SEBI Poised for Significant Action Following Warnings on SME IPOs

On Wednesday, the Securities and Exchange Board of India (SEBI) issued a warning to investors regarding the increasing presence of unethical promoters in the small and medium enterprises (SME) sector. These promoters are known to engage in illegal practices after listing their companies, such as artificially inflating stock prices by creating a misleadingly positive image of their business, attracting investors, and then exiting the market. SEBI advised investors to avoid making decisions based on unverified social media posts, tips, or rumors.

According to a press release from SEBI, SMEs have successfully raised over ₹14,000 crore since the launch of trading platforms for SME stocks in 2012, with ₹6,000 crore raised in the fiscal year 2024 alone.

Recently, the National Stock Exchange (NSE) implemented stricter rules for SME initial public offerings (IPOs), stating that, effective from September 1, only companies with positive free cash flow—money remaining after all capital and operating expenses have been paid—will be eligible to list on its platform. SEBI observed that after listing, some SMEs and their promoters have been engaging in activities that create an inflated perception of their business operations.

These companies often follow up these announcements with various corporate actions like bonus issues, stock splits, and preferential allotments, which generate positive sentiment among investors, enticing them to purchase shares. This simultaneously provides promoters with an opportunity to sell their holdings at elevated prices," the release stated.

SEBI has recently taken action against several such entities, noting that their methods often follow a consistent pattern. For example, earlier this week, SEBI took action against Debock Industries and three related entities, including its promoters. Debock Industries, which was listed on NSE's SME platform in June 2018 and later moved to the main board in March 2022, was found to have engaged in extensive related-party transactions to artificially boost its business and revenue figures.

Following its migration to the main board, the company conducted a preferential allotment to entities connected to the promoters. Shares from this allotment were subsequently transferred to the promoters through off-market transactions and then sold in the market. By the time SEBI began its investigation, the promoters had made illegal gains totaling ₹89.2 crore, while shareholders were left holding nearly worthless shares.

India's market regulator has expressed concerns about unethical practices within the SME sector, cautioning investors about inflated projections by some SMEs. In an advisory, SEBI highlighted that after listing, certain SME companies or their promoters make public announcements that present an overly optimistic view of their operations. These are often followed by corporate actions such as bonus issues, stock splits, and preferential allotments.

"Such companies or promoters have been seen making public announcements that create a positive picture of their operations. These announcements are typically followed up with various corporate actions such as bonus issues, stock splits, preferential allotments, etc.," the two-page advisory stated.

Despite these positive announcements, many of these SME companies are engaging in manipulative practices. Promoters often take advantage of these artificially inflated valuations to sell their shares at high prices, leaving investors at a disadvantage.

This advisory follows a statement from SEBI's chairperson, Madhabi Puri Buch, in March, expressing concerns about price manipulation at the IPO and trading levels by some SMEs. She indicated that the regulator plans to seek more disclosures to increase transparency in SME IPOs.

SEBI has taken action against such entities in the past, noting that their operations often follow a similar pattern. For instance, in May, SEBI barred Add-Shop E-Retail Ltd and its promoters from accessing the capital markets after discovering that over 46% of the company's sales in the past three years were fictitious, with related-party transactions lacking proper approvals. In the same month, SEBI also banned Varanium Cloud Ltd from the markets due to the misuse of IPO proceeds.

"Earlier this year, SEBI took action against three other SME companies for similar violations, including the misuse of public funds, misstating facts in offer documents, and manipulating financial statements. These companies had inflated their operations to create false perceptions and boost investor interest, allowing promoters to offload shares at elevated prices," said Nilesh Tribhuvann, managing partner at White & Brief Advocates & Solicitors.

Since the launch of the SME platform on stock exchanges in 2012, the market has experienced significant growth, with over ₹14,000 crore raised in the past decade, including approximately ₹6,000 crore in 2023-24, according to the SEBI advisory note.

The BSE SME IPO index has seen a dramatic rise, reaching 111,683.62 from 35,558.66 on August 28, 2023—a 140.03% year-on-year increase and a 214.08% increase this year to date. However, this rapid growth has raised concerns about transparency and fair practices.

SEBI has urged investors to exercise caution when investing in SME securities, advising them to avoid relying on unverified social media posts or making investments based on tips or rumors. Instead, investors are encouraged to conduct thorough due diligence and seek professional advice before making investment decisions.

Tribhuvan added that SEBI is considering tighter regulations, such as raising the minimum size for public offers and requiring more comprehensive disclosures from companies seeking SME listings. "These measures aim to protect retail investors and ensure that only compliant companies access the capital markets, fostering trust and stability within the SME sector."

The Association of Mutual Funds in India (Amfi) has also been in discussions with asset management companies (AMCs) about implementing measures to prevent front-running. Amfi has communicated with AMCs about adopting better practices to curb front-running. However, a member of the Brokers Committee told Mint that this is considered standard procedure and part of the risk management framework.

SEBI and Amfi have been particularly vigilant in recent months, especially following front-running cases involving Axis and Quant mutual funds, according to an industry insider who spoke on condition of anonymity. "However, circulars requesting the implementation of institutional mechanisms are not unusual," the source added.