The Ides of March typically falls on the 15. But for the stocks in the small and medium enterprises (SME) segment, all hell broke loose on March 11. There was a bloodbath on the bourses as 41 SME stocks were hammered mercilessly causing the Bombay Stock Exchange (BSE) SME IPO index to plummet a massive 20 per cent from its peak. The index lost around eight per cent in the subsequent sessions.
Notably, since last year, the BSE SME initial public offering (IPO) index had until then more than doubled in value and outpaced the benchmark Sensex index by a significant margin.
What derailed the gravy train was a warning from the market regulator about potential manipulation within the segment in the stock market. "We do see signs of manipulation in the small and medium enterprises (SME) segment," said Madhabi Puri Buch, Chairperson, Securities and Exchange Board of India (Sebi) on March 11, suggesting that suggest certain players may be engaging in unethical practices to manipulate prices and that the market regulator will likely intensify its scrutiny of the SME segment by deploying enhanced surveillance tools and stepping up enforcement actions against perpetrators of market abuse.
Atmastco, Inflame Appliances, Srivasavi Adhesive Tapes and Goyal Salt were among the major casualties that took a hit of 16 to 20 per cent in their stock prices. Atmastco, which launched its public issue on 23 February, saw significant investor interest, with its IPO getting oversubscribed by more than 15 times. The stock debuted at a premium of over 18 per cent above its issue price.
The turmoil in the stock markets led some experts to come down heavily on the regulator. "It is better to be proactive than reactive when it comes to regulation. It is the foremost duty of the regulator to ensure the right market condition for all participants in terms of information exchange, market accessibility and price discovery. Any isolated instances of wrongdoings can be catastrophic for the regulator as it would raise serious questions on the overall ecosystem of the securities market," said Manish Chowdhury, Head of Research, StoxBox while talking about Buch’s statement.
Signs Of Weakness
The party in the small-cap segment, in fact, began to wind down much before the March 11 mayhem. Since February, more than 80 per cent of stocks in the BSE small-cap index have reported negative returns while in the same period, Nifty has gained nearly one per cent. The SME segment, while offering several opportunities for smaller companies to raise capital and for investors to diversify their portfolios, is facing challenges related to fraudulent activities.
Experts attribute these troubles to factors like lower free float, smaller IPO size and low liquidity contribute to the potential for manipulation.
“One of the red flags indicating possible manipulation is the absence of regular trading activity in a stock. This lack of volume suggests limited genuine investor interest and may indicate artificial price movements. A sudden and substantial increase in the price of a security over a short period, especially when not supported by fundamental factors," says Kresha Gupta, Founder, Chanakya Opportunities Fund.
Gupta explains that an unusually high price-to-earnings (P/E) ratio, disproportionate to the company's earnings growth and financial performance, dilution of the promoter or insider holdings, particularly through unexplained or irregular transactions, can raise suspicion of manipulation.
As the current volatility in the Indian capital markets, especially in the small and midcap segments, is largely driven by sentiment, the recent news about manipulations in the SME segment has heightened investor panic.
Over the past year, SMEs have experienced significant interest from various investor groups, leading to a surge in demand and substantial listing gains. Some listings have seen gains far exceeding their fair valuations, raising concerns about long-term viability. Notably, some IPOs were oversubscribed by about 500 to 1,000 times and subsequently listed at 100 to 300 per cent premium suggesting irrational valuation.
However, experts caution that this does not indicate that the market is booming only because of manipulation. “The primary victims of stock market manipulation are often individual investors, especially those who are less experienced and may not have the resources to thoroughly research their investments. They can suffer significant financial losses as a result of these manipulative schemes, which can deter them from future participation in the stock market,” says Vipin Maheshwari, Chief Financial Officer, Olyv (formerly SmartCoin).
Sebi's Challenges
The simpler organisational structures and weaker internal controls within SMEs, while advantageous in some respects, can make it more challenging to detect malpractices within the companies themselves. The increasing number of SME listings poses a significant surveillance challenge, spreading SEBI's resources thin and potentially allowing manipulative practices to slip through the cracks.
