CHAPTER- V PERFORMANCE EVALUATION OF MERCHANT BANKERS-II (UNDERWRITING OF PUBLIC ISSUES)

Underwr iting of shares is linked with the management of public issues as it involves marketing and distr ibution o f securities offered to public. Mer chant bankers as lead managers to the public issues are not responsible only for selecting and appo inting other financial intermed iaries related to the issue, but also for arranging and coordinating the activities o f underwriters, brokers, registrar and bankers to the issue etc.

Underwr iting, in the context of pr imar y capital market, refer s to co ntractually guaranteeing su bscr iption to shares and other secur ities. Herein, the underwriters undertake a responsibility or give a guarantee that the securities offered to the public or sharehold ers will be subscribed fo r. I f the issuer is not sure o f the su bscriptio n o f the issue, he first underwr ites the shares with fin ancial institution/lead managers. If the shares ar e su bscr ibed fully by the public, the under wr iters get a commission as a percentage of total amount of shares issued. In case the issue is undersubscribed, then the underwr iters have to buy the unsubscribed portion o f the issue or to the extent o f his guarantee.

Underwr iting of cap ital issues in India is regulated by Securities and Exchange Boar d o f I nd ia. Acco rding to SEBI (Underwr iters) Ru les, 1993, underwriting means an agreement with or without conditions to subscribe to the securities of a body co rporate when the existing shar eholder s of such bod y corpo rate or the public do not subscr ibe to the securities o ffered to them. And an underwriter has been defined as a perso n, who engages in the business o f u nderwriting o f an issue o f secur ities o f a body cor po rate.

In the western countries, especially UK and USA, underwriting means purchase of securities fro m the company by the investment bankers, who subsequently sell it to the public. In India, if the minimum subscr iption of 90% o f the issue is not subscribed by the public, then the company has to refund the amo unt to the app licants. So the promo ter s, befo re issuing the prospectus fo r the issu e of shares, have to ensure against the co ntingent risk of failure of the issue.

The underwriters repose a co nfidence in the minds of investors and help in the mobilization of fu nds o f the individual investors. The retail investors always need 121

protection of his investment in a pro ject and so the services of und erwriting institutions ar e required. Do lvin in his research paper has stated that underwriters do create valu e for issuer in the sense that o ffer price go es higher for the issu es managed by r eputed underwr iters. It implies that higher quality underwriters apply more subjective cr iter ia fo r selecting offer pr ices and/o r that the cr iteria emplo yed are o f higher quality1.

In the selection of underwriters, financial strength is a major consideratio n.

Other aspects taken into consideration are experience in the primary market, past underwriting performance and defaults, outstanding underwriting commitments, the netwo rk of investo rs, clients of the underwriter and overall reputation. The underwriter on his part has to assess the co mpanys standing and reco rd, competence of the management, objects o f the issue, project details, offer price and o ther terms o f the issue and off balance sheet liabilities befo re accepting the underwr iting obligations2.

5.1 Underwriting of Capita l Issues in India

Underwr iting o f capital issues in India is o f recent origin as co mpared to the
develo ped capital markets of UK and USA. During the British rule, London based Managing Agency Ho uses in I nd ia per fo rmed the principal activities of floatatio n of co rporate securities and hence the presence o f pure merchant banks was neglig ible. Indian business houses also co pied the system f rom Br itish f ir ms and established Managing Agency Houses as family business in the pre Wo rld War-II era. Many o f these later o n converted into partnership firms and pu blic limited co mp anies. The prominent Indian managing agency housed included: Tatas, Birlas, Dalmias, Singhanias, Thapars, Bhadanis, Narangs, Ruias, Poddars and J.K.3.

Underwr iting o f capital issues did not develop in I ndia during this per iod
because o f the monopo ly o f managing agency houses d istributing shares to their friend s and relatives. The under developed capital market was characterized by lo w inco me, low savings, poverty circle and the absence of banking habits amo ng pu blic at large4.

Underwr iting of securities in India had its beginn ing in 1912, when M/s Batliwala and Karani, a firm of share brokers in Bombay had underwritten the capital issue of 50 lakh shares o f Central India Spinning & Weaving Co. Ltd. In the year

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1913, Chunilal Saralya u nderwrote the pu blic issue o f preference shares o f Tata Mills Ltd. The amend ments in the I ndian Co mpanies Act, 1936 made it obligatory to
include in the pr ospectus, the names o f the underwriters, the underwr iting commissio n payable and a statement by the d irectors to the effect that the underwr iters have requ isite financial resources. The co ntract between the issuing co mpany and the underwriters was made accessible to the shareho lders5.

Immediately after independence, the Capital Issues (Control) Act, 1947 was passed by Parliament to regulate and contro l the capital issues by co mpanies. I t was ad ministered through the office of the Controller of Capital Issues under the Ministry of Finance (Department of Eco no mic Affairs). Indian Companies Act, 1956 further streamlined the pro cedure for capital issues including underwriting o f capital issu es and it facilitated the growth of cap ital market in the country after independence.

