This article is written by Vaibhav Chauhan, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.com

Introduction

Do you know about the obligation of the merchant banker and of the issuer? From general understating merchant banker is the one who is associated with high worth individuals and companies for the purpose of selling, buying and subscribing to the securities. Subsequently, the issuer is the one who issues the security with the intent to raise capital for the purpose of its project.

The present article provides the snapshot of who merchant banker and issuer is along with the help of illustration to connect the working of same in the practical aspect. Further, this article primarily focuses upon the obligation of merchant banker and issuer which they are obligated to perform as provided under their governing regulation and act along with the emphasis on the case laws to highlight the penalty and strict adherence to the obligations.

Who is a merchant banker and issuer?

It was National grindlays Bank who first introduced the concept of merchant bank in the year 1967. Subsequently, the State Bank of India became the first Indian commercial bank to establish the Merchant Banking division in the year 1972. As per Webster’s New Collegiate Dictionary defines merchant bank as, “that specializes in bankers’ acceptances and in underwriting or syndicating equity or bond issues”.

Further, as per Regulation 2 (cb) of Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 defines the term merchant banker as “any person who is involved in the business of issue management either by making arrangements pertaining to selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management”.

Therefore, in simple words, merchant bankers are in charge of the issue process and act as a linking pin between the investor and the company. They are also obligated with the preparation of prospectus and marketing advertisement for the issue. Also, the obligations of merchant banker are covered further in this article.

Moreover, Section 2(1) (f) of the Depository Act, 1996 defines the term “issuer” as any person who is indulged in making the issue of the securities. In furtherance of this, the issuer is a legal entity who sells securities to provide finance to its operations and issuer can be investment trusts, corporation or domestic or foreign government and Securities issued by the issuer include equity, shares, bonds and warrants etc. 

Illustration to understand the concept of issuer is provided below:

XYZ is a corporation sells shares to the general public in order to generate the capital to finance its project or say its business operation. The selling of shares by XYZ makes it the issuer and is required to relevant financial statements with the regulator such as Securities and Exchange Commission. 

After, understanding the concept of merchant banker and issuer let’s see what are the regulations and acts governs their obligation.

Regulation governing merchant bankers

Security Exchange Board of India (hereinafter referred to as SEBI) has made regulation for different components of the capital market after exercising its power under Section 30 of the SEBI Act, 1992. In furtherance of which merchant bankers are regulated by SEBI (Merchant Bankers) Regulations, 1992 (hereinafter referred to as the Merchant Banker Regulation). Present regulation consists of five chapters that are definitions, compulsory registration with SEBI, obligation and responsibilities, code of conduct, code of conduct, the procedure for inspection by SEBI, of documents, records and books of accounts, the procedure in case of default, i.e. the action to be taken against concerned merchant banker (cancellation or suspension of registration by SEBI).

Merchant Banking is the noble profession, like other professions and merchant banker also has to abide by some of the obligations as provided by the above-mentioned Merchant banker Regulations.

To move further with the aspect of merchant baker obligation it is pertinent to mention here the general definition of term “obligation” which means that “A duty imposed on one either legally or socially with the duty to perform and not to perform some action.”

Therefore, the obligation of the merchant bankers governed by Chapter III of the SEBI (Merchant Bankers) Regulations, 1992. Further, in the light of above-mentioned chapter the obligation of the merchant banker is provided below: 

Merchant Banker not to Associate with any Business other than that of the Securities Market

No, merchant banker as per Regulation 13A of the Merchant Banker Regulation who have obtained the certificate of registration after 30th June 1988 can carry on any business apart from business in the securities market. But, the Bank or Public Financial Institution can do so.

However, if a merchant banker has entered into a contract with respect to the business apart from the securities market, prior to the Merchant Banking Regulation, 1997, then he may if so desire can discharge his obligation under such contract.

Maintenance of Book of Accounts, Records, etc.

As per Regulation 14 of the Merchant Banking Regulation merchant banker has to maintain the copy of balance sheet at the end of each accounting year along with profit and loss account of the respective period and an auditors report for the accounting period with a statement of financial position. Further, merchant bankers also have to maintain all records and documents related to due diligence related to per-issue and post-issue activities of issue management as well as in case of a takeover, delisting of securities and buyback of securities.

Moreover, Board should be informed about the place where above mentioned pertinent document are maintained and every merchant banker shall, after the end of each accounting period furnish to the Board copies of the balance sheet, profit and loss account and such other documents for any other preceding five accounting years when required by the Board.

Submission of Half-yearly Results and Maintenance of Books of Accounts, Records and other Documents

Regulation 15 of the Merchant Banker Regulation obligates every merchant banker to provide half-yearly unaudited financial results to the Board with a view to keep a tab on the capital adequacy of the merchant banker. Further, in accordance with Regulation 16, he should also maintain the records such as books of accounts and other pertinent records for the minimum period of 5 years.

