[Owais is a student at Government Law College.]
On 3 December 2024, the Securities and Exchange Board of India (SEBI) in the matter of initial public offer (IPO) of Trakifsol ITS Technologies Limited, directed Trafiksol ITS Technologies Limited (Trafiksol) to refund the money paid by the investor for subscribing its shares in the IPO and deferred the listing of its shares. Following SEBI's ruling, Trafiksol contested the judgement before the Securities Appellate Tribunal, which issued an interim stay on the order, enabling the company to continue its normal operations while the case is being reviewed.
The fact that the shares were already credited to the accounts of the eligible applicants of the IPO, and the listing of the shares was deferred one day prior to the scheduled listing, on the basis of a complaint, is what makes SEBI’s order critical and unique through manifold interpretations. In this backdrop, the present article evaluates the regulatory activism undertaken by SEBI in this order and the dereliction of obligations and malfeasance by the stock exchange and the merchant banker (MB) acting as the book running lead manager (BRLM) for the issue.
Factual Background
Trafiksol provides automation solution in transport system for toll and traffic management. It filed a draft red herring prospectus (DRHP) with the Bombay Stock Exchange (BSE) for listing its proposed IPO on the small and medium enterprise (SME) platform. An MB was appointed as the BRLM for the issue, and the IPO was resultantly oversubscribed by 345.66 times, raising proceeds worth INR 44.87 crores. Subsequently, the eligible applicants were allotted the shares in their demat accounts.
Before the final listing, a complaint was received from Small Investors Welfare Association by SEBI and BSE, alleging the purchase of a software valued at INR 17.70 crores from a third-party vendor (TPV) by Trafiksol, as stated in the objects of the DRHP, who has questionable financial credentials, for enabling Trafiksol to develop an Integrated Command Control Centre Software. Basis the complaint, the listing of shares of Trakifsol was deferred by an ex-parte interim order.
SEBI’s Findings
Initially, SEBI delved into understanding the obligations of intermediaries for an IPO. In furtherance of the same, it investigated the TPV and identified multiple deformities in its operation, which revealed several irregularities regarding TPV. The financial statements of TPV submitted to BSE for the past three years were all generated on the same day. It was also uncovered that the company’s entire shareholding had been transferred to one of its directors for just INR 20,000. Claims were made about projects worth INR 12.82 crore being in progress with three companies; however, two of these companies denied any association with TPV. Additionally, a site inspection found the registered office locked. Based on these findings, SEBI held that TPV was operating as a shell entity.
Trafiksol claimed it had no association with TPV and argued that, as per Clause 7(b) of Schedule VI of the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018 (ICDR Regulations), it was obligated to disclose technology purchases or orders in the DRHP. In the absence of any confirmed orders, the disclosure could be based on estimated quotations. Trafiksol maintained that no order had been placed with TPV, only an estimation is quoted and thus, the disclosure could not be deemed fraudulent to justify the deferral in its share listing and a refund to the investors. SEBI concluded that there could be no justification for obtaining quotations from a company lacking credibility at the first place.
Critical Analysis of SEBI’s Order
The author is of the firm view that this order by SEBI is an act of regulatory overreach and inadvertently creates impediments in the thriving SME platform IPO boom and humbly attempts to provide a constructive criticism on this order below:
Inconsistencies in due diligence
Firstly, there are evident errors in due diligence (DD) by the MB acting as the BRLM to the issue. The BRLM failed to excavate the irregularities and fraudulent operations of the TPV. Schedule II of the SEBI (Merchant Bankers) Regulations 1992 outlining the code of conduct to be followed by MB provides for undertaking DD and adequate disclosure to the investors by the MB. Similarly, Regulation 24 of the ICDR Regulations provides for ensuring the veracity and adequacy of disclosure made in the draft offer document and the offer document. Thus, the MB appointed for this issue failed on multiple fronts.