“While smaller market cap and liquidity in SMEs may heighten manipulation risks, it's a broader market issue, not exclusive to SMEs. Vigilance is crucial in both IPO and secondary markets to safeguard market integrity. Sebi's efforts to monitor the SME segment are commendable, with its regulatory framework and vigilance matching, if not exceeding, global standards. However, the unique challenges of smaller markets demand continuous adaptation and innovation in regulatory practices,” says Manick Wadhwa, Director, SKI Capital.
Despite advancements in technology and analytics, the allocation of sufficient resources for in-depth, company-specific investigations remains a challenge, particularly given the large and growing number of SMEs. “Sebi can enhance SME market oversight by collaborating with entities like the GSTN and ROC, leveraging their insights for more coherent and transparent market monitoring, thereby strengthening investor confidence,” adds Wadhwa.
Experts note that Sebi’s observation regarding the heightened susceptibility of small entities to price manipulation holds merit. During IPOs, when companies first sell their shares to the public, because the offerings are small and there aren't many investors involved, it's easier for a small group of people to work together to buy up a lot of shares and drive the prices up artificially.
After the shares start trading on the market, if there aren't many buyers and sellers and the trading happens less frequently, it becomes easier for people to manipulate the prices by trading amongst themselves in a coordinated way.
“However, it's important to note that not all small entities are vulnerable to manipulation. Factors such as the quality of corporate governance, transparency in financial reporting, and regulatory oversight can significantly influence the risk profile of these entities,” says Gupta.
SME IPOs
While speaking at an industry event in Mumbai, Buch stated that apart from having the technology to detect patterns that suggest manipulation, the regulator has received feedback from stakeholders on how such fraudulent activity can be identified and how to deal with them. However, action is still pending because Sebi is trying to construct a case in a "robust manner", she added.
The Sebi’s observation of manipulation in the SME segment highlights the need for vigilance. While the size of SME IPOs may increase susceptibility to manipulation, it's essential to focus on the opportunities and growth they offer. Enhanced disclosure norms are steps towards a transparent, secure market, encouraging investor confidence in quality SMEs.
"It is important to evaluate the underlying potential of the SME company before considering it as a long-term bet. The oversubscription figures and listing gains are not the right parameters to decide the fate of the company in the long run as these factors may lead to irrational exuberance in these companies," cautions StoxBox's Chowdhury.
In India, SME IPOs represent a significant opportunity for smaller companies to access equity capital, a critical resource that was previously challenging to secure. These enterprises, despite their smaller IPO sizes, have shown resilience and potential, with several noteworthy companies making successful debuts on SME exchanges.
“Recognising the importance of transparency and investor protection, the SME exchanges have proactively enhanced disclosure norms in their offer documents, which should reassure investors about the commitment to maintaining market integrity. Ultimately, the SME sector remains an attractive avenue for investors seeking to diversify their portfolios with good quality SMEs, offering a unique blend of growth potential and innovation,” states SKI Capital’s Wadhwa.
Olyv’s Maheshwari believes that educating investors about the risks associated with investing in the SME segment and the signs of market manipulation can empower them to make more informed decisions and potentially avoid falling victim to manipulative schemes. “Strengthening the regulatory framework specifically for the SME segment, including stricter listing requirements, enhanced disclosure norms, and more severe penalties for manipulative practices, can help deter manipulation and promote a healthier market environment,” he says.
According to experts, Sebi should collaborate with market participants, regulatory bodies, and other stakeholders to enhance surveillance and enforcement efforts in the SME segment by setting trading limits with market participants, implementing maximum bidding limits, introducing share lock a mechanism for significant shareholders and implementing circuit limit.
“By addressing issues of manipulation and excessive valuation, Sebi's interventions will ultimately create a more stable environment for all investors, particularly long-term investors. Investing with a long-term perspective and staying patient in the current market with resilience will ultimately lead to greater stability and growth in the market,” states Chanakya Opportunities Fund’s Gupta.
Buch's warning sheds light on the urgent need for heightened vigilance and regulatory measures within the SME segment, however, there is a need to include market participants in the scrutiny process to avoid any further jolts in the market and maintain the stability of the stock market ecosystem amid ongoing turbulence.
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