Report on Steps taken on Auditor’s Report

Regulation 17 provides that within 2 months from the receipt of the auditor’s report, the merchant baker shall rectify the deficiencies mentioned in such report. 

Responsibilities of Lead Managers

Regulation 20 of the Merchant Banker Regulation governs the provision related to the responsibilities of the lead merchant banker to which he has to compulsorily oblige with. As per this regulation lead manager shall not agree to take care or be associated with any issue unless his responsibilities have been determined and a statement specifying the same furnished by the board at least 1 month prior to the issue for a subscription. Also, prior to such period as mentioned above if there is more than one lead merchant banker then their responsibilities should be clearly demarcated along with such statements mentioning the same.

Further, if the issue is made by any other body corporate and that body corporate is an associate of the lead merchant banker then he shall not agree to manage the same. Subsequently, as per regulation 21 of the Merchant Banking Regulation, lead merchant bankers should not be associated with the merchant banker associated with the issue without holding a certificate.

Underwriting Obligations

This obligation is provided under Regulation 22 of the Merchant Banking Regulation which provides that the lead merchant banker shall accept a minimum underwriting obligation of 5% of total commitment or INR 25 Lacs, whichever is less.

The proviso to this regulation states that, if the lead merchant banker is unable to accept the minimum underwriting obligation, then he shall make the merchant banker associated with the issue to underwrite the up to the minimum extent and should inform the same to the Board. This regulation further provides that in any issue in the light of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, the merchant banker shall, itself or jointly with other merchant bankers connected with the issue, underwrite at least 15% of the issue size.

Acquisition of Shares Prohibited

Regulation 26 provides that merchant bankers shall not enter into any transaction related to the securities of the bodies corporate based upon unpublished price sensitive information obtained by them either from the clients or otherwise through the course of any professional duty.

Information to the Board

Regulation 27 of the Merchant Banker Regulation provides that merchant bankers shall within 15 days from the date of entering into any transaction for the acquisition of securities of anybody corporate, submit the report of such particulars related pertaining to the abovementioned transaction to the board. This regulation further provides that complete particulars of any transaction for the acquisition of securities made in pursuance of underwriting or market-making obligations in accordance with Chapter XA of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 shall be submitted to the Board on a quarterly basis. 

Disclosures to the Board

Regulation 28 of the Merchant Banker Regulation governs the provision related to the disclosures of the board and provides that a merchant banker shall disclose to the Board following information provided below:

• Responsibilities with respect to the management of the issue;
• If any particulars changed which were previously furnished, have a bearing on the certificate granted to it;
• Names of body corporates whose issue is managed by him or he has been related/associated with;
• The particulars relating to the breach of the capital adequacy requirement;
• Disclose information related to the activities carried by him as a manager, underwriter, consultant or adviser to an issue as the case may be.

Appointment of Compliance Officer

This obligation is governed by regulation 29 of the Merchant Banker Regulation which mandates that merchant baker shall appoint compliance officers for carrying out responsibilities as provided under the above-mentioned regulation. The compliance officer appointed by the merchant banker shall report to the board independently and spontaneously about any of the non-compliance noticed by him and make sure that non-compliance marked out in the draft prospectus and letter of offer should not persist.

Obligations of Merchant Banker on Inspection by the Board

Under this head of the obligation, every employee of the merchant banker shall, while he is being inspected to produce the relevant books, accounts and other documents as required by the inspecting officer. Further, it should also provide the statements and information relating to his activities as a merchant banker at the time required by the inspecting officer.

Reasonable access to the premises that are occupied by the merchant banker or by any person on his behalf along with that the reasonable access to examine books, records, and data stored in the computer should also be provided by the merchant banker. Moreover, a copy of the documents as asked by the inspecting officer for the purpose of investigation should be provided by the merchant banker.

Furthermore, merchant bankers should provide reasonable assistance as expected to the inspecting officer for the purpose of conducting investigation smoothly.

At last, above mentioned are the obligations which merchant bankers have to abide by. Moreover, in case of default, he is liable under Regulation 34 which provides that if a merchant banker contravenes any provision of the regulation, rules or act then he shall be liable for one or more actions instated in SEBI (Intermediaries) Regulations, 2008, Chapter five. 

Case Laws

Do you know that penalty is imposed upon merchant bankers as soon as the statutory obligation is contravened and neither the intention of the merchant banker nor the impact of that violation is not considered relevant at the time of assessing the violation?

In response to the above, it is relevant to mention the recent case of Medicamen Biotech Limited (Target Company) where SEBI held that merchant banker has failed to exercise required due diligence pertaining to the compliance record of the promoters of the Target Company because he did not disclose in its due diligence findings that shareholding of the promoter would trigger the requirement to make an open offer under Takeover Regulation.

