Firms diverting IPO money through ICDs, finds Sebi

Taking advantage of a regulatory gap, some companies have diverted the funds raised through IPOs for personal gains of promoters through Inter Corporate Deposits, prompting regulator Sebi to plug this loophole.

In its meeting last week, Sebi board decided that the companies will have to mandatorily deposit the money raised through Initial Public Offers (IPOs) with the scheduled commercial banks, pending utilisation of such funds for the specified purposes. The move is aimed at putting a check on misuse of the IPO funds or their diversion for purposes other than those stated in the draft papers while approaching the investors.

According to a board memorandum in this regard, Sebi found in its investigations that IPO proceeds were being misused in certain cases by way of siphoning off the money through Inter Corporate Deposits (ICDs) immediately after garnering the funds through the public issue. As per the current regulations, the companies need to make a disclosure in their rights and public issues that the interim use of funds would be done for “investment avenues in which the management proposes to deploy issue proceeds, pending its utilisation in the proposed project”. Sebi, however, found that a number of companies stated in their offer documents that pending utilisation of the net proceeds, the issuer would temporarily invest the same in various instruments.

These instruments included “high quality interest-bearing liquid instruments, including money market mutual funds, or other interest-bearing instruments or deposits with banks, financial institutions or for reducing overdrafts, etc”. Also, there are no specific provisions for interim use of funds in certain cases of public issues. To remove these regulatory gaps and check misuse of funds, the matter was referred to the Sebi’s Committee for Reviewing the Disclosures and Application Form in public issues, which suggested changes in the relevant clauses in the Issue of Capital and Disclosure Requirements (ICDR) Regulations. The Committee suggested that the ICDR norms needed to be modified to ensure that issuers invest only in bank deposits as they are not market linked.

So far, Sebi has been advising merchant bankers to incorporate a disclosure in offer documents to state that “net issue proceeds pending utilisation (for the stated objects) shall be deposited only in the scheduled commercial banks included in the Second Schedule of the RBI Act, 1934”. 

The practice of incorporating such an observation in offer documents has been in place for about a 

<g data-gr-id="63">year</g> now. However, since the current provisions in ICDR norms do not provide for the same, Sebi has now decided to amend the regulations in cases of public issues as well as rights issue of shares. In the case of public issue, the shares are issued to new investors, and to the existing investors in rights issues. 

Accordingly, the amended ICDR norms would provide that the interim use of funds would be limited to money being deposited only in the scheduled commercial banks under the RBI Act. In the case of IDRs, or Indian Depository Receipts, the issuer company is a foreign company with business operations in <g data-gr-id="41">foreign</g> jurisdiction. Therefore, it has been decided that the company in such cases would need to keep funds in a bank having a credit rating of A or above, assigned by an international credit rating agency.

These measures would prevent the companies from diverting their IPO or rights issue funds for other purposes, including for making profits through mutual funds and other market instruments. While raising funds through a public issue, the company has to specify the purpose for raising the funds. However, there has been a widespread practice of companies using these funds for other purposes in the interim period.