Investment Banking

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Investment Banking
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Topics of Investment Banking:-
Introduction
Meaning
Overview
~Evolution of Investment Banking
~Its Mechanism (statement of investment banking)
Products/Services Offered
~Lists of explanation
~Special services
How these services server the purpose of clients?
Risks associated with investment banking?
~Types
~Explanation (example){problem impact}
How the risks are managed effectively?
~Why risks management?
~Ways (example){problem action}
Future Scenario
Conclusion
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INTRODUCTION
At a very macro level, Investment Banking as term suggests, is concerned
with the primary function of assisting the capital market in its function of
capital intermediation, i.e., the movement of financial resources from those
who have them (the Investors), to those who need to make use of them for
generating GDP (the Issuers). Banking and financial institution on the one
hand and the capital market on the other are the two broad platforms of
institutional that investment for capital flows in economy. Therefore, it
could be inferred that investment banks are those institutions that are
counterparts of banks in the capital markets in the function of intermediation
in the resource allocation. Nevertheless, it would be unfair to conclude so, as
that would confine investment banking to very narrow sphere of its activities
in the modern world of high finance. Over the decades, backed by evolution
and also fuelled by recent technologies developments, an investment
banking has transformed repeatedly to suit the needs of the finance
community and thus become one of the most vibrant and exciting segment
of financial services. Investment bankers have always enjoyed celebrity
status, but at times, they have paid the price for the price for excessive
flamboyance as well.
To continue from the above words of J ohn F. Marshall and
M.E. Eills, investment banking is what investment banks do. This
definition can be explained in the context of how investment banks have
evolved in their functionality and how history and regulatory intervention
have shaped such an evolution. Much of investment banking in its present
form, thus owes its origins to the financial markets in USA, due o which,
American investment banks have banks have been leaders in the American
and Euro markets as well. Therefore, the term investment banking can
arguably be said to be of American origin. Their counterparts in UK were
termed as merchants banks since they had confined themselves to capital
market intermediation until the US investments banks entered the UK and
European markets and extended the scope of such businesses.
Investment banks help companies and governments and their agencies to
raise money by issuing and selling securities in the primary market. They
assist public and private corporations in raising funds in the capital markets
(both equity and debt), as well as in providing strategic advisory services for
mergers, acquisitions and other types of financial transactions.
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Investment banks also act as intermediaries in trading for clients. Investment
banks differ from commercial banks, which take deposits and make
commercial and retail loans. In recent years, however, the lines between the
two types of structures have blurred, especially as commercial banks have
offered more investment banking services. In the US, the Glass-Steagall Act,
initially created in the wake of the Stock Market Crash of 1929, prohibited
banks from both accepting deposits and underwriting securities; Glass-
Steagall was repealed by the Gramm-Leach-Bliley Act in 1999. Investment
banks may also differ from brokerages, which in general assist in the
purchase and sale of stocks, bonds, and mutual funds. However some firms
operate as both brokerages and investment banks; this includes some of the
best known financial services firms in the world.
More commonly used today to characterize what was traditionally termed
investment banking is sells side." This is trading securities for cash or
securities (i.e., facilitating transactions, market-making), or the promotion of
securities (i.e. underwriting, research, etc.).
The "buy side" constitutes the pension funds, mutual funds, hedge funds, and
the investing public who consume the products and services of the sell-side
in order to maximize their return on investment. Many firms have both buy
and sell side components.
Definition
An individual or institution, which acts as an underwriter or agent for
corporations and municipalities issuing securities. Most also maintain
broker/dealer operations, maintain markets for previously issued
securities, and offer advisory services to investors. Investment banks
also have a large role in facilitating mergers and acquisitions, private
equity placements and corporate restructuring. Unlike traditional
banks, investment banks do not accept deposits from and provide loans
to individuals. Also called investment banker.
Who needs an Investment Bank?
Any firm contemplating a significant transaction can benefit from the advice
of an investment bank. Although large corporations often have sophisticated
finance and corporate development departments provide objectivity, a
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valuable contact network, allows for efficient use of client personnel, and is
vitally interested in seeing the transaction close.
Most small to medium sized companies do not have a large in-house staff,
and in a financial transaction may be at a disadvantage versus larger
competitors. A quality investment banking firm can provide the services
required to initiate and execute a major transaction, thereby empowering
small to medium sized companies with financial and transaction experience
without the addition of permanent overhead, an investment bank provides
objectivity, a valuable contact network, allows for efficient use of client
personnel, and is vitally interested in seeing the transaction close.
Most small to medium sized companies do not have a large in-house staff,
and in a financial transaction may be at a disadvantage versus larger
competitors. A quality investment-banking firm can provide the services
Organizational structure of an investment bank
The main activities and units
The primary function of an investment bank is buying and selling products
both on behalf of the bank's clients and also for the bank itself. Banks
undertake risk through proprietary trading, done by a special set of traders
who do not interface with clients and through Principal Risk, risk
undertaken by a trader after he or she buys or sells a product to a client and
does not hedge his or her total exposure. Banks seek to maximize
profitability for a given amount of risk on their balance sheet
An investment bank is split into the so-called Front Office, Middle Office
and Back Office. The individual activities are described below:
Front Office
Investment Banking is the traditional aspect of investment banks
which involves helping customers raise funds in the Capital Markets
and advising on mergers and acquisitions. Investment bankers prepare
idea pitches that they bring to meetings with their clients, with the
expectation that their effort will be rewarded with a mandate when the
client is ready to undertake a transaction. Once mandated, an
investment bank is responsible for preparing all materials necessary
for the transaction as well as the execution of the deal, which may
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involve subscribing investors to a security issuance, coordinating with
bidders, or negotiating with a merger target. Other terms for the
Investment Banking Division include Mergers & Acquisitions (M&A)
and Corporate Finance (often pronounced "corpfin").
Investment management is the professional management of various
securities (shares, bonds etc) and other assets (e.g. real estate), to meet
specified investment goals for the benefit of the investors. Investors
may be institutions (insurance companies, pension funds, corporations
etc.) or private investors (both directly via investment contracts and
more commonly via collective investment schemes eg. mutual funds) .
Financial Markets is split into four key divisions: Sales, Trading,
Research and Structuring.
o Sales and Trading is often the most profitable area of an
investment bank

, responsible for the majority of revenue of
most investment banks

In the process of market making, traders
will buy and sell financial products with the goal of making an
incremental amount of money on each trade. Sales is the term
for the investment banks sales force, whose primary job is to
call on institutional and high-net-worth investors to suggest
trading ideas (on caveat emptor basis) and take orders. Sales
desks then communicate their clients' orders to the appropriate
trading desks, which can price and execute trades, or structure
new products that fit a specific need.
o Research is the division which reviews companies and writes
reports about their prospects, often with "buy" or "sell" ratings.
While the research division generates no revenue, its resources
are used to assist traders in trading, the sales force in suggesting
ideas to customers, and investment bankers by covering their
clients. In recent years the relationship between investment
banking and research has become highly regulated, reducing its
importance to the investment bank.
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o Structuring has been a relatively recent division as derivatives
have come into play, with highly technical and numerate
employees working on creating complex structured products
which typically offer much greater margins and returns than
underlying cash securities.
Middle Office
Risk Management involves analysing the market and credit risk that
traders are taking onto the balance sheet in conducting their daily
trades, and setting limits on the amount of capital that they are able to
trade in order to prevent 'bad' trades having a detrimental effect to a
desk overall. Another key Middle Office role is to ensure that the
above mentioned economic risks are captured accurately (as per
agreement of commercial terms with the counterparty) correctly (as
per standardised booking models in the most appropriate systems) and
on time (typically within 30 minutes of trade execution). In recent
years the risk of errors has become known as "operational risk" and
the assurance Middle Offices provide now include measures to
address this risk. When this assurance is not in place, market and
credit risk analysis can be unreliable and open to deliberate
manipulation.
Back Office
Operations involve data-checking trades that have been conducted, ensuring that
they are not erroneous, and transacting the required transfers. While it provides
the greatest job security

of the divisions within an investment bank, it is a critical
part of the bank that involves managing the financial information of the bank and
ensures efficient capital markets through the financial reporting function. The
staff in these areas are often highly qualified and need to understand in depth the
deals and transactions that occur across all the divisions of the bank.
Recent evolution of the business
New products
Investment banking is one of the most global industries and is hence
continuously challenged to respond to new developments and innovation in
the global financial markets. Throughout the history of investment banking,
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many have theorized that all investment banking products and services
would be commoditized. New products with higher margins are constantly
invented and manufactured by bankers in hopes of winning over clients and
developing trading know-how in new markets. However, since these can
usually not be patented or copyrighted, they are very often copied quickly by
competing banks, pushing down trading margins.
For example, trading bonds and equities for customers is not a commodity
business but structuring and trading derivatives is highly profitable.Each
OTC contract has to be uniquely structured and could involve complex pay-
off and risk profiles. Listed option contracts are traded through major
exchanges, such as the CBOE, and are almost as commoditized as general
equity securities.
In addition, while many products have been commoditized, an increasing
amount of profit within investment banks has come from proprietary trading,
where size creates a positive network benefit (since the more trades an
investment bank does, the more it knows about the market flow, allowing it
to theoretically make better trades and pass on better guidance to clients).
Possible conflicts of interest
Potential conflicts of interest may arise between different parts of a bank,
creating the potential for financial movements that could be market
manipulation. Authorities that regulate investment banking (the FSA in the
United Kingdom and the SEC in the United States) require that banks
impose a Chinese wall which prohibits communication between investment
banking on one side and research and equities on the other.
Some of the conflicts of interest that can be found in investment banking
are listed here:
Historically, equity research firms were founded and owned by
investment banks. One common practice is for equity analysts to
initiate coverage on a company in order to develop relationships that
lead to highly profitable investment banking business. In the 1990s,
many equity researchers allegedly traded positive stock ratings
directly for investment banking business. On the flip side of the coin:
companies would threaten to divert investment banking business to
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competitors unless their stock was rated favorably. Politicians acted to
pass laws to criminalize such acts. Increased pressure from regulators
and a series of lawsuits, settlements, and prosecutions curbed this
business to a large extent following the 2001 stock market tumble
Many investment banks also own retail brokerages. Also during the
1990s, some retail brokerages sold consumers securities which did not
meet their stated risk profile. This behavior may have led to
investment banking business or even sales of surplus shares during a
public offering to keep public perception of the stock favorable.
Since investment banks engage heavily in trading for their own account, there is
always the temptation or possibility that they might engage in some form of front
running.
Types of investment banks
Investment banks "underwrite" (guarantee the sale of) stock and bond
issues, trade for their own accounts, make markets, and advise corporations
on capital markets activities such as mergers and acquisitions.