Further, in this respect, SEBI highlighted that due diligence is a very crucial part and was an independent dusty of every merchant banker and identified the non-compliance that was already available in the public domain. Thus, SEBI states it was reasonable to expect from the merchant banker to remain careful and diligent about the same. Therefore, in the light of Supreme Court order in the case of SEBI v Shriram Mutual Fund (2006) 5 SCC 361, SEBI opined that penalty is to be imposed upon the merchant banker for its failure to comply with the provisions of  SEBI (Merchant Banker) Regulations, 1992 and SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.

In view of the above imposition of the penalty by SEBI, it is clear that onus of diligence is upon the merchant banker to provide complete compliance status of the promoters and acquirer irrespective of the fact that these details are provided by the target company or stock exchanges. SEBI has imposed penalty upon merchant bankers so that every merchant banker should take care of its obligation to provide a complete wider picture of the target company as these disclosures and details might impact the decision of the shareholders. Thus, merchant bankers have to abide by its obligation as well as a duty as prescribed under the above-mentioned regulation. 

Act Governing Issuer

After seeing the regulation governing merchant banker above, present section covers the act governing issuer obligation. Chapter III of Depositors Act, 1996 (hereinafter referred to as the Act) provides the provision governing the obligation of issuer. The obligations of the issuer are provided below:

Duty to register the name of depository as the registered owner

The obligation of the issuer starts when any person who wants to avail the services of a depository has to enter into an agreement with him as prescribed under section 5 of the Act and in furtherance of this that person has to surrender its certificate of security to the issuer in the light of section 6 of the Act. From here the role of issuer begins that on receipt of security, the issuer that is the company, shall cancel the certificate security provided earlier under section 6 and enter the name of the depository as a registered owner accordingly and inform the depository about the same. Subsequently, on receipt of the information by the depository, he enters the name of the person who has entered into a contract with him as the beneficial owner. 

Inform the details of allotment

In the light of section 8 of the Act if a person subscribing to the security offered to hold the same with the depository then the issuer shall provide the depository with the details of allotment of the security.

Obligation to enter into an agreement

This obligation is governed by section 19B and covers depository or participant or any issuer or agent but for the present article is focused upon the issuer part. So in the light of above-mentioned section issuer if registered as an intermediary under Section12 of the SEBI Act, 1992 then he is required to enter into an agreement under the present act and rules and regulation in this respect and if an issuer fails to enter into such an agreement then he shall be liable to pay a penalty of Rupees 1 lakh for each day till such failure to enter into an agreement continues or Rupees 1 crore, whichever is less for such failure. 

Duty to redress the investor’s grievances

This also a penal provision under section 19C which provides that if the issuer is registered as an intermediary under section 12 of the SEBI Act, then failure to redress the investor’s grievance within the time period prescribed by the SEBI then issuer shall be liable to pay One lakh rupees for each day during which such failure continues or one crore rupees, whichever is less.

Dematerialization of shares or issue of certificate of securities in time

If the issuer has failed to perform his obligation related to the dematerialization or issue the certificate of securities on choosing out of a depository by the investors, within the time specified under this Act or regulations then he is liable for the penalty prescribed under section 19D of the Act.

Obligation to reconcile records

If the issuer failed to maintain/merge the records of dematerialized securities with that of securities that have been issued by the issuer in the spirit of the regulation concerning the same then issuer shall be liable to pay the penalty of INR 1 lakh or INR 1 Crore, whichever is less.

Thus, above-mentioned are the obligations to which the issuer has to be abiding by and if he doesn’t abide by the obligations then he would be liable under the penal provisions as mentioned hereinbefore.

Conclusion

At last, as mentioned in the article above defined the term “obligation” which makes the person perform the duty which he is legally or socially bound by to perform. Therefore, merchant banker and issuer are also legally obligated as per the SEBI (Merchant Banker) Regulation, 1992 and the Depositories Act, 1996. Further, merchant banker plays a very crucial role and of prime importance, while it’s being associated with the enterprise or any person or body corporate for issuing management or takeover because the moment any violation of obligation provided in the Merchant Banking Regulation took place merchant banker would be held accountable for the same and penalty will be imposed irrespective of his intention or impact of his negligence upon the transaction. Therefore, the importance of obligation related to due diligence is highlighted in the above-mentioned case of Medicamen Biotech Limited.

Moreover, the same reliance is placed upon the issuer to perform his obligations diligently. SEBI and SAT have taken strict stance related to the obligations of both to provide full and fair disclosures and where there is a lapse in the abiding by the obligations it would lead to wrong information among shareholders and investors. So, obligations are expected to be performed with the utmost care in accordance with the applicable regulation and act as mentioned above.

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