low floating stock) and the shares are then dumped on unsuspecting investors, who are drawn to the counter because of high volumes. Rather than placing circuit filters, the regulator needs to tighten its surveillance, identify the manipulators and then come down on them heavily. Once a few culprits are penalised heavily, the instances of manipulation will drop sharply. Seasoned financial market crooks are known to continue their operations despite Sebi restrictions, by transacting through a new set of investors/brokers/finance companies. The regulators biggest challenge has been to prove these entities are known to each other and are acting in concert. Only closer co-ordination with the Income Tax department and other investigating agencies can help resolve this problem.
Another way to curb manipulation in newly listed shares, especially of smaller companies, is to make merchant banks more accountable. Perhaps Sebi could make it mandatory for merchant banks to act as market makers in the first month of listing. A market offers a two-way quote (buy and sell quotes) on a financial instrument or commodity, and profits from the spread. Often, merchant banks are in cahoots with big investors who subscribe to the issue with the aim of manipulating it later on. Much of the trading volume on the listing day is fictitious, with the result that a genuine investor does not get to exit when he wants to. The presence of market makers will make it a bit tougher to manipulate the stock. That is because the merchant bankers will be using their own capital for market making, and will have to keep booking profits so as to not get caught on the wrong foot.
Also, Sebi has to ensure that a Small and Medium Enterprises (SME) exchange becomes a reality at the earliest. Rampant price rigging in small-sized IPOs could lead to a general aversion for small and mid-cap companies, making it difficult to for them to raise money. But above all, Sebi needs to crack the whip on market manipulators and make an example out of a few culprits to assure the ordinary investor that it is very much in command.