Burdening independent directors with responsibility for IPO pricing

Life of Independent Directors in Indian companies was never easy, now it going to get even tougher.  In addition to various fiduciary and other obligations cast upon them under law and otherwise, they’d have to be extra cautious if their company is to come out with a public issue.

Price fixing of shares has recently become one of the most controversial aspect of Indian capital markets. In recent years, there is a worrying trend going on in the capital market i.e overhype around share pricing at the time of initial public offering (IPO) by companies which price in no time would collapse by a hefty margin and remain so, even though markets bounce back to their best.

This pattern causing significant monetary loss to investors, the Securities & Exchange Board of India (SEBI), to control this issue brought a new ruling putting onus of justification of pricing of shares on the independent directors.

In a recent statement, SEBI has said that it is duty of committee of independent directors to recommend the pricing is justified based on quantitative factors or key performance indicators vis-à-vis the weighted average cost of acquisition of primary or secondary transactions – It is anticipated that SEBI will make this new ruling mandatory as a law in November by amending applicable rules and regulations.

This intended ruling brings multiple challenges for independent directors:

a)       It is highly impossible for every independent director to be a financial subject matter expert as independent directors do come from non-financial ground, this makes it difficult for independent directors to immediately catch up with the pace of this new requirement – As a result this new ruling will force independent directors to gain requisite practical knowledge about price fixing and its implications or make them dependent on third party vendors for assistance.

b)       Until now, liability for issues in pricing fixing will be on merchant bankers and executive directors, with inclusion of independent directors to this bandwagon will attract civil and criminal liabilities on independent directors.

c)       This could discourage independent professionals of repute and standing from taking the position of independent directors making existing vacuum much deeper in the independent directors’ segment as this segment is already struggling with a dearth of independent directors - As per available media reports, 1970 listed companies have a total of 6266 individuals taking 7991 independent director’ positions (some candidates taking multiple positions, i.e 82 of them hold independent director position in five or more companies) and also there are 104 foreign nationals.

SEBI is of the opinion that independent directors are the watchdogs of the companies and of minority stakeholders and surely this new ruling will not be a burden on them, yet an additional due diligence check and to perform the same, independent directors will need to take assistance of third party vendors, if needed. Further SEBI says that this is important to ensure founders and other stakeholders do not engage in overhyped pricing of shares to the detriment of the investors.

Given the constraints attached to the new ruling it will be interesting to see if the independent directors’ fraternity will embrace this new requirement successfully or make professionals hesitant to take the role of independent director.

New ruling is definitely a welcome measure to ensure pricing of shares is appropriately justified and no overhyping of shares with the intent to lure investors to make investments and this could serve as a safeguard to economic interest of genuine investors.

However, it is crucial to clearly define the role of and liability on the independent directors in this whole price fixing scheme to bring clarity on consequence of independent directors authentication of price justification on such independent directors, and to give assurance to independent directors who act in the best interests of the company and in compliance with laws will be protected and only those who go out of line and commit default and breach the laws in price fixing will be punished.

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