Even in previous orders like Enam Securities Limited, dealing with the IPO of Yes Bank, SEBI had imposed a penalty of INR 25,00,000 on the MBs, for alleged failure in disclosure. Similarly, in the order of Almonds Global Securities Limited, dealing with the IPO of PG Electroplast Limited. SEBI barred the MB from taking up any new assignment of capital issue including an IPO for 5 years. Unfortunately, not a single comment was made on the role of MB in the present Trafiksol order.
Thus, post this order, SEBI has recently formulated a mechanism of an online document repository which shall be maintained by the stock exchanges to aid and enable the MBs in their DD process, by allowing them to upload the IPO documents on the repository. Similarly, the responsibilities of the MBs acting as the BRLM for the issue shall now be outlined within the DRHP and the offer document. Earlier this was to be disclosed to SEBI after 1 month of submission of DRHP. Further, post SEBI’s board meeting of December 2024, the issuer of an SME IPO shall now provide a QR code in the newspaper to allow the public to access the DRHP for 21 days. Similar other reforms have been incorporated for bringing SME IPO at par with main board IPO.
Liability of the stock exchange
Secondly, it is important to note that in case of an SME, IPO is submitted only to the stock exchange, where the shares are proposed to be listed, as provided in Regulation 227 of the ICDR Regulations unlike the main board IPO, where DRHP is also provided to SEBI. All the major stock exchanges of the country, including BSE, have the power to reject the DRHP under Chapter IX of ICDR Regulations in case of any deformity or illegality in the DRHP.
However, in this instance, the BSE failed to examine this aspect in its review of the DRHP and the IPO subsequently went ahead to the extent of crediting the shares in the accounts of the applicants. Thus, there was belting of the stable door only after the horse escaped. The stock exchange clearly erred in the review mechanism and subsequently attempted to dress the wound by deferring the listing. The issuer and the subscribers turned out to be ultimate sufferer.
Lack of material record
Thirdly, and most notably, the connection between the issuer and the TPV is based on mere presumption and surmise. The order states that “… it can be reasonably presumed that the Managing Director of the company, given his long association with this sector, at the very least, was aware that the profile of the TPV’s directors …” (emphasis supplied).
It has been held in various landmark cases including Balram Garg v. SEBI, that there has to be a material on record to prove the allegations levelled by SEBI. This judgement has limited the role of circumstantial evidences paving way for the superiority of evidentiary burden. However, in the present case, no material was placed on record to prove the relation.
Overlook of alternative directives
It becomes pertinent to note that in this case, no order as such was placed with the TPV and that only a quotation based on estimation was provided. Thus, rather than providing for a refund, SEBI could have directed the issuer to place the order with some other entity and deposit the amount of INR 17.70 crores in an escrow account until the execution of the said transaction.
Additionally, instead of directing refund to the investors, SEBI could have allowed the investors to withdraw their bids. This was followed in various previous IPOs. However, the order provides only for refund of money. This goes against the rights of the investors who were successfully allotted shares in the IPO, and desired to continue with the same.
Conclusion
The SME IPO Segment is on a boom and has emerged as a fertile ground for raising capital. In 2024, around 230 SMEs secured INR 8,414 crores through funding, with 126 IPOs attracting subscriptions that surpassed 100 times. Additionally, the average bid increased to 178 times.
It is indeed true that SEBI is under a statutory obligation to protect the interest of the retail investors and can undertake any measure necessary in furtherance of the same, by virtue of Section 11(1) of the SEBI Act 1992. However, adjudicating on the basis of presumptions and making the issuer suffer for negligence by the intermediaries could demoralize the ease of doing business and rising tide of entrepreneurial zeal in the commercial landscape.
Thus, the author opposes this order as it reflects SEBI’s regulatory overreach, overlooking the MB’s due diligence failures, stock exchange’s review lapses, and the lack of concrete evidence linking the issuer to TPV. Constructive reforms are essential to balance regulatory oversight with fostering SME IPO growth while ensuring investor rights and market integrity are preserved.
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