Merchant banks were traditionally banks which engaged in trade financing.
The modern definition, however, refers to banks which provide capital to
firms in the form of shares rather than loans. Unlike Venture capital firms,
they tend not to invest in new companies.
Investment banks provide four primary types of services:
Raising capital, advising in mergers and acquisitions, executing securities
sales and trading, and performing general advisory services. Most of the
major Wall Street firms are active in each of these categories. Smaller
investment banks may specialize in two or three of these categories.
Raising Capital
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An investment bank can assist a firm in raising funds to achieve a variety of
objectives, such as to acquire another company, reduce its debt load, expand
existing operations, or for specific project financing. Capital can include
some combination of debt, common equity, preferred equity, and hybrid
securities such as convertible debt or debt with warrants. Although many
people associate raising capital with public stock offerings, a great deal of
capital is actually raised through private placements with institutions,
specialized investment funds, and private individuals. The investment bank
will work with the client to structure the transaction to meet specific
objectives while being attractive to investors.
Mergers and Acquisitions
Investment banks often represent firms in mergers, acquisitions, and
divestitures. Example projects include the acquisition of a specific firm, the
sale of a company or a subsidiary of the company, and assistance in
identifying, structuring, and executing a merger or joint venture. In each
case, the investment bank should provide a thorough analysis of the entity
bought or sold, as well as a valuation range and recommended structure.
Sales and Trading
These services are primarily relevant only to publicly traded firms, or firms,
which plan to go public in the near future. Specific functions include making
a market in a stock, placing new offerings, and publishing research reports.
General Advisory Services:
Advisory services include assignments such as strategic planning, business
valuations, assisting in financial restructurings, and providing an opinion as
to the fairness of a proposed transaction.
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Terms Related To Investment Bank
Buying and Selling
Buying
Deciding on the proper time to purchase a security that you would like to
add to your holdings can be a daunting task. If the price drops immediately
after you buy, it may seem as if you missed out on a better buying
opportunity. If the price jumps right before you make your move, you may
feel as if you paid too much. As it turns out, you should not let these small
fluctuations influence your decision too much. As long as the fundamentals
that led you to decide on the purchase have not changed, a few points in
either direction should not have a large impact on the long-term value of
your investment.
Similarly, the fact that an investment has been increasing in value of late is
not a sufficient reason for you to purchase it. Momentum can be very fickle,
and recent movement is not necessarily an indicator of future movement.
Therefore, buying decisions should be based on sound and thorough research
geared toward discerning the future value of a security relative to its current
price. This analysis will probably not touch upon price movement in the very
recent past. As you learn more about investing you'll get better at deciding
when to buy, but most experts recommend that beginners avoid trying to
time the market, and just get in as soon as they can and stay in for the long
haul.
The proper time to buy a security is quite simply when it is available for less
than its actual value. These undervalued securities are actually not as rare as
they sound. However, the problem is simply that they are never sure bets.
The value of a security includes estimates of the future performance of
factors underlying the value of the security. For stocks, these factors include
things like earnings growth and market share. Changes can be predicted to a
degree, but they are subject to fluctuation due to forces both within and
beyond the control of the company.
The overall economic climate, changes in the industry or even bad decisions
by management can all cause a security poised to ascend in value to become
an under performer. Therefore, it is essential to practice your analysis before
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putting your money into action. Make some mock purchases based on your
personal analysis technique and track the results. Not all of your decisions
will lead to the results you were expecting, but if most of your choices turn
out to be good and there are mitigating factors that you can learn from to
explain your missteps, then you may be ready to put your analysis technique
and investing strategy into action.
At this point, the need to continuously monitor your investments does not
disappear. Both under performers and overachievers should be studied
carefully to fine-tune your strategy. You should also regularly look at your
securities to make sure that the fundamentals for success that led you to buy
in the first place are intact. If not, you may need to prepare to cash in and
start looking for the next opportunity.
One way to avoid the hassles of deciding when to buy altogether is to
practice dollar-cost averaging. This strategy advocates investing a fixed
dollar amount at regular intervals. The price when you first invest is
relatively unimportant (as long as the fundamentals are sound) because you
will be purchasing shares at a different price each time you buy. The success
of your investment then lies not with short-term fluctuations, but with the
long-term movement of the value of the security.
Selling:
There comes a time when investments must be liquidated and converted
back into cash. In a perfect world, selling would only be necessary when
investment goals have been reached or time horizons have expired, but, in
reality, decisions about selling can be much more difficult. For one thing, it
can be just as hard to decide when to sell as it can be to decide when to buy.
No one wishes to miss out on gains by selling too soon, but, at the same
time, no one wishes to watch an investment peak in value and then begin to
decline.
Investors often seek to sell investments that have dropped in value in the
short-term. However, if conditions have not changed significantly, drops in
price may actually represent an opportunity to buy at a better price. If the
initial research, which led to the purchase, was sound, a temporary decline
does not preclude the success that was originally predicted. Of course, things
change, and if the security no longer meets the criteria that led to its
purchase, selling may in fact be the best option.
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Selling may also become necessary if investment goals change over time.
You may need to reduce the amount of risk in your portfolio or you may
have the opportunity to seek out greater returns. Additionally, a security may
have increased in value to the point that it is overvalued. This creates an
excellent opportunity to cash in and seek out new undervalued investments.
Often you will need to make this type of sale in the course of rebalancing a
portfolio necessitated by gains and losses in different areas.
Selling can be especially difficult when an under performing stock must be
dumped. Some investors let their emotions dictate their actions and hold on
to stocks that have fallen in value rather than to sell, thinking that selling at a
loss is like admitting that they made a mistake. However, realizing the loss
and moving on to better investments is often preferable to continuing to hold
onto a loser in the hopes that it will somehow rebound.
When considering any sale, you must factor in the costs of the sale itself.
Fees and taxes will eat into profits, so they must be subtracted from any
increases in value to understand the true impact of the transaction. Capital
gains taxes are higher for gains on investments held less than one year, so
it's often wise to invest for the long term rather than to buy and sell quickly.
On the other hand, it can be dangerous to hold an investment longer than you
want to, simply to reduce the tax burden.
It is essential to remember that just because an investment increases in value
after it has been sold does not necessarily mean that it was sold prematurely.
Managing risk and diversification are often more important than capitalizing
on short-term gains in a particular security. Keeping in mind the initial goals
for the investment and adjusting them to fit your present goals will allow
you to make smarter decisions about selling.
Principles of Investing
1. Start Investing Now
We say this not just to discourage procrastination, but because an early start
can make all the difference. In general, every six years you wait doubles the
required monthly savings to reach the same level of retirement income.
Another motivational statistic: If you contributed some amount each month
for the next nine years, and then nothing afterwards, or if you contributed
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nothing for the first nine years, then contributed the same amount each
month for the next 41 years, you would have about the same amount.
Compounding is a beautiful thing.
2. Know Yourself
The right course of action depends on your current situation, your future
goals, and your personality. If you don't take a close look at these, and make
them explicit, you might be headed in the wrong direction.
Current Situation: How healthy are you, financially? What's your
net worth right now? What's your monthly income? What are your
expenses (and where could they be reduced)? How much debt are you
carrying? At what rate of interest? How much are you saving? How are
you investing it? What are your returns? What are your expenses?
Goals: What are your financial goals? How much will you need to
achieve them? Are you on the right track?
Risk Tolerance: How much risk are you willing and able to accept in
pursuit of your objectives? The appropriate level of risk is determined by
your personality, age, job security, health, net worth, amount of cash you
have to cover emergencies, and the length of your investing horizon.
3. Get Your Financial House In Order
Even though investing may be more fun than personal finance, it makes
more sense to get started on them in the reverse order. If you don't know
where the money goes each month, you shouldn't be thinking about
investing yet. Tracking your spending habits is the first step toward
improving them. If you're carrying debt at a high rate of interest (especially
credit card debt), you should unburden yourself before you begin investing.
If you don't know how much you save each month and how much you'll
need to save to reach your goals, theres no way to know what investments
are right for you.
If you've transitioned from a debt situation to paycheck-to-paycheck
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situation to a saving some money every month situation, youre ready to
begin investing what you save. You should start by amassing enough to
cover three to six months of expenses, and keep this money in a very safe
investment like a money market account, so you're prepared in the event of
an emergency. Once you've saved up this emergency reserve, you can
progress to higher risk (and higher return) investments: bonds for money that
you expect to need in the next few years, and stocks or stock mutual funds
for the rest. Use dollar cost averaging, by investing about the same amount
each month. This is always a good idea, but even more so with the dramatic
fluctuations in the market in the past 10 years. Dollar cost averaging will
make it easier to stomach the inevitable dips.
And remember; never invest in anything you don't understand.
4. Develop A Long Term Plan
Now that you know your current situation, goals, and personality, you
should have a pretty good idea of what your long-term plan should be. It
should detail where the money will go: cars, houses, college, and retirement.
It should also detail where the money will come from. Hopefully the
numbers will be about the same.
Don't try to time the market. Get in and stay in. We don't know what
direction the next 10% move will be, but we do know what direction the
next100% move will be.
Review your plan periodically, and whenever your needs or circumstances
change. If you are not confident that your plan makes sense, talk to an
investment advisor or someone you trust.
5. Buy Stocks
Now that you've got a long term view, you can more safely invest in 'riskier'
investments, which the market rewards (in general). This requires patience
and discipline, but it increases returns. This approach reduces the entire
universe of investment vehicles to two choices: stocks and stock mutual
funds. In the long run, they're the winners: In this century, stocks beat bonds
8 out of 9 decades, and they're well in the lead again. According to
Ibbotson's Stocks, Bonds, Bills and Inflation 1995 Yearbook, here are the
average annual returns from 1926 to 1994 (before inflation):
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Stocks: 10.2% (and small company stocks were 12.1%)
Intermediate term treasury bonds: 5.1%
30-day T-bills: 3.7%
But is it really worth the additional risk just for a few percentage points? The
answer is yes. 10% a year for 20 years is 570%, but 7% a year for 20 years is
only 280%. Compounding is God's gift to long-term planners.
If you buy outstanding companies, and hold them through the market's
gyrations, you will be rewarded. If you aren't good at selecting stocks, select
some mutual funds. If you aren't good at selecting mutual funds, go with an
index fund (like the Vanguard S&P 500).
6. Investigate Before You Invest
Always do your homework. The more you know, the better off you are. This
requires that you keep learning, and pay attention to events that might affect
you. Understand personal finance matters that could affect you (for example,
proposed tax changes). Understand how each of your investments fits in
with the rest of your portfolio and with your overall strategy. Understand the
risks associated with each investment. Gather unbiased, objective
information. Get a second opinion, a third opinion, etc. Be cautious when
evaluating the advice of anyone with a vested interest.
