Concealing Loan Use For IPO & NCD Bids Breaches Investor’s Trust: Expert
The Reserve Bank of India (RBI) has ceased and desisted JM Financial Products (JMFPL) from doing any form of financing against shares and debentures, including sanction and disbursal of loans against Initial Public Offering (IPO) of shares as well as against subscription to debentures.
“This action is necessitated due to certain serious deficiencies observed in respect of loans sanctioned by the company for IPO financing as well as non-convertible debentures (NCD) subscriptions. The RBI carried out a limited review of the books of the company on the basis of the information shared by the Securities and Exchange Board of India (Sebi),” the RBI stated in the notification.
The Reserve Bank of India (RBI) has prohibited JM Financial Products from issuing shares and debentures.
However, the incident highlights how this mechanism can be used to bypass regulatory compliance. Elucidating the mechanism, Jyoti Prakash Gadia, Managing Director at Resurgent India said, “The investments in IPO and NCD etc. are expected to be made by duly identifiable individuals or legal entities as genuine investors, after completion of the due know your customer (KYC) process and other formalities.
The sources of funding can be own funds of the investor or borrowed funds. In case of borrowings however the securities should be fully paid up and clearly identifiable, properly assigned or charged to the lender and prescribed margin in terms of loan to asset value need to be complied with.”
Gadia further added that the violations and by-passing of the rules have happened in such instances with the improper opening of the account and operating of transactions not directly by the individual investors but through power of attorney (POA) and the intention apparently is to generate additional business and make profits through multiple accounts which are virtually benami in nature.
According to a notification by the central bank, JM Financial helped a group of its customers bid for various IPO and NCD offerings by using loaned funds. The credit underwriting was found to be perfunctory and financing was done against meagre margins.
The company operated the applications for subscriptions, demat accounts and bank accounts using a Power of Attorney (POA) and a Master Agreement obtained from these customers without their involvement. This allowed the company to effectively act as both a lender and a borrower, which is not permitted by the central bank.
“It is common for brokers or portfolio managers to obtain powers of attorney (PoA) from Clients to execute transactions on their behalf. However, it would be improper for a broker or portfolio manager to utilise the PoA for subscribing to share or debt offerings by its own or affiliated companies,” said Kinjal Champaneria, Partner, Solomon & Co.
The Reserve Bank of India (RBI) has expressed serious concerns about the company acting as an arranger of bank account openings and operator of those accounts using the Power of Attorney (POA). According to the RBI, this action was in violation of regulatory guidelines and raised governance issues. In the press note, the RBI stated that these issues were detrimental to the interests of the customers.
Highlighting this Gadia said, “Certain financial entities who are engaged in merchant banking activities as advisors and managers of the issues and also have group entities as lenders can misuse the system . The mechanism adopted is to create a disproportionate amount of investment in the IPO or NCD in the names of individuals who were provided with loans in an unauthorised manner to invest in such public issues and then the allotted shares or bonds are disposed of to make profits.
Names and identities of Individuals who do not fall within the ambit of income tax payment are generally chosen to carry out such transactions based on one-time power of attorney obtained from them without any subsequent involvement of the individual investors.”
Champaneria added that the mechanism is violative of regulations against direct or indirect payment or offer of any incentive to the investors by the person connected with the issue for making an application in any issue of securities, manipulative or fraudulent or unfair trade practices in the securities market, breach of the merchant bankers code of conduct, creation of a false market, and criminal breach of trust (if undertaken without the knowledge of the client). However, it will depend on the views taken by Sebi in its final order upon further investigation, he mentioned
In a separate order, Sebi's Whole Time Member Ashwini Bhatia said, "We can also conclude from the data with us that JMFPL-NBFC was the seller, buyer and then a reseller of the NCDs of which JM Financial was the Merchant Banker. They were able to seamlessly pull this off because they were the PoA (Power of Attorney) holders for many of the investors in question."