Data co llected from the Reports of the RBI on Currency and Finance has revealed that the proportion o f private cap ital issues u nderwr itten was 91. 65% in 1971, 97.09% in 1976, 56.84% in 1981, 63.78% in 1986, 60. 65% in 1987 and 61.59% in 1988. Under wr iters subscription as a per centage to total su bscr iptio n stood at 41.95% in 1971, 49.35% in 1976, 11.27% in 1981, 0.95% in 1986, 3. 26% in 1987 and 17.36% in 1988.

Since 1992, the regulatio ns and co ntrol of various p layers in the pr imar y mar ket have been und er the supervision and control o f SEBI. Fro m time to time, it has laid down guidelines for these players includin g under wr iters of capital issues in India.

5.1.1 SEBI Guidelines on Underwriting

Secur ities and Exchange Bo ard o f India (Underwriters) Rules, 1993 as amended fro m time to time provide fo r the compu lsor y r egistration o f underwriters, provisions for the capital adequacy requirements, general oblig atio ns and responsibilities with a specified code of conduct, inspectio n and disciplinar y proceedings by the SEBI and the procedure for action against underwriters in case o f defau lt.

Similarly SEBI (Disclosure & Investor Protectio n) Guidelines, 2000 as amended from time to time have prescribed a number of guidelines for the underwriters to the

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capital The issues same and shall the lead be incorporated managers respo in the nsibinter-se le for the allocation success of of the responsibilities issue. So meooff these guidelines lead manag have ersbeen and mentio shall accompany ned belo w. the due diligence certificate submitted by (a) As the perlead orig merchant inal guidelines bankerissued to SEBI. by SEBI on June 11, 1992, underwr iting was (i) In case mandato thereryisfo a rdevolvement full issues and on underwr minimum iters, requirements the lead omanager f 90% subscr shall iptio ensure n was also mandatory fo r each issue of cap ital to public. However, fro m October that the underwriter(s) ho no ur their commitments within 60 days from the date 1994, under wr iting is not mandatory and now the issuer has the option to of clo sure of the issue. decide whether the issue is to be underwritten or no t. Number of underwriters would be subscribed decid ed by issues, the issuer (j) In case of also under the s. lead manager shall furnish informatio n to SEBI, in respect of underwriters, who have failed to meet their u nderwr iting devo lvement. (b) The lead manager(s) must satisfy themselves about the net worth of the (k) In case underwriters of Bo ok and Building the outstand Issues:ing co mmitment and disclose the same to SEBI. A statement to this effect has to be incorporated in the prospectus. (i) The syndicate members shall enter into an underwriting agreement (c) If the issue with is the underwritten Book Runner and the (s) indicating co mpany do thees number no t receive of securities 90% o which f the they wou ld subscribe at the pre determined price. issued amount fro m public subscription plus accepted devolvement fro m

underwriters within 60 days of the opening o f the issue, the company will (ii) The Bo ok Runner (s) shall in turn enter into an under wr iting refund the amou nt of su bscr iptio n. In case of d isputed devolvement, the co mpany sho uld with refund the subscr iption, if the above conditio ns are not met. agreement the issu ing co mpany. (iii) In the event of syndicate members not fu lfilling their underwriting

(d) If the issue obligations, is not underwritten the Boo k Runner and theLead minimum Managers subscription shall beorespo f 90% nsib of lethe for bringing the amount devolved. offer to the public is not received, the entire amo unt received as su bscr iptio n would have to be r eturned.

5.1.2 Underwriting Commission

The equirement offor min imum 90%iters, subscr iption will guarantee not apply against for The r Consideration the underwr who provide under exclusive issues provided theo issuer makes n adequate abo ut at thea subscr iptio n of debt securities, is by way f commissio payabledisclosures on issue pr ice alternative source of finance that have been tied up . predetermined rate, of co urse within Go vt. guidelines. So metimes underwriting agreement may state to pay the commissio n only on the amou nt devo lved on the (e) The underwriting may be ofiled SEBI and sho uldcontingent be open to underwriters and no t agreement o n the total size f thewith issue. This is called underwriting. public during the per iod issue remains open. (f) In respect to every u nderwr itten issue, the lead merchant bank er(s) shall undertake imum underwriting o as bligation of by 5%the ofGovt. the total The rate of a u min nderwr iting co mmission permitted is underwr stated initing the co mmitment or Rs 25 lacs, whichever is less, or else arrange for und erwriting follo wing table. of an equal amount by merchant bank er associated with the issue and intimate the same to SEBI. (g) The outstanding underwriting commitments of a merchant banker shall not exceed 20 times its networth at any po int of time. (h) In the case of u nder su bscriptio n of an issue, the lead merchant bank responsible fo r underwr iting arrangement shall invoke und erwriting obligations and ensure that the under wr iters pay the amount of devo lvement. 124 125