Fraud concerns raise red flags for India’s booming SME IPOs

Fraud concerns raise red flags for India’s booming tiny IPOs

A string of accounting frauds unearthed by India’s securities regulator this month poses another risk to the blistering rally in shares of tiny businesses.

Varanium Cloud Ltd. and Add-Shop E-Retail Ltd. — both listed on the small and medium enterprises platform —  were found to have manipulated their financial statements to fuel gains in their shares, according to initial orders issued by the Securities and Exchange Board of India. The authorities have banned both companies and their founders from dealing in the country’s capital market.

The crackdown comes after the regulator issued warnings earlier this year of price manipulation in tiny IPOs. Analysts say the development presages greater regulatory action, which may temper further gains in the S&P BSE SME IPO Index of micro listings that has soared more than 5,000% since the start of 2021.

“This is just the tip of the iceberg,” said Ambareesh Baliga, an independent market expert who has been tracking Indian equities for over two decades. “Fewer regulations were meant to attract good quality SMEs to the market, instead it has attracted the wrong ones.”

Technology firm Varanium Cloud was found to have misused funds raised from its public offering in 2022, and “manipulated its financial statements by recording fictitious sales and purchases,” SEBI said in its order dated May 10.

Add-Shop E-Retail has been “passing fictitious sales transactions between its related parties” to inflate sales, the regulator said in a separate notice dated May 6.

In both cases, the founders had reduced their stakes in the companies during the period under investigation, according to SEBI.

The findings underscore the vulnerability of millions of traders to the risks of price manipulation in this segment due to fewer compliance requirements. They also highlight the limitation of regulatory warnings aimed at curbing enthusiasm for tiny IPOs in India, where retail investors have emerged as a major force.

Earlier this year, regulators clamped down on equity markets financing to cool pre-IPO sale frenzy. Still, the nation’s market for first-time share sales remains vibrant, with 102 deals priced since the start of 2024. That’s nearly three times as many as in China, data compiled by Bloomberg show. The BSE SME IPO Index surged to a record last week.

“Another 10 cases like this and this bubble will burst,” Baliga said. The veteran investor and investment advisor warned that majority of the investors are putting their money in such small public offerings with their eyes closed.