The Vulnerability in Going Public and the Indispensable Need for ‘Pre-Filing’
[Shaurya is a student at Jindal Global Law School.]
An IPO is a door to bring in a substantial amount of capital along with several other opportunities that follow the former. However, due to certain unanticipated circumstances, if the issuer decides to close the door and pull out from the IPO, certain requirements of the procedure which mandate the issuer to disclose key information about the company to the public would affect the issuer regardless. Hence, the situation is a lose-lose for the issuer as it is not only losing the opportunity to raise the capital by pulling out (which usually happens due to an unfavourable event) but also disclosure under The Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations) makes sensitive information about the issuer public, therefore also giving access to its competitors, which can further hurt the issuer.
To protect the issuers in such a situation, foreign regulators like the US Securities and Exchange Commission and Financial Conduct Authority of the UK have allowed the issuers to pre-file the draft offer document (also known as the draft red herring prospectus (DRHP)) with only the regulatory bodies without making it public during the initial review which eliminates the public accessibility during the period between submission and evaluation of the initial draft.
Recently, the Primary Market Advisory Committee (PMAC) too deliberated with SEBI on the current process of issuance and suggested allowing the pre-filing of the offer document. The Indian capital markets regulator has this reform on its table, so it becomes vital to analyse the issues with the current procedure of issuance and determine the effectiveness of the said reform.
Vulnerability of the Issuer
The ICDR Regulations govern the entire process of an IPO. As of now, the issuer is required to file the DRHP for the initial review with SEBI, while the DRHP will also have to be made available in the public domain including the websites of the stock exchanges, SEBI, issuer, and the merchant bankers. SEBI would then review the DRHP and get back to the entity with approval or comments on the document. SEBI usually takes around 30-90 days to give a nod to the DRHP and allow the issuer to further continue with the succeeding steps of the process. Therefore, even the draft offer document will have to remain in the public domain since the very inception of the regulatory filing process. For instance, the recently listed Campus Activewear received SEBI’s nod after over 2.5 months since it first filed the DRHP on 27 December 2021. Now, this disclosure regulation might not be a problem for a company that eventually gets listed on the exchange. However, the vulnerability of the issuer would truly take its shape when the issuer decides to pull out from the IPO in the period between filling and receiving SEBI’s review. Now, pull-outs at this stage usually happen due to an unprecedented event which is unfruitful or which has a negative impact on the issuing entity. The disclosure would add salt to the wounds of the issuer as the competition would also have the vital data which was disclosed, which may benefit its competition.
The ICDR Regulations exist to ensure proper disclosure of relevant information to safeguard the investors (and potential investors) while maintaining a fair market environment by ensuring the accessibility of the information. However, it fails to do the same despite making the DRHP public since the very beginning of the process as the red herring prospectus (RHP, the document which contains all the updated information regarding the price and the size of the issue along with the comments received by SEBI after the initial review) stays in the public domain for only 2-5 days before the issue, for a considerably short period of time.
Therefore, it is pretty evident that there are certain areas the SEBI must focus on and make the necessary changes.
Pre-filing of DRHP: A Much Needed Reform
Unlike in a lot of earlier scenarios SEBI, this time is aware of its problem. It did address these issues in a consultation paper- which sought public comments on the introduction of prefilling, released on 11 May 2022. To solve these issues, the paper suggests allowing the pre-filling of the offer document with just the regulatory body without disclosing it to the public. This pre-filing of the offer documents is permitted in foreign jurisdictions like the US, the UK, and Canada where the regulatory authorities review the initial draft offer document, provide their comments, and then if the issuer still is willing to go ahead with the IPO, the document along with the mandated changes is made public.
The paper also had the framework for incorporating the same in India which was laid out by PMAC:
PMAC suggested that the ‘pre-filing’ of the DRHP shall be allowed without making it public. However, the issuer shall make a public announcement stating that it has commenced the process of an IPO by pre-filing the offer document with SEBI and the stock exchanges. The issuer shall also state that pre-filing of the offer document does not necessarily translate into the issuer actually undertaking the IPO. The issuer and the book running lead managers are also required to submit an undertaking stating that they won't indulge in any sort of marketing/campaign for the IPO at this stage.
After receiving SEBI’s in-principle approval and the observations on the DRHP, the issuer can further proceed with the process if it desires to. The issuer shall now file an updated version of the DRHP with the mandated changes, which is to be referred to as UDRHP-I (a public document). The UDHRP-I has to be made public for at least 21 days on the websites of SEBI, stock exchanges, issuer, and the lead managers for public comments, and only after this stage, the issuer and the lead managers can commence the campaigning for the IPO.
After the 21-day period expires the issuer is required to file the details of the received comments with SEBI. If certain changes are made to the document at this stage either due to public comments or to meet regulatory requirements, then it shall be named UDRHP-II and submitted to SEBI. The issuer shall then proceed further with the regular filing procedure (file the RHP, a public document, with the Registrar of Companies, the stock exchanges, and SEBI) once SEBI takes note of alterations in the UDRHP-II.
This framework by PMAC directly solves the core issue of the issuer by allowing pre-filing and would alter Part VI: Disclosures in and Filing of Offer Documents of the ICDR Regulations. However, it does not explicitly solve the problem of accessibility of the RHP. While it does mention a 21-day period for the UDRHP-I, that document lacks a lot of relevant information which is usually present only in the RHP, especially regarding the price of the issue and the latest financial data. Therefore, a minimum time period between the filing of RHP and the opening of the issue must be prescribed so that enough time is provided for the RHP to be consumed.
The Indian capital market is one of the biggest in the world; with huge domestic and foreign inflows, it can prove to be a gateway to tremendous opportunities. However, in order to allow the entities to fully capitalise on these opportunities, it is important to acknowledge the issues with the current set of regulations and act accordingly. The regulator has acknowledged the issue already, and now is the time to act on the same and bring the desired reforms as suggested by the PMAC and also mandate a minimum time period after which the issue could open once the RHP is filed. These reforms would not only safeguard the issuers and their investors but will also eliminate a further deterrence in the minds of potential issuing entities from pursuing an IPO when the short-term market conditions are uncertain.