The Auditor's Resignation Nobody Wants to Disclose
Northbridge Capital is lead manager to a Rs 500 crore IPO by a consumer products company. Two weeks before the RHP is to be filed, four facts surface. The statutory auditor resigned during the quarter, citing an inability to obtain complete information from a subsidiary; the draft RHP says the resignation was 'due to personal reasons and pre-occupation'. That subsidiary has a Rs 22 crore GST show-cause notice under appeal, which appears nowhere in the draft. Twenty-seven per cent of consolidated revenue comes from a distribution firm owned by the managing director's brother-in-law; the related-party note covers the transactions but the risk section is silent. Northbridge's own associate holds 3.2% of the issuer's pre-issue equity, bought eight months ago. Finally, the managing director offers to raise Northbridge's fee by 40% on condition that its 'market feedback' report avoids any negative remark, and proposes a Rs 40 lakh 'coordination fee' to a consultancy owned by his cousin.
1. Assess each of the first three facts and state what the merchant banker must do before the RHP is filed.
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Auditor resignation. This is material and the draft characterisation is false. The merchant banker should read the auditor's resignation letter and the limited review reports, speak to both the outgoing and incoming auditors, and require disclosure of the actual reason and the audit committee's response. 'Personal reasons' covering an information-access failure in a subsidiary is a misstatement in a regulated document.
GST show-cause notice. Outstanding litigation and regulatory proceedings must be disclosed, with the amount, the stage and the issuer's assessment. Rs 22 crore against a Rs 500 crore issue is material on any test, and the appeal is a defence, not a reason for silence.
Related-party distributor. A firm owned by the MD's brother-in-law generating 27% of revenue is simultaneously a related-party transaction and a business-continuity risk. It belongs in the risk factors, not only in the notes to accounts.
Action. The merchant banker cannot certify the due diligence certificate while these are unresolved. Give the issuer a written list, refuse to file until it is remedied, and put the reasons to the audit committee and the board. If the issuer refuses, the merchant banker must decline to sign and withdraw as lead manager.
2. How should the associate's 3.2% shareholding be handled?
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Disclose it. The offer document must disclose the interest of the lead manager and its associates in the issuer, including this shareholding, the price paid, the date of acquisition and the absence or presence of any understanding about exit. Undisclosed, a small stake looks like a hidden promoter interest; disclosed, it is a manageable conflict.
Manage it internally. The associate should be walled off from the issue team, should not receive allocation in the IPO, and should not deal in the scrip around the issue. The firm's compliance officer should record the wall-crossing arrangements.
Think about the substance, not only the form. A stake acquired eight months before the IPO, at a pre-issue price, is being marked up by the very offering the firm is managing. That is not prohibited, but it sharpens the question of whether the firm can be objective about pricing. If the stake was acquired on the basis of information about the proposed issue, the insider-trading prohibition is engaged and the firm's position becomes far more serious than a disclosure lapse.
Note the pricing link. The lead manager's fee should be unrelated to the value its associate's holding derives from the issue. If it is not, expect the regulator to ask.
3. The MD's fee offer and the 'coordination fee' to his cousin: how should the merchant banker respond, and why does it matter under the Code of Conduct?
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Refuse both, in writing. A 40% fee uplift conditional on the market feedback report omitting negative findings is a payment for a favourable opinion. The report is a professional assessment; if it is written to a price, it is worthless, and the merchant banker would be selling its judgement to the issuer. The Rs 40 lakh 'coordination fee' to a consultancy owned by the MD's cousin is a related-party payment dressed as a professional fee - there is no identifiable service, and it is routed through the issuer to a person connected to the promoter.
Why the Code of Conduct matters. Schedule III of the SEBI (Merchant Bankers) Regulations, 1992 obliges a merchant banker to be honest and fair, to refrain from misleading representations, and not to offer or accept inducements in connection with its professional work. Both proposals offend that standard, and accepting either would taint every certificate the firm signs on this issue.
Practical handling. (1) Reply to the MD confirming that the fee is the contracted fee and no more, and that the market feedback report will reflect the firm's findings. (2) Decline the coordination fee and ask that no payment be made to any entity connected with the promoter outside disclosed related-party transactions. (3) Inform the compliance officer and, if pressure continues, the audit committee and independent directors. (4) Keep a contemporaneous record: if the firm later withdraws, the file should show exactly why.