If you're going to invest in stocks, learn as much as you can about the
companies youre considering. Understand before you invest. Research,
research, Read books. Consider joining an investment club or an
organization like the American Association of Individual Investors.
Experiment with various strategies before you put your own money on the
line. Examine historical data or participate in a stock market simulation. Try
a momentum portfolio, a technical analysis portfolio, a bottom fisher
portfolio, a dividend portfolio, a price/earnings growth portfolio, an intuition
portfolio, a mega trends portfolio, and any others you think of. In the process
you'll find out which ones work best for you. Learn from your own mistakes,
and learn from the mistakes of others.
If you don't have time for all this work consider mutual funds, especially
index funds.
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7. Develop the Right Attitude
The following personality traits will help you achieve financial success:
Discipline: Develop a plan, and stick with it. As you continue to
learn, youll become more confident that you're on the right track. Alter
your asset allocation based on changes in your personal situation, not
because of some short-term market fluctuation.
Confidence: Let your intelligence, not your emotions; make your
decisions for you. Understand that you will make mistakes and take losses;
even the best investors do. Re-evaluate your strategy from time to time,
but don't second-guess it.
Patience: Don't let your emotions be ruled by today's performance. In
most cases, you shouldn't even be watching the day-to-day performance,
unless you like to. Also, don't ever feel like it's now or never. Don't be
pressured into an investment you dont yet understand or feel comfortable
with.
The following personality traits will hurt your chances of financial
success:
Fear: If you are unwilling to take any risk, you will be stuck with
investments that barely beat inflation.
Greed: As an investment class, 'get rich quick' schemes have the
worst returns. If your expectations are unrealistically high, you'll go for the
big scores, which usually dont work.
It is generally a good idea to avoid making financial decisions based on
emotional factors.
8. Get Help If You Need It
The do-it-yourself approach isn't for everyone. If you try it and it's not
working, or you're afraid to try it at all, or you just don't have the time or
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desire, there's nothing wrong with seeking professional assistance.
If you want others to handle your financial affairs for you, you will
nevertheless want to remain involved to some degree, to make sure your
money is being spent wisely.
Initial Public Offerings
Initial Public Offerings (IPOs) are the first time a company sells its stock to
the public. Sometimes IPOs are associated with huge first-day gains; other
times, when the market is cold, they flop. It's often difficult for an individual
investor to realize the huge gains, since in most cases only institutional
investors have access to the stock at the offering price. By the time the
general public can trade the stock, most of its first-day gains have already
been made. However, a savvy and informed investor should still watch the
IPO market, because this is the first opportunity to buy these stocks.
Reasons for an IPO
When a privately held corporation needs to raise additional capital, it can
either take on debt or sell partial ownership. If the corporation chooses to
sell ownership to the public, it engages in an IPO. Corporations choose to
"go public" instead of issuing debt securities for several reasons. The most
common reason is that capital raised through an IPO does not have to be
repaid, whereas debt securities such as bonds must be repaid with interest.
Despite this apparent benefit, there are also many drawbacks to an IPO. A
large drawback to going public is that the current owners of the privately
held corporation lose a part of their ownership. Corporations weigh the costs
and benefits of an IPO carefully before performing an IPO.
Going Public
If a corporation decides that it is going to perform an IPO, it will first hire an
investment bank to facilitate the sale of its shares to the public. This process
is commonly called "underwriting"; the bank's role as the underwriter varies
according to the method of underwriting agreed upon, but its primary
function remains the same.
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In accordance with the Securities Act of 1933, the corporation will file a
registration statement with the Securities and Exchange Commission (SEC).
The registration statement must fully disclose all material information to the
SEC, including a description of the corporation, detailed financial
statements, biographical information on insiders, and the number of shares
owned by each insider. After filing, the corporation must wait for the SEC to
investigate the registration statement and approve of the full disclosure.
During this period while the SEC investigates the corporation's filings, the
underwriter will try to increase demand for the corporation's stock. Many
investment banks will print "tombstone" advertisements that offer "bare-
bones" information to prospective investors. The underwriter will also issue
a preliminary prospectus, or "red herring", to potential investors. These red
herrings include much of the information contained in the registration
statement, but are incomplete and subject to change. An official summary of
the corporation, or prospectus, must be issued either before or along with the
actual stock offering.
After the SEC approves of the corporation's full disclosure, the corporation
and the underwriter decide on the price and date of the IPO; the IPO is then
conducted on the determined date. IPOs are sometimes postponed or even
withdrawn in poor market conditions.
Performance
The aftermarket performance of an IPO is how the stock price behaves after
the day of its offering on the secondary market (such as the NYSE or the
NASDAQ). Investors can use this information to judge the likelihood that an
IPO in a specific industry or from a specific lead underwriter will perform
well in the days (or months) following its offering. The first-day gains of
some IPOs have made investors all too aware of the money to be had in IPO
investing. Unfortunately, for the small individual investor, realizing those
much-publicized gains is nearly impossible. The crux of the problem is that
individual investors are just too small to get in on the IPO market before the
jump. Those large first-day returns are made over the offering price of the
stock, at which only large, institutional investors can buy in. The system is
one of reciprocal back scratching, in which the underwriters offer the shares
first to the clients who have brought them the most business recently. By the
time the average investor gets his hands on a hot IPO, it's on the secondary
market, and the stock's price has already shot up.
19
SEBI Guidelines
The Government has setup Securities Exchange Board of India
(SEBI) in April 1988. For more then three years, it had no statutory powers.
Its interim functions during the period were:
i. To collect information and advise the Government on matters relating
to Stock and Capital Markets.
ii. Licensing and regulatory and Merchant Banks, Mutual Fund, etc..
iii. To prepare the legal drafts for regulatory and developmental role of
SEBI and
iv. To perform any other functions as may be entrusted to it by
Government.
The need for setting up independent Government agency to regulate
and develop the Stock and Capital Market in India as in many
developed countries was recognised since the Seventh Five Year was
launched (1985) when some major industrial policy changes like
opening up of the economy to out side the world and greater role to
the Private Sector were initiated. The rampant malpractices noticed in
the Stock and Capital Markets stood in the way of infusing confidence
of investors, which is necessary for mobilisation of large quantity of
funds from the public, and help the growth of the industry.
The malpractices were noticed in the case of companies,
Merchant Bankers and Brokers who are all operating in Capital
Markets. The need to curb the malpractices and to promote healthy
Capital Market in India was felt. The security industry in India has to
develop on the right lines for which a competent Government agency
as in UK (SIB) or in USA (SEC) is needed.
20
As referred to earlier, malpractices have been reported in
both the primary market and secondary market. A few examples of
malpractices in the primary market are as follows:
a) Too may self styled Investment Advisers and Consultants.
b) Grey Market or unofficial premiums on the new issues.
c) Manipulation of markets before new issues is floated.
d) Delay in allotment letters or refund orders or in dispatch of Share
Certificates
e) Delay in listing and commencement of trading in shares.
A few examples of malpractices in the Secondary Market are as fallows:
a) Lack of transparency in the trading operations and prices charged to
clients.
b) Poor service due to delay in passing contract notes or not passing
contracts notes, at all.
c) Delay in making payments to clients or in giving delivery of shares.
d) Persistence of odd lots and refusal of companies to stop this practice
of allotting shares in odd lots, which disappeared with the introduction
of Demat form of trading.
e) Insider trading by agents of companies or brokers rigging and
manipulating prices.
f) Takeover bids to destabilise management.
Objectives:
The SEBI has been entrusted with both the regulatory and
development function. The objectives of SEBI are as follows:
a) Investor protection, so that there is a steady flow of savings into
the Capital Markets.
21
b) Ensuring the fair practices by the issuers of securities, namely,
companies so that they can raise resources at least cost.
c) Promotion of efficient services by brokers, merchant bankers
and others intermediaries so that they become competitive and
professional.
SEBI AND FREE PRICING OF EQUITY SHARES
With the repeat of Capital Issuers Control Act of 1947 in May
1992, the SEBI issued fresh guidelines for new Capital issues from J une 11,
1992. Pricing of Shares expect in case of new companies with no track
record is left to free market forces. The new Companies have to issues
shares at par only. The existing unlisted companies if they desire listing can
make public issue upto 20% of equity and price can be determined by free
market forces, as determined by the issuer or the lead manager. Similarly, an
existing listed company can also fix the price of issue depending on the
markets forces. In all these cases, the reasons for such price fixation,
transparency and proper disclosers are insisted upon by the SEBI. The draft
letter of offer to the public is to be vetted by SEBI, which was delegated to
lead merchant bankers by SEBI after 1996.
As per SEBI guidelines, 12 months should elapse between
bonus issue and public or rights issue. A private placement of promoters
quota is not permitted. Merchant bankers held responsible for ensuring that
prospectus is fair and disclosures are full and correct and that highlights and
risk factors are slept out in all issues. Although free pricing is permitted, the
rationale of such fixation is to be provided to the SEBI when it examines the
drafts letter of offer.
SEBI POWERS
The SEBI powers on stock exchanges and their member brokers and sub
brokers were exercised under SEBI (stock brokers and sub brokers)
Regulations of October 23 1992. These relate to registration, licensing, code
of conduct, and inspection of books accounts, etc. These powers were
exercised under Section 12 of SEBI Act.
22
SEBI was delegated more powers of administration of SC (R)
Act in respect of many provisions including recognition of stocks exchanges
(Sec.3, 4&5) and control and regulation of stocks exchanges under Sections
7, 13, 18, 22 and 28 etc., These were concurrent powers wielded by both
Government and SEBI, effective from September1993.
Subsequently, by an ordinance in J anuary 1995, the SEBI was
given further powers to impose penalties on insider trading and capital
markets intermediaries for violation of SEBI regulations and companies for
not complying with Listing agreement. In particular penalties can be
imposed in monetary terms, for failure to furnish books of accounts, failure
to enter into agreements with clients, failure to redress investor grievances,
defaults in case of mutual funds, and non-disclosures of acquisition of shares
and take over etc.
Venture capital funds like mutual funds were brought under the
control of SEBI. Earlier to that, the SEBI has started licensing and
regulations the underwriters, debenture trustees, collecting bankers, and all
intermediaries in the capital market.
SEBI in the New Millennium:
SEBI has got all the needed powers to regulate the Capital
Market including all affairs of listed Companies, Venture Funds, MMMFs,
etc. Already it has been regulating the foreign agencies or a body operating
in the capital market and it has announced guidelines for all players in
markets, including a code of conduct.
