Sebi bars JM Financial from acting as lead manager of any public debt issue

The regulator had investigated issue of NCDs in 2023

The market regulator has barred JM Financial from taking any new mandate for acting as a lead manager for any public issue of debt securities.

In an interim order, dated March 7, the Securities and Exchange Board of India (Sebi) stated that JM Financial may continue to act as a lead manager for public issue of debt securities for a period of 60 days from the date of this Order. Sebi has stated that the observations made in the order are based on the material available on record and that the investigation into this matter will be completed in six months.

Also read: RBI bars JM Financial from financing against shares and debentures; major deficiencies cited

How it started

These proceedings started with the regulator's routine examination into public issues of non-convertible debentures (NCDs) in 2023. The examination looked into the role of three different businesses--one of the parent company and merchant banker JM Financial Limited, wholly owned subsidiary and broker JM Financial Services (JMFSL) and subsidiary and a non-banking financial corporation (NBFC) JM Financial Products Limited (JMFPL)--in a debt issue.

The issue, which was the first tranche of NCDs issued under a shelf prospectus (document that gives details of the debt-issuing company) dated October 16, 2023, had a base issue size of Rs. 200 Crore with a green shoe option of Rs. 800 Crore.

JM Financial was the lead manager to the issue. The examination showed that its NBFC arm JMFPL not only funded the investors who subscribed to this issue but also gave them an exit, at a loss to itself. Its brokerage JMFSL facilitated the investors' trades.

The Sebi order stated, "we can also conclude from the data with us that JMFPL-NBFC was the seller, buyer and then a re-seller of the NCDs of which JM Financial Limited was the Merchant Banker. They were able to seamlessly pull this off because they were the PoA (Power of Attorney) holders for many of the investors in question."

The regulator noted the "shocking" manner in which subscriptions were managed in a public issue of debt instrument.  The Sebi order stated that the transactions at every stage of the public issue appeared to have been done in a "pre determined and pre-meditated manner; and executed clinically to ensure subscription and success".

According to the regulator, it resulted in market integrity and fair-price discovery being compromised.

Letter of law?

While JM Financial and its group companies said that they have followed the letter of the law, the Sebi order stated that their actions when "aggregated" shows "a complete disregard for restrictions imposed by SEBI on providing incentives to investors for subscribing to debt securities".

The order stated, "The attempt has been to wrap their actions with the cloak of formal legality."

There may have been a contravention of regulatory mandate as well, suggested the order. While Sebi (Issue and Listing of Non-convertible Securities) Regulations, 2021, prohibits giving any incentive for making an application in any issue of securities, JM Financial and its group companies promised assured returns to certain investors at a profit and thereby incentivised them to apply to the public issue.

The scheme

The order stated, "The scheme, it is prima facie noted, involved getting individual investors, who would otherwise not have participated in the issue, to make applications not just by providing funds to them but also by assuring them an exit at a profit on the listing day."

Also read: Exclusive: Markets regulator has been investigating IPO financiers for over a year, say sources

It added, "An investor seeking funding to apply in a public issue of securities is looking to make trading gains by virtue of the movement in the price of the security post-listing. However, given the interest charged by the lender on such loans, there needs to be a jump in the price of the security post-listing for such trades to be profitable."

The order noted that therefore such trades are more prevalent in the equity markets and are rare in the debt segment. An investor in the debt market is usually looking for fixed returns from the coupon rate and not looking at returns from trading the instrument. Most of the investors in NCDs hold the instrument till maturity.

Therefore, if they are taking leveraged bets (like they did with this issue), with the promise of listing gains, then liquidity in the instrument would be of utmost importance, the order noted.

The order stated, "in case of debt issues, with the limited trades that are generally observed, investors typically would not make leveraged bets unless they are assured of exiting their positions immediately on listing day."

Prima facie, the regulator's examination points to incentivising the investors to subscribe to the issue with a promise of an assured exit. This seems to be a contravention of the law.