Sebi ban on DLF: Why merchant bankers of the IPO shouldn't go scot free

There are reports that the Sebi wants to proceed against the merchant bankers involved in the DLF IPO in 2007 for their failure to ensure that the prospectus disclosed the scandalous and post-haste de-subsidiarisation of as many as 288 companies in the run up to the IPO including Sudipti, Shalika and Felicite.

These three companies in particular have become a butt of joke ever since the Sebi order debarring DLF and its promoters from the capital market for three years was passed a few days ago with the fig-leaf of excuse for disowning these companies that they had passed into the hands of wives of the key managerial personnel of DLF not fooling the Sebi.

The market regulator found that a clutch of 100% subsidiaries of DLF that owned these three companies continued to control them despite the shares having been sold to the housewives.

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In an article on 14 October, I had pointed out how the merchant bankers went happily along with the DLF promoters in enacting this elaborate charade of desubsidiarisation so that the activities and performance of these de facto subsidiaries were kept out of the DLF prospectus.

Schedule III of the Sebi Merchant bankers’ regulations 1992 vide its code of conduct for merchant bankers clearly asks them to do everything in their power to ensure that the investors were not misled. The Sebi Disclosure and Investor Protection guidelines of 2000, in fact, makes the merchant banker the lynchpin in the whole exercise of IPO.

In the event, merchant bankers cannot get away with the self-serving excuse that they relied on the averments made and documents furnished by auditors and legal advisors of the company - the defence normally taken by them when faced with negligence charge.

As far as the Sebi is concerned, the buck stops with the merchant bankers because the very purpose of appointing them is to ensure that the blame game does not go on to the detriment of the public.

Chartered accountants and lawyers come under the regulatory powers of their respective professional bodies and it is for them to proceed against their negligent members. But merchant bankers come squarely under the Sebi oversight, having gotten the unique privilege of marketing an IPO for a fat fee. Moreover, they are registered with the Sebi.

With this comes the responsibility. In other words, having conferred a unique status to merchant bankers, the Sebi has the moral authority as well, apart from the explicit powers conferred by its various regulations, to ensure the tribe of merchant bankers were not blas about their responsibilities.

The Sebi regulations on merchant bankers seeks to ensure that they are spared the blushes. Blush they have to if they have any conflict of interest which is why a merchant banker should not do any other function apart from merchant banking.

But Kotak Mahindra’s role in the sordid DLF saga does raise questions about the effectiveness of the Chinese wall between merchant bankers and commercial bankers. That Kotak Mahindra Bank gave loans of Rs 20 lakh each to key managerial personnel of DLF which in turn were passed on to their respective wives so as to be able to buy off the three subsidiaries has raised eyebrows. Its merchant banking outfit was the lead manager and ought to have known about these transactions and hence should have ensured that they were disclosed in the prospectus.

Of course, the Kotak Mahindra group would give a spin and rationalise that the Chinese wall was so impenetrable that the merchant bank did not get wind of what the commercial bank had done. But that would be as laughable as the explanation by DLF that the housewives controlled companies were not its subsidiaries.

The Sebi needs to ponder afresh in the light of the DLF episode whether allowing merchant banking outfits of commercial banks with which the issuer has account to act as merchant banker to the issue is kosher.

Indeed policy wonks need to ponder whether the ideas of financial supermarket itself sows the seeds of potential conflict of interest. It would be idle for SBI Capital Markets to contend that it does not know anything about the operations of its commercial banking parent. Ideally, a merchant bank should have no interest direct or indirect with the issuing company.