Institutional Agencies:
All the FIIs together can invest upto 24-30% of the companys
paid up capital, of which a limit of 50% is allowed to foreign individuals and
corporates investing in India through FIIs; this limit of 30% was raised to
40% by the Central Budget for 2000-01.
The SEBI has also allowed the domestic Mutual Funds to invest in foreign
listed securities and to manage foreign portfolios. According to some
23
amendments to Mutual Fund regulations of SEBI, the Mutual Funds are
required to send a complete statement of their portfolios to all unit holders
within one month from the close of each half-year. In order to deter mutual
funds from delay in despatch of redemption warrants, SEBI has directed
mutual funds to provide for payment of interest to the unit holders on this
delayed payment, wherever applicable.
Latest Primary Markets Reforms
In pursuance with the recommendations of the Informal Group
on Primary Markets, the SEBI has dispensed with the requirements of
issuing shares at fixed par value of Rs.10 and Rs.100. They are now free to
issue shares at any value of Rs.1 and above. The SEBI modified the existing
framework for the book building. Some issues following the book building
process have already been issued in 1999-2000.
In order to encourage Initial Public Offer, the SEBI has relaxed
the guidelines stipulating the ability to pay criteria in place of existing
criteria of actual payment of dividend by the issuing companies to be
eligible to make public offers. The regulations for Credit Rating Agencies
were finalised and published by the SEBI. The categories of promoters who
are eligible to promote CRAs are laid down.
Book Building Process:
The changes in book building guidelines:
The modified framework makes display of demand at terminals
optional. The reservation of 15% of issue size for individual investors
bidding upto 10 marketable lots is no longer compulsory. Allotment in Book
Building process should be in Demat form only and other requirements shall
be the same as for any public issue. The issuer is allowed to disclose either
the issue size or number of securities to be offered to the public.
The regulatory mechanism on secondary market was
strengthened during 1999-2000, through the rationalisation and refinement
of margin system and through mark to market margins, volatility margins,
incremental carry forward margins, etc. The circuit breakers for the volatility
24
have been fixed by SEBI at 8% to 12% to be raised upto 16%. The exposure
limits for members are also fixed.
Informal Group on Primary Market
As part of its efforts to receive the dressed primary market, the
SEBI has relaxed the listed norms for I.T. sector companies to make initial
public offers with a minimum offer of 10%, instead of 25% for all other
companies. Book building norms are to encourage new issues. The norm of
90% subscription as the minimum for enabling the company offering public
issue to make allotment was waived. Similarly, the stipulation of actual
payment of dividend in three out of the past 5 years for the company to come
out with a public issue was replaced by requirements of ability to pay the
dividends. As recommended Informal Group on primary market, measures
initiated to improve the sentiment in the Primary Market. The SEBI has
given freedom to the Companies to determine the par value of shares issued
by them in accordance with section 13(4) of the Companies Act, 1956. the
companies with dematerialized shares have been allowed to alter the par
value of share indicated in the Memorandum and Articles of Association
Reference was already to changes in Book Building Norms.
SEBI has also accepted the introduction of a system of using
the existing infrastructure of stocks Exchanges for marketing of IPOs and
NSE has offered these services through its wide network terminals spread all
over the country.
Demat Coverage:
From J anuary 2000, the scrips for trading in Demat form was
raised to 200. With this, the compulsory trading in Demat form has raised
the proportion of market deliveries in Demat form to 90% of the total
deliverers. The physical deliverers of shares has come down drastically. The
25
transaction costs have been reduced and volume have increased
phenomenally due to electronic form of trading and in demat form.
Committee on Market Making:
A committee on the Market Making under the Chairmanship of
Shri G.P. Gupta was set by the SEBI to study the various facets of the
market making, including the merits and demerits of order driven system
and quote driven system. The committee was of the view that shares should
be classified into the categories namely liquid and illiquid and market
making facility should be provided to the illiquid category of shares. Market
making should be made compulsory in such cases and market markers have
to give two way quotes for each such scrip. The mechanism pf market
making and risked involved in it are to be understood by market makers.
Legal Framework:
In the legal field, the securities Laws, 1999 was passed by the
Parliament in December 1999. This has incorporated the derivative
instruments in the definition of securities under Securities Contract
Regulation Act, 1956, as also the units of Collective Investments Schemes,
with a view to facilitating their transaction and regulation. The new Act
provided for transfer of Appellate functions under the securities Laws
Securities Appellate Tribunal (SAT). The stamp duty payable on derivative
transactions those in demat Form was withdrawn by necessary legal
changes. Banks now accept the ownership pf securities in Demat Form.
Negotiated Deals:
A negotiated deal in listed company has to be reported to stock
exchange within 15 minutes and information in such deals has to be
disseminated to all Stock Exchanges. A negotiated deal is defined as any
transaction which has on order value of 25 lakhs or trade volume of not less
than 10,000shares at one price, not formed on Stock Exchanges and through
the order matching system. But with a view to enhance the price discovery
26
process and improve the transparency, SEBI made such deals not
permissible in 1999. Guidelines were issued to permit negotiated deals only
if they are executed on the screen of Stock Exchange, following the price
and order matching system of the exchange.
SEBI Committee on Corporate Governance:
The committee on Corporate Governance, set up by SEBI has
reported and the report was accepted by SEBI and implemented. The Stock
Exchanges listing agreement was amended to include a clause on corporate
governance to be observed by listed companies. It is an important tool for
corporates listed on Stock Exchange. The SEBI code on Corporate
Governance was released in J anuary 2000 for adoption by listed companies.
It is expected that this measures may raise the standard of corporate
governance in India and improve the disclosure standards and investor
protection.
SEBI Guidelines on Listing:
In February 2000, the SEBI has asked the Stock Exchanges to amend
the listing agreement by adding clause 49, providing for corporate
governance mandatory for companies seeking listing for the first time. The
companies which are included Group A of BSE and in S&P CNX Nifty
Index have to comply with the requirements by March 31, 2001. Besides
listed companies with paid up capital of Rs.10crores and above or networth
of Rs.25crores or more have to comply with this requirement by March end
2002. Other listed companies with a paid up capital of Rs.3crores and above
have to comply with this requirement of corporate governance by March end
2003.
The SEBI has also directed the companies listed, to reduce the No-
delivery period to one week in the case of Demat shares. A committee was
set up to streamline the existing risk containment measures namely the
margin system and simplify it.
SEBIs Record:
27
The SEBI has set a creditable record of regulation for the
growth of a healthy Capital Market during the period of 1995-2000. In the
year 2000, it has set for itself the tasks of speeding up the following
measures.
1) Pursuit of healthy Corporate Governance Regulations.
2) Strengthening of Rolling Settlement System by adding 500 more
scrips to its.
3) Introduction of Derivative Trading.
4) Development of the internet practices by brokers.
5) Promotion of trading in debt market and in securities debt
instruments.
Products and Services
Venture Capital:
Venture capital is risks money, which is used in risky
enterprises either as equity or debt capital. It may be in new sunshine
industries or older risk enterprises. The funds, which finance such risky,
venture capital funds.
Ventures capital was originated & popularised in USA in
sixties. In developed countries, this capital came from pension funds,
insurance companies & even large banks. Some large companies with excess
funds may provide this capital to achieve diversification, market expansion
& window on technology or to share in this result of R&D of others.
In India, as the majority of the above institutions are in the
public sector, only the government or public financial institutions can
provide the funds for venture capital.
What is Venture Capital?
28
Venture capital is a post-war phenomenon in the business
world, mainly developed as a sideline activity of the rich in USA. To
connote the risk & adventure & some element of investment, the generic
name of venture capital was coined. In the late 1960s a new breed of
professional investors called venture capitalists emerged whose specialty
was to combine risk capital with entrepreneurial management & to use
advance technology to launch new products and companies in the markets
place. Undoubtedly, it was venture capitalists astute ability to assess and
manage enormous risks & export from them tremendous returns that
changed the face of America.
Innovative, hi-tech ideas are necessarily risky. It is here that the
concept of venture capital steps in. Venture Capital provides long start up
costs to high risks & returns project. Typically, these projects have mortality
rates and therefore are unattractive to risks-averse bankers & private sectors
companies.
Venture Projects:
Proposals come to the venture capitalists in the form of
business plans. He appraises the same, giving due regard to the credentials
of the founders, the nature of the product or services to be developed, the
market to be saved & the financing required. If satisfied, he will invest his
own money in the equity shares of the new company, known as the assisted
company.
In addition to money, managerial & marketing assistance may
also be provided that is, the venture capitalist not only provides funds but
also on line operational advice. In short, he identifies himself with the
project as much as the innovator promoter & as such works hard to
accomplish ambitious targets & consequents higher appreciation of his
capital.
Indian Position:

In India, most project financing schemes require at least 25 per
cent of the project cost to be contributed by the promoters, while the latter
can raise barely 5-10 percent. For long, there were a few agencies such as
29
IFCIs subsidiary company, Risks Capital And Technology Foundation of
India, which provides finance to bridge the shortfall in the promoter
contribution, but they could fulfill the requirements of a great many budding
entrepreneurs. As results of promoters not being able to bring in those vital
initial inputs of money, many of their good projects were hanging fire.
Venture capital could remedy this situation as well.
A beginning was made in this direction by the setting up of
venture capital divisions under the aegis of ICICI, IDBI & IFCI.
Encouraged by the response to technology financing, ICICI floated a
separate company ---Technology Development and Information Company of
India (TDICI) includes, apart from venture capital financing, technology,
consultancy as well as entrepreneur escort services such as marketing,
business management, vendor development etc. The successful operation of
this fund will hopefully spark off some interest from the private sector,
which will then consider entering this line of activity. Ultimately, it is only
when venture capital financing becomes more broad-based and widespread
that it will truly taking root in economy. In tune with its tradition of
pioneering new ideas, ICICI deviated from the beaten path to usher in an
unusual type of financial support. Addition to equity participation (up to
maximum of 49 percent) undertaken by typical venture capital companies,
TDICI offer the conditional loans. The entrepreneur neither pays interest on
it nor does he have to repay the principal amount. If the venture capital
succeeds, TDICI recoups its investment in the form of royalty on sales
which ranges between two and eight percent. On the other hand, if the
venture fails to take off even after five years TDICI will consider writing off
the loan.
Public financing agencies :
It is to be noted that the floating venture capital companies are
the financial institutions or banks (the Andhra Pradesh Industrial
Development Corporation, Canara bank and others). This can be directly
30
attributed to the Government guidelines, which restrict private sector
participation in venture capital funds to a maximum of 20 percent.
But if the concept is to make a mark in the economy it needs
private sector initiative and not institutional or government patronage. In
fact, herein lies the strategic significance of the venture capital. It paves, the
way for the private sector to share the burden of industrial finance,
particularly risk finance with the public sector.
The activities of the venture capital fund of ANZ Grindlays
bank include making equity investments in new companies, which may or
may not involve any new technology or other such related risk. This activity
of the direct subscriptions by financial institutions and banks has been going
on for decades and cannot be termed as venture capital activity. The
difference in ANZ Grindlays bank activity id one of the nomenclature and
not of means of financing. Also, on the whole, venture capital is provided
more in the nature of mezzanine loans than equity.
Private Agencies:
One Venture Capital fund set up the private sector in India is
Credit Capital Venture Capital (India) or CVF for the short, the principal
shareholders of which are Credit Capital Finance Corporation, Bank of
India, Asian Development Bank, and CommonWealth Development
Corporation. Another set up in the private sector jointly by the ICICI 20
th
Century Finance Corporation, bank of Baroda, Asian development Bank and
Asian Finance and investment Corporation is the 20
th
Century Venture
Capital Corporation Ltd. One reason why private capitalists are generally
shy may be the high rate of capital gains tax applicable to the profit of
Venture Capital Funds. Though the guidelines provide for a concessional
rate of capital gains tax, the move can hardly be deemed as a concession in
view of the enormous risks involved in the activity.
Policy Initiatives:
The idea of providing venture capital finance (VCF) to the new
entrepreneurs in India was mooted by the then finance minister in the long-
term fiscal policy announced by him in 1985. A fresh reference to the
31
difficulties faced by new entrepreneurs in raising equity capital was
made by the finance minister in his 1988-89 budget speech and detailed
guidelines for providing such finance by registered companies or funds were
announced.
In India, the government has set up a Venture Capital Funds
with a contribution of Rs.10crore. The fund was brought into operation
on 1
st
April 1986 by the IDBI. For financing this fund, a levy was
imposed on all payments made by Indian industries for the acquisition of
foreign technologies. This fund finance projects with minimum and
maximum project costs of Rs.5lakhs and Rs.250lakhs respectively.
Grindlays Bank has set up the Indian Investment Fund to
Finance the start up cost of entrepreneurs. This fund was subscribed
mainly by Non-resident Indians. The Government of India also
announced on 1989 a National Equity Fund for financing small-scale
entrepreneurs setting up units in rural areas and urban areas population of
below Rs.5lakhs. Institutions like ICICI,IFCI,SBI Capital Markets
Canbank Financial Services and others have also set up their own funds
for providing Venture Capital Finance.
However, in general, the experience is that the Indian financial
institutions are yet to reorient their financing policies to meet the Venture
Capital maxims. The traditional conservation of these organisations
makes their approach unacceptable. They fail to recognise that normal
criteria of debt-equity ratio, existence of security etc., are not the criteria
for evaluating venture capital projects.
The policy of Government with regard to Venture Capital
Funds has changed in 1999-2000. The Government has allowed a free
hand and transparency for I.T. Venture Funds Foreign Funds are allowed
freely into these Funds.
Difficulties in India:
Fundamentally, there are no private pools of the capital of finance risk
ventures in India. The financial institutions perforce occupy a dominant
position in the provision of long-term capital to Indian industry. They and
the State development agencies do provide limited amount of equity finance
to assist the development of new business but there is no private,
32
professionally managed investment capital sources. There are no private
sector insurance companies or the pension funds gathering regular premium
income and virtually no private banks willing to devote a small portion of
their resources to the venture capital niche. It is unlikely that such
enterprises will be created in the foreseeable future to mobilise private
saving for investments. As an answer the situation, mutual funds and
investment trusts are permitted to set up and to commit the part of their
resources to the venture capital area. As a part of the broader equity
investment fund, given suitable standards of the valuation for unquoted
investments, it should be possible for the fund managers to commit the
portion of there portfolios to venture capital situations. The participation of
the private sector in venture capital funding, as it has come to be defined in
the narrow Indian context, is not possible in isolation from the opportunity to
develop a broadly spread investment business.
Tax Treatment:
The tax treatment of the venture capital funds in India is
ungenerous and falls well short of what is required. Whereas the Mutual
Funds established by the government controlled financial institutions and
nationalised commercial bank suffer no tax on either income or capital
gains, a venture capital fund would suffer at 20 per cent on dividend income
and a similar rate on long-term capital gains. Given an adequate investment
spread and tax incentives, mutual funds step into the early stage financing
arena, professionally assess and the monitor investments assist the launch of
new medium size businesses. SBI Mutual Fund is really undertaking
investment work with its brought deals. The creation of more funds to
participate in this area of the market is now clearly seen. Early stage
financings could then be syndicated between number of professionally
managed funds and sound, competitive situation between them might also be
created.
The Government has since 1995-96 been treating the venture
funds like Mutual funds for tax benefits and brought them under Regulation
of SEBI. The SEBI has set out the guidelines for their registration and
control by itself a code of conduct for them to operate as in the case of
capital market mutual funds and for their investment and operations on the
fund. In the Central Budget for 2000-01 the income of the Venture Capital
33
Fund is taxed at the rate of 20%, although the dividends declared in the
hands of the investors are tax-free.
Need for Growth of Venture Capital:
There is need for encouragement of risk capital in India, as this
will widen the industrial base of, high-tech industries and promote the
growth of technology.
The initial step might be to permit the launch of the mutual
fund by all those banks authorise to conduct business in India, at the same
time extending the investment range of such funds to embrace unquoted
stocks.
Liberating the capital market would bring greater depth to the
capital market as a whole, introducing more genuine investors of substance
with long time horizons, provide avenues for the institutions to realise their
equity portfolios more easily (freeing funds for more new investments), and
generally improve market liquidity. This would improve equity cult.
So moves towards a freer and less regulated market are
important in considering measures to simulate the entry of the private sector
into the risk capital formation.
Latest Policy Charges:
In the year of 2000 of new millennium, the I.T. industry along-
with many start up industries like Telecom, Biotech, Multimedia etchave
experienced rapid growth potential but with Scarcity of the Venture Funds.
To encourage Venture Capital Funds to grow rapidly to help these
industries, the Government has announced the following measures early in
2000.
1. SEBI to be the sole authority for the regulation of Venture Capitals.
2. The single window clearance facility is extended without the need for
going for clearance with the government RBI and I.T. Authorities.
34
3. In the first Millennium Budget, 2000-2001, Venture Capital have got
on par Status with Mutual Funds for the purpose of the tax
treatment under section 10(23D) of I.T. Act. Tax exemption is granted
to Venture Capitals like those of Mutual Funds, so that double
taxation is avoided and tax is levied only at one level, namely at the
hands of investors.
4. The IPO norms are liberalised for the Venture Capital Funds for the
purpose of listing. Appraisal and finding are allowed to extent of 10%
of the equity capital of a start-up company. The condition of 3 years
track record of profitability is waived. Even a public issue of 10% of
paid up capital is enough for the I.T companies for the purpose of
listing.
5. The Government have set up a separate ministry of I.T and started an
I.T Venture Fund of Rs.100crores for the financing new start up I.T
projects.
6. Venture Funds were set up by ICICI, UTI, IDBI, Tatas etc.
Venture Capital Vs. Mutual Fund
In the matters of tax, venture capital funds and mutual fund are
kept on par. Foreign Venture funds are given a free hand tom flow in for the
investments permitted for foreign investment. During the first quarter of
2000, about $17 billon have flowed in as Venture Funds mostly invested in
the technology based small companies, according to a Survey Conducted by
price waterhouse coopers (PWC) Company.
Among the measures to promote the capital market banks are
now allowed to invest in equities and bonds on a discretionary basis and to
invest in Venture Capital Funds beyond the permitted ceiling of 5% of their
funds in shares and securities of the companies during 1999-2000.
Rules on Venture Capital Funds:
The norms of Venture Capital Funds are liberalized early
J anuary 2000. While earlier, a Venture Capital Funds could not acquire
more than 40% of equity of a high risk business or a start up company,
now there is no such ceiling and Venture Capital Funds is free to invest
as it likes. However, the only restriction that remains is that the Venture
35
Capital Funds cannot invest more than 25% of its own Fund base in any
one company. Now Venture Capital Funds can hold upto even 100% of
equity of a start up the company as that ceiling of 40% is now removed,
but it can now hold up to 25% of its own fund in any companys equity.
Foreign Venture Capital is made eligible to participate in book
building process since J uly 2001. There is no lock in period for the pre
issue share capital of an unlisted company held by Venture Capital Funds
and FVCFs. Mutual Funds are now eligible to invest in units of the
Venture Capital Funds, like investments in listed and unlisted securities.
There has been a considerable liberalisation in investments by Venture
Capital Funds as much as investments in Venture Capital Funds.
Merchant banking
What is Merchant Banking?
Merchant banks are issue houses rendering such services to industrial
projects or corporate units as floatation of new ventures and new companies,
preparation, planning and execution of new projects, consultancy and advice
in technical, financial, managerial and organisational fields. A number of
other function such as restructuring, revaluation of assets, takeovers,
acquisitions, etc, are also undertaken by them.
A major function of merchant banking is the issue management. The
issue can be public issue through prospectus, offer of sale, or private
placements etc.
Issue Management
The issue management involves the following functions in respect of
issue through prospectus:
(a) Obtaining approval for the issue from the SEBI
(b) Arranging underwriting for the proposed issue.
(c) Drafting and finalizing of the prospectus and obtaining its clearance from
the underwriters, stock exchanges, auditors, solicitors, Registrar of
Companies and other necessary consents required for filing the prospectus.
(d) Drafting and finalization of other documents such as application forms,
stock exchanges.
36
(e) Selection of the registrar to the issue, printing press, advertising agencies
underwriters, brokers and bankers to the issue and finalisation of the fees
and charges to be paid to them.
(f) Arranging through the advertising agency the press, brokers and
investor's conferences.
(g) Co-coordinating the printing, and advertisements relating to the issue,
and work of the
registrars to the issue, the receipt and processing of applications and
preparation of the basis of allotment, negotiation of the same with the stock
exchanges and preparation of register of allotment.
In the case of management of debentures, apart from the Managers to
the issue have to do the following things:
(a) To finalize the terms of the issue which will make the debenture issue
attractive; and
(b) To assist in the finalisation of the relative security or mortgage
documents and obtaining approval there to from the Company's solicitors
and trustees
Other Functions
Merchant banks in foreign countries undertake a larger number of
activities. They operate both in the money market and capital market,
undertake direct and indirect lending portfolio management for institutions,
trusts, charities, etc, funds management for existing companies, underwriting
for new and old companies etc. They are also active in the money market
and discount market operations in undertaking bills discounting and
investing the short-term funds in treasury bills, commercial bills and other
money market instruments. In India, these functions are carried on by banks
themselves with the result that their merchant banking divisions confine to
underwriting, consultancy, new issue business, involving management of
issues and related activities. The Indian merchant banking is still in its
infancy and their activities are, therefore, limited to a few selected activities
of new issues market at present such as project planning, financial
consultancy, advice and planning and execution of these projects, involving
the preparation for the public issue, observance of necessary formalities for
37
such issued applications to SEBI, RBI and for listing on the stock exchange,
collection and allotment of share application moneys, underwriting etc .s
Offer of Sale
Usually, when the closely-held companies, whose shares are not listed
on the stock exchange, approach the financial institutions for assistance for
the expansion of their existing operations or diversification, the financial
institutions stipulate a condition that the company should get its shares
listed. Where the capital base of the company is already large and issuing
further equity capital is not justified from the servicing angle, the promoters
can offer such part of their exist holding for sale through a letter of offer to
the members of the public as Is necessary to get the equity shares of the
company listed on the stock exchange. Although the letter of offer is not
governed by the provisions of the Companies Act, 1956, in practice, the
letter of offer contains all the similar provisions which are to be found in the
prospectus.
The offer for sale must give all material particulars relating to the
company as if it were a prospectus issued under the Companies Act. In
particular, it should include information regarding the shares on offer and
the terms of sale, its capital structure, and capitalisation of reserves, any
revaluation of assets or schemes of arrangements or reorganizations, last five
years' profit and loss account summarised accordance with the prescribed
listing requirements.
Any document by which the offer for sale to the public is made shall, for
all purposes, be deemed to be a prospectus issued by the company and all
enactments and rules of law as to the contents of prospectuses and as to the
liabilities in respect of statements or omissions from prospectuses otherwise
relating to the prospectus, shall apply as if the shares or debentures had
been offered to the public for subscription and as if the persons accepting the
offer in respects of any shares or debentures were subscribers for those
shares or debentures.
The said letter of offer will have to be signed by the persons offering the
shares or debentures for sale in the same manner as the directors of the
company sign the prospectus in terms of Section 60 of the Companies Act.
The offers collectively and individually accept full responsibility for the
38
accuracy of the information given in this offer of sale and confirm that to the
best of their knowledge and belief there are no other facts, the commission
of which makes any statement in the offer for sale misleading, and they
further confirm that they have made all reasonable inquiries to ascertain such
facts.
The offers have to certify that neither the stock exchange to which an
application for official quotation is made nor the Central Government or
SEBI has any responsibility for the financial soundness of this offer, or for
the price at which the offer of sale is made, or for the statements made or
opinions expressed in the offer of sale.
The initial issues should normally be at par and if further issues are made
at a premium, this has to be justified by acceptable norms by the merchant
bankers.
Private Placement
When the financial institutions directly subscribes to the
equity/preference shares and/or debentures issued by the company, the
company is said to have privately placed these securities with the financial
institutions. This does not require either a prospectus or letter of offer. The
terms and conditions subject to which the financial institutions agree to
subscribe to the privately placed shares or debentures are usually
incorporated in the debenture subscription agreement or the investment
agreement entered into between the financial institutions and the company.
The company could, if it so desires, approach, in the place of financial
institutions, a well-identifiable body of persons like merchant banks for
private placement. The provision of the Act are to be interpreted strictly and
therefore, if the company sends the offer to Mr. X and the offer is accepted
by Mrs.X to whom the allotment is finally made, it could deem to be the
public offer necessitating compliance of requirements of the prospectus.
This exercise is, therefore, to be undertaken with great caution to see that the
final transfer takes place only to those for whom the original offer was
made. In practice, till recently the companies hardly took any recourse to
this mode of private placement of their securities due to these restrictions.
The company has to agree upon the list of persons to whom the offer is to
be sent much in advance and its is thereafter necessary that the company
39
should send offers to the same persons as per the list approved by the
Company with a clear-cut instructions to the officers that the securities
offered are strictly to be subscribed for by them and them alone and the
officers are not supposed to pass on the offer of the company to someone
else. He would also ensure that the company would receive subscription
only from those persons to whom the original offers had been sent by the
company and finally, the company would allot securities to the same
persons.
Services of Merchant Banks
Merchant banking is normally considered to be related only to the
services associated with public issue management but they also offer
domestic project finance syndication. Large merchant banks in the
country offer a wide range of services. Merchant banks offer
generally the following services.
(a) Pre-investment studies for investors: These are in the nature
of financial feasibility explorations in selected areas of interest of the
client. They include such studies for foreign companies wishing to
participate in joint adventures in India, and often involve a package
covering advice on the nature of participation and Government
regulatory factors.
(b) Project finance: Once the decision embark on a particular
project/expansion/modernisation scheme has been taken, assistance in
working out a comprehension package for the project funding and
pattern of financing is available from the merchant banks. They work
in close liaison with the client, his technical consultants, and the
funding institutions, prepare and submit complete e financial dossiers,
and arrange for the various sources of finance. Assistance in legal
documentation for the finance arranged is also provided.
(c) Working capital: Finance for working capital, particularly for
new ventures, often needs to be syndicated on behalf of the promoters,
and merchant banks assist in this as well. For existing companies,
non/traditional sources such as through the issue of debentures for this
purpose, and others have been successfully tapped by merchant
40
bankers.
(d) Foreign currency finance: Of late, India has become
increasingly active in the international money markets, and this trend
is likely to continue. For import of capital goods and services from
overseas, the arrangement of various kinds of export credits from
different countries is also required.
In addition to this wide range of services, some of the larger banks
are also involved in areas such as the arrangement of lease finance,
and assistance in acquisitions and mergers etc.
Why Merchant Banks?
The following are some of the reasons why specialist merchant
banks have a crucial role to play in India:
1. Growing industrialisation and increase of technologically
advanced industries.
2. Need for encouragement of small and medium industrialists,
who require specialist services.
3. Growing complexity in rules and procedures of the
Government.
4. Need to develop backward areas and states which require
different criteria.
5. Exploring the possibility of joint ventures abroad and foreign
markets.
6. Promoting the role of New Issue Market in mobilising savings
from of public.
Functions
With increasing industrialisation of the country and the growing
emphasis in the Five Year Plans on industrialisation, merchant
banking in India has a very extensive role to play. The National &
Gsrindlays Bank was the first to set up merchant banking division in
India followed by the State Bank of India and other banks.
Functions of the merchant banking divisions are as follows:
1 advice and liaison obtaining consent of the Central and Stat e
41
Government, for the project if necessary;
2. Preparation of economic, technical and financial feasibility reports;
3. Initial project preparation, pre-investment survey, and market
studies;
4. Help in raising rupee resources from financial institutions and
commercial banks;
5. Underwriting and also for subscription, if necessary, to the new
issues or syndication of loans, etc;
6. Assistance in raising foreign exchange resources so as to enable
the industrial concerns to import machinery and technical know-how
and secure foreign collaboration.
7. Advice on setting up turnkey project s in foreign countries and
locating foreign markets;
8. Help in financial management and in designing proper capital
structure and debt-equity ratio, etc, for the company.
9. Advice on restructuring of capital, amalgamation, mergers,
takeovers, etc;
10. Management of investment trust, charitable trusts etc;
11. Management aid and entrepreneurial aid (management audit
providing designs of the complete system, operational research and
management consultancy); and
12. Recruitment (selection of technical and managerial personnel),
etc.
Role of Merchant Banks
To promote the new issue market there is need for a qualitative
improvement in the offer of new issues both in terms of time taken
and the cost of floatation. The time taken for organising a new issue
is between 12 to 18 months and the cost of raising new capital varied
from 3% to 8% and sometimes even 20%. This has been brought
down relatively by specialised merchant banking institutions by
catering to the requirements of both large and small industrial units.
Cost of floatation of equity and preference capital is higher for new
companies than for existing companies, indicating thereby the
difficulties experienced by new companies in making a new issue.
Merchant banks help saving in the cost of new companies and of
small companies.
The new issue market has not succeeded fully in mobilising
42
savings partly due to the preferences of the public to company
deposits and partly due to low yields on equities as compared to those
on fixed interest securities. There has been a decline in the proportion
of share capital in the total capital employed due to the steep rise in
the cost of new issues. There are certain minimum costs to be
incurred in respect of fees to brokers, promoters' expenses,
underwriting commission etc, irrespective of the size of the project.
While bigger companies are able to manage this, small units find it
extremely difficult to meet this minimum cost with uncertain
prospects of their own internal resources in order to avoid the high
cost of making public issues.
Underwriting
The main work of merchant banks relates to underwriting of new
issues and rising of new capital for the corporate sector. Of the
amount underwritten, some part devolves on the underwriters, which
varies depending on the state of the capital market, and the intrinsic
worth of the project. The SEBI has made underwriting
Compulsory for all issues offered to Public first but later it was made
optional. SEBI made it necessary for merchant bank to undertake or
make a firm commitment for 5% of issued amount to the public.
Type of Expertise Required
The type of staff required for a merchant bank will depend upon its
functions which are themselves flexible. The merchant bank should
have an organisation large enough to deal with a number of
applications at a time. The issue house which acts as the merchant
banker normally pays visits to the company's plant, warehouses, and
other physical assets and if a company is making its first issue, it
might secure independent reports from Chartered Accountants,
industrial consultants, technical experts etc. The issue house, which is
a merchant bank also, requires, plant, management, labour,
competitors, profit margins, taxations, etc. They have to keep ready all
the information needed in the form of dossiers with respect to the
affairs of the company generally enquired into by the investing public,
lending financial institutions and the government.
Secondly, a merchant bank has to suggest an appropriate time of
43
issue and provisional terms. Once these terms are settled the share
certificates, prospectus and other documents are drafted by the
merchant bank with the assistance of lawyers, accountants and others.
They have to satisfy the Companies Act and other SS requirements of
law. Subsequently, the merchant bank may have to get ready the
application to the SEBI for the public issues. This requires
familiarity with the regulations under the Companies Act and the
SEBI guidelines and the procedures to be followed and the authorities
to be approached. The provisions under the MRTP Act regulating
monopoly practices and other activities of big industrial houses should
also be looked into.
Thirdly, they may have to make an application to the appropriate
stock exchange for quotation and satisfy the stock exchange
authorities with respect to the terms of issue and prospectus.Listing
requirements are to be observed and familiarity with the stock
exchange rules and bye-laws as well as the provisions of the
Securities Contracts Regulations) Act would be essential. They may
have to advise on the desirability or otherwise of listing on the stock
exchange as well as help the companies go through the process of
getting their shares listed. Advertisements containing all the
information legally required to be given in the prospectus must be
published in all the leading proposed date of opening and closing, a
summary of the companys business history, balance sheet, etc, to
which a reference was made earlier. Once the issue made, the work of
the merchant bank relates to arranging for the allotment of shares in
consultation with the company and the stock exchange authorities
with the help of Registrars.
SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)
MERCHANT BANKING -ROLE & FUNCTIONS
(a) Authorisation
Any person or body proposing to engage in the business of
Merchant Banking would need authorisation by SEBI in the
prescribed format. This will apply to those presently engaged in the
44
Merchant Banking activity, including as Manager, Consultants or
Advisers to issues.
(b) Authorised Activity
(i) Issue Management
(ii) Corporates Advisory services relating to the issue
(iii) Underwriting
(iv) Portfolio Management Services
(v) Managers, Consultants or Advisers to the issue
(c) Authorisation Criteria
All Merchant Bankers are expected to perform with high standards
of integrity and fairness in all their dealings. A code of conduct for the
Merchant Bankers is prescribed by SEBI which will take into account
the following:
(i) Professional Competence
(ii) Personnel, their adequacy and quality and other infrastructure
(iii) Capital Adequacy
(iv) Past track record, experience, general reputation and fairness in
all their transactions.
(d) Terms of Authorisation
(i) All Merchant bankers shall have a minimum net worth of Rs.5
crore.
(ii) The Authorisation will be for an initial period of 3 years.
(iii) All issues should be managed by at least one authorised to
Merchant banker functioning as the Lead Manager or sole
Manager.
Issue Amount No. of Lead
Managers
Up to Rs. 50crores Not
more than 2
45
Over Rs. 50 crores not more Not
more than 3
Than Rs.100 crores
Over Rs.100 crores Not
more than 4
(iv) The Merchant Bankers shall exercise due diligences
independently verifying the contents of the prospectus. The Merchant
Bankers of the issues shall certify to this effect to SEBI.
(v) In respect of issues managed by the Merchant Bankers, they
would be required to accept a minimum 5% underwriting obligation in
the issue subject to a ceiling of Rs. 25 lakh.
(vi) Lead managers would be responsible for ensuring timely
refunds and allotment of securities to the investor.
(vii) The merchant bankers involvement will continue till the
complete on of essential follow-up steps including listing of the shares
and dispatch of certificates and refund.
(viii) The Merchant Banker shall make available to SEBI such
information, returns and reports as may be called for.
(ix) Merchant Bankers shall adhere to the code of conduct which
shall prepared by SEBI.
(x) Merchant Bankers to ensure that Publicity / Advertisement
material accompanying the application form to the issue meets the
requirement of GOI/SEBI.
(xi) SEBI shall be informed well before the opening of the issue the
Inter allocation of activities/sub-activities, among lead managers to
the issue.
(xii) Merchant Bankers performing or planning to perform portfolio
management services shall furnish the details in the prescribed format.
(e) Classification of merchant Bankers
46
------------------------------------------------------------------------------------
-----------------------------------
Category Requirement
Authorised to Act as
(1) (2) (3)

-----------------------------------------------------------------------------
------------------------------------------
Category 1 Minimum Net worth Rs.50 crore Lead
Manager/co.manager
Adviser/consultant to an issue,
Portfolio
manager and
underwriter
to an issue is
Mandatory
required.
------------------------------------
-----------------------------------------------------------------------------------
(f) Grading of Prospectus
Grading of Prospectus will be done by SEBI using the following
parameters:
(i) Objective description of the project, its status and
implementation.
(ii) Track record of the promoters and their competence.
(iii) Disclosure about Demand - Supply position, Market and
Marketing arrangements, Raw materials availability and
infrastructural facility.
(iv) Disclosure of Risk factors.
(v) Objective assessment of Business prospects and profitability.
If highlights are provided the following deficiencies will attract
negative points:
47
1. Absence of Risk Factor
2. Absence of Listing
3. Extraneous contents in prospectus
The Maximum grading points of prospectus will be 10
Points
Category
More than or Equal to 8
+A
More than or equal to 6 but less than 8
A
More than or equal to 4 but less than 6
B
Less than 4
C
(g) Penalty Point System
SEBI has introduced penalty point system for Merchant Bankers
who fail to comply with the various provisions. The areas of non-
compliance/defaults have been categorised into following four
categories. The activities are classified within these four categories:
Type Nature Penalty Points
------------------------------------------------------------------------------------
-----------------------------------
I General Defaults 1
II Minor Defaults 2
III Major Defaults 3
48
IV Serious Defaults 4
INVESTOR PROTECTION
Introduction
The term "Investor Protection is a wide term encompassing
various measures designed to protect the investors from malpractices
of companies, brokers, merchant bankers issue managers, Registrars
of new issues, etc. "Investors Beware" should be the watchword of all
programmes for mobilisation of savings for investment. As all
investment has some risk element, this risk factor should be borne in
mind by the investors and they should take all precautions to protect
their interests in the first place. If caution is thrown to the winds and
they invest in any venture without a proper assessment of the risk,
they have only to blame themselves. But if there are malpractices by
companies, brokers, etc, they have every reason to complain. Such
grievances have been increasing in number in more recent years.
The complaints of investors come from two major sources:
(i) Against member brokers of Stock Exchanges;
(ii) Against companies listed for trading on the Stock Exchanges.
Besides, there can be complaints against sub-brokers, agents,
merchant bankers, issue managers, etc, which cannot be entertained
by the stock exchanges as per their rules. However, complaints
against registered sub-brokers can be entertained.
Complaints against Members
Investors have complaints against brokers regarding the price,
quantity etc. at which transactions are put through, defective delivery
or delayed delivery, delayed payment or non-payments etc, non-
49
settlement of vyaj badla ducs, non-payment of agreed brokerage to
authorised assistants, etc. In the event of default of a member broker,
the dues of clients are also to be looked into.
There is a Grievance Cell in many Stock Exchanges which attends
to investor complaints. Of the total, nearly 95% are against
companies and they are more difficult to settle, as many companies do
not attend to the complaints promptly despite reminders and warnings
by the stock exchange, in view of the fact that penal powers of the
Exchange are limited SEBI has been given these penal powers in
respect of listed companies by an amendment to the SEBI Act in 1995
and many other subsequent a amendments including the latest in
2002.
The grievance procedure in respect of complaints against
members is as follows:
(a) J oint meeting of members vis--vis the clients for an
amicable settlement.
(b) Arbitration proceedings by the committee under the bye-laws.
(c) Special committee appointed by the Executive Director for
settlement
(d) Disciplinary proceedings including warnings, fines penalties,
etc. particularly in cases of fraud, cheating, etc. by the
members.
Grievances Cell
Complaints against members were in the nature of non-payment of
sale proceeds, non-settlement of accounts etc. Of the total complaints
against members, about 85% are settled during the year, itself.
50
Complaints against Companies
The complaints against companies are in the nature of non-receipt
of allotment Letters, refund orders, non receipt of dividends, interest
etc., delay in transfer of shares and in splitting and consolidation. The
clearance of these complaints is also attended to by the Cell by writing
to the companies, follow-up telexes, etc. and finally by warning to
delist the companies concerned. But the clearance of these complaints
is slow due to the non-compliance or slow compliance by the
companies to the References made by the Cell. The powers of the
Stock Exchange are limited to warnings and delisting of shares and as
such compliance by the companies was poor.
Customers' Protection Fund
The Customers' Protection Fund is constituted by all Stock
Exchange to safeguard the interests of the investor clients from
defaults of the stock brokers. The Fund is financed by way of a levy
on the turnover of members and from out of the listing fees,
earmarked by the Exchanges.
Investors Beware
Investors in stock and capital market need a word of caution.
Firstly, these investments are more risky, returns are uncertain and
share values are subjected to wide fluctuations. Secondly, such
investments require an art and expertise to pick up the right stocks,
failing which the investors would burn their fingers. Thirdly, the
players in the market namely, Brokers and issuers of securities,
companies etc are not rated high for their honesty with the result that
the investors complaints against stock brokers and companies have
been increasing over the years.
Specific Goals
The investor should be clear in the objectives of the income, capital appreciation,
short term gains or long term gains etc. He should have made already enough investments in
housing and for a regular income to meet his minimum needs and comforts of life. Even if
all the stock market investments are wiped out due to a market crash, the investor should not
51
be pauper on the streets. Besides, if the investor spends sleepless nights on the fall of share
prices, he cannot be a good stock market investor.
Pre-requisites of Investor
The investor should have abundant common sense and a strong heart to withstand
the vicissitudes of fortune. He need not be a holder of high academic degrees like an MBA
from Harvard or a finance graduation from the Wharton School. Nor does he need to have
hereditary characteristics or family tradition of investment. The only requirement he should
have is abundant logic and common sense and strong nerves and develops the art of
investment on a scientific basis.
Preparing to Invest
Investors desiring to invest in stocks require a lot of preparation. The weak hearted and
risk -averter should first make an entry by buying only debentures, particularly convertible
debentures of good companies, or subscribe to new issues of promising and well-established
companies. After sufficient study and preparation, the investor should act like stag-pickers
in the market, picking up scripts on a selective basis. That means selected companies from
promising and growing industries should be picked up after collection of all relevant
information and data on the companies and scientific analysis of their fundamentals. The
undervalued scripts should be purchased at the right time with the help of technical analysis.
Rumors and advices: of so-called consultants have to be carefully scrutinized. As the market
investment is both a science and an art, it requires both expertise and intuition. There is
need for prior preparation and a lot of home works before investments are undertaken. A
high degree of caution and planning is necessary but the scientific basis and knowledge are
to be acquired by a proper study.
Balance Sheet Study
Investors entering the stock market should also get into the
habit of detailed and careful study of the balance sheets of companies in
which they wish to invest. Similarly, they should examine carefully the
detailed prospectus before subscribing to the new issues of companies. The
habit of relying on rumours, or advice of brokers or friends should be
replaced by habit of self-study of balance sheets and prospectus of the
companies.
Choice of a Broker
Investors should as far as possible deal only with registered
members of recognised stocks exchanges. In place where no stock
52
exchanges are; they may deal with those sub-brokers who have connections
with registered brokers. An honest and dependable broker is too chosen
through proper introduction and orders should be placed with him in proper
manner with limits on prices at which sales or purchases can be made. As
and when a transaction is completed, he should insist on a contract note in
due time.
Protection in the New Issues Market
The main sources of information on which investors depend in
the new issues market is the prospectus, which should contain correct
statements of fats. Any false statements, fraud, etc. are punishable under the
Companies Act. Under Section56 of the Companies Act, the Directors are
subject to civil liability for any misstatement facts or untrue statements.
Under Section 63 and 68 of the companies Act, the directors are
also liable criminally for any fraud of false statement in the prospectus.
Companies liability for misstatements arises from statements and
statements, which are material to the investors and the particulars on which
investors depend to make investments. The directors or promoters of the
company are thus subject to both criminal and civil liability under the Act
for nay misstatements in the prospectus. Even so, the small investors cannot
afford to go to court and, should therefore, carefully read and examine the
prospectus for the viability of the project and marketability of the product
and for integrity and dependability of the promoters. The investors have also
a responsibility to assess the prospectus and risk involved in the project
before making any investment.
Protection for Fixed Deposits
Section 58A of Companies Act, deals with the subject of Fixed
Deposits. There are some rules, which apply to non-banking companies,
private limited companies, who wish to raise deposits from the public.
No deposits can be invited from investors or the public unless
the companies follow the rules and guidelines made by the Department of
company Affairs in consultation with the RBI. Interest rates, maturity period
of deposits, and the amounts permissible to be raised by the companies are
all given in the form of guidelines by the Department of Company Affairs.
The companies have to follow these guidelines while accepting deposits
53
from the public. Renewal and repayments are also regulated by the
Companies Act and the rules framed by the Department of Company
Affairs. When the company fails to repay the deposit, the depositor can
complain to the Company Law Board (CLB) in the specified form duly
filled in together with the fees for non-payment of the interest or non-
payment of deposits. The order of the CLB is final and binding on the
company and the company has to comply with it. Any non-law would invite
penalty of imprisonment and fine. This provision however, does not apply to
sick companies.
All NBFCs been registered and licensed by the RBI since J uly
1997 and guidelines for them have been issued by the RBI early in 1998.
The raising of deposits by them is subject to credit rating and a host of other
requirements.
Guidelines to Investors
1. Deal with a registered member of the stock exchange. If you are
dealing with a sub-broker, make sure that all bills and contracts
are made in the name of a registered broker and sub-broker is
also registered with the SEBI.
2. Insist that all your deals are done in the trading ring or through
the exchange.
3. Give specific orders to buy or sell within the fixed price limits
and/or time periods within which orders have be executed.
4. Insist on contacts notes to be passed on to you on the dates.
When the orders are executed.
5. Make sure that your deal is registered with the stock exchange.
In the case of a dispute, this will help trace the details of the
deal easily.
6. Collect a settlement table from the stock exchange mentioning
the pay-in and payout days. Each stock exchange has its one
trading periods, which are called settlements. All transactions
done within this period are settled at end of it. All payments for
the shares bought and share deliveries take place on the pay-in
day. An awareness of pay-in and payout days is use full when a
broker tries to make excuses.
7. Keep separate records of dealings in specified shares (Group A)
and non-specified shares (Group B1 and B2). The settlements
for each is on different days with the present compulsory
54
rolling settlements system, deliveries and payments are made
quicker with in three to five days.
8. Execute periodic settlements of dues and delivery of shares to
avoid accumulation of transactions.
9. Insist on delivery. If the company returns your papers and
shares with objections, contact your broker immediately.
10. Ensure that shares bought are transferred in your name before
the companys book closure date. This is necessary to make
sure that you receive benefits like dividend, interest and bonus
shares. All companies have a book closure date on which the
list of shareholders in the company is finalised.
11. Complain if broker does not deliver the shares bought in your
name. Proceed to contact another broker with the bill/ contact
given to you by the earlier broker and the latter will purchase
the shares on your behalf. In such an event, the first broker will
have to pay the difference in price.
12. Do not sell shares that are transferred in your name after the
book closure, as there are not valid in the market.
13. Do not sell/deal in shares where even one of the holders has
passed away. In cases where the holder has died, a succession
certificate is necessary. In cases where one of the joint holders
passed away, the surviving holder should send the shares along
with the death certificate to the company. Only after the name
of the deceased has been deleted from the shares, can they be
transferred.
14. Do not expect the money shares to come immediately. It will
take at least 7 to 15 days from the date of transaction, which is
now made quicker in, demat form of trading.
15. Unless you have special arrangements with the broker, do not
expect the adjustments of purchases and sales against one
another. One pays first and receives later.
16. Do not take delays or harassment lying down. You have to
complain to the Grievance Cell of the stock exchanges or
Securities and Exchanges Broad of the India (SEBI) in case of
delay or harassment.
PORTFOLIO MANAGEMENT SERVICES
55
A list of all those services and facilities that are provided by a
portfolio manager to its clients, relating to the management and
administration of portfolio of securities or the funds of clients, is referred
to as portfolio management services. The term portfolio means the
total holdings of securities belonging to any person.
Portfolio Manager:
According to SEBI, Portfolio Manager means any person who
pursuant to contract or arrangements with a clients, advices or directs or
undertakes on behalf of the clients the management or administration of a
portfolio of securities or the funds of client, as the case may be
Discretionary Portfolio Manager:
According to SEBI, discretionary portfolio manager means a
portfolio manager who exercises or may, under a contract relating to
portfolio management, exercises any degree of discretion as to the
investments or management of the portfolio of securities or the funds of
the clients, as the case may be.
FUNCTIONS
The objective of portfolio management is to develop a portfolio
that has maximum return at whatever level of risk the investor deems
appropriate.
Risk Diversification
An essential function of portfolio management is spread risk akin to
investment of assets. Diversification could take place across different
securities and across different industries. Diversification achieved in
different industries is an effective way of diversifying the risk in an
investment. Simple diversification reduces risk within categories of
stocks that all have the same quality rating.
The portfolio managers could as well adopt the Markotiwz model
whereby portfolio risk are sought to be reduced through combining
assets, which are less than perfectly positively correlated.
Efficient Portfolio:
56
A portfolio manager aims at building dominant investment called
efficient portfolio. An efficient portfolio consists of combination of
assets that maximizes return and maximizes the risk level of expected
return. The objective of portfolio management is to analyze different
individual assets and delineate efficient portfolios. A group of portfolio
of efficient portfolios is called efficient set of portfolios. The efficient
set of portfolio comprises efficient frontier.
Asset allocation
An important function of portfolio management is asset allocation. It
deals with attaining proportion of investments from categories. Portfolio
managers basically aim at stock-bond mix. For this purpose equally
weighted categories of assets are used.
Beta Estimation
Another important function of a portfolio manger is to make an estimate
of beta coefficient. It measures and ranks the systematic risk of different
assets. Beta coefficient is an index of the systematic risk. This is useful in
making ultimate selection of securities for investment by portfolio
manager.
Rebalancing Portfolios:
Rebalancing of portfolio involves the process of periodically adjusting
the portfolios to maintain the original conditions of portfolio. The
adjustments may be made either by way of constant proportion
portfolio or by way of constant beta portfolio. In constant proportion
portfolio, adjustments are made in such a way as to maintain the relative
weighting in portfolio components according to the change in prices.
Under the constant beta portfolio, adjustments are made to accommodate
the values of component betas in the portfolio.
STRATEGIES
A Portfolio manager may adopt any of the following strategies as
part of an efficient management:
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Buy and Hold Strategy
Under the buy and hold strategy, the portfolio manager builds a
portfolio of stock, which is not disturbed at all for a long period of time.
This practice is common in case of perpetual securities such as common
stock.
Indexing
Another strategy employed by portfolio managers is indexing.
Indexing involves an attempt to replicate the investment characteristics of
a popular measure of the bond market. Securities that are held in best-
known bond indexes are basically high-grade issues.
Laddered Portfolio
Under the laddered portfolio, bonds are selected in such a way that their
maturities are spread uniformly over a long period of time. This way a
portfolio manager aims at distributing the funds throughout the yield
curve.
Barbell Portfolio
Under this portfolio strategy, less investment of funds is made in middle
maturities.
REGISTERATION OF PORTFOLIO MANAGERS
Following are steps involved in the registration of portfolio
managers:
Application for Grant of Certificate
An application by portfolio manager for grant of a certificate shall be
made to the Board in Form A. Any application is made by portfolio
manager prior to coming into force of these regulations containing such
particulars or as near thereto as mentioned in the Form A shall be treated
as an application made in pursuance of sub-regulation (1) and dealt with
accordingly.
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Conformance to Requirements
Any application, which is not complete in all respects and does not
conform to the instructions specified in the form, shall be rejected by the
Board. Before rejecting any such application, the applicant shall be given
an opportunity to remove within the time specified such objectives as
may be indicated by the Board.
Furnishing of Further Information, ETC.
The board may require the applicant to furnish further information or
clarification regarding matters relevant to his activity of a portfolio
manager for the purpose of disposal of application. The applicant or its
principal officer shall, if so required, appear before the Board for
personal representation.
Consideration of Application
For the consideration the grant of certificate of registration to the
applicant, the Board takes into account all matters, which it deems
relevant to activities relating to the activities to portfolio management.
The Board considers the following in this regard:
1. Whether the applicant is a body corporate.
2. Whether the applicant has the necessary infrastructure like
adequate office space, equipments and the manpower to effectively
discharge the activities of a portfolio manager.
3. Whether the principal officer of the applicant has the professional
qualifications in finance, law, accountancy or business
management from an institution recognized by the Government.
4. Whether the applicant has in its employment a minimum of two
persons who, between them, have at least five years of experience
as portfolio manager or stock broker or investment manager or in
the areas related to fund management.
5. Whether any previous application for grant of certificate made by
any person directly or indirectly connected with the applicant has
been rejected by the Board.
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6. Whether any disciplinary action has been taken by the Board
against a person directly or indirectly connected with the applicant
has been under the Act or the Rules or the Regulations made
thereunder.
7. Whether the applicant fulfills the Capital adequacy requirements
as specified in regulation 7
8. Whether the applicant, its director, principal officer or the
employee as specified in clause (d) is involved in any litigation
connected with securities markets which has an adverse bearing on
the business of the applicant.
9. Whether the applicant, its director, principal officer or the
employee as specified in clause (d) has at any time been convicted
for any offence involving moral turpitude or has been found guilty
of any economic offence.
10. Whether the applicant is a fit and proper person.
11.Whether the granting of certificate to the applicant is in the
interests of investors.
Capital Adequacy Requirement
The capital adequacy requirement shall not be less than the net worth of
fifty lakhs rupees. For the purpose of this regulation, net worth means
the aggregate value of paid up equity capital value of paid up equity
capital plus free reserves reduced by the aggregate value of accumulated
losses and deferred expenditure not written off, including miscellaneous
expenses not written off.
Procedure for Registration
The Broad on being satisfied that the applicant and on receipts of the
payment of fees as specified in Schedule II, then grants a certificate in
Form B.

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