NISM Series IX Merchant Banking Study Notes: Chapter VI – Issue Management: General Obligations and Due Diligence (Part 1 of 3)

Issue management represents one of the most critical and highly regulated functions in the Indian capital markets. As intermediaries bridging the gap between issuers and the investing public, merchant bankers bear a fiduciary responsibility to maintain market integrity, ensure transparency, and protect investor interests.

This study guide is Part 1 of a 3-part comprehensive series covering Chapter VI: Issue Management — General Obligations of Merchant Bankers and Due Diligence. This part focuses on the fundamentals of issue management, the complete due diligence framework, the crucial roles played by external professionals, and the primary general obligations governing public communications, incentives, and financial disclosures.

1. Introduction to Issue Management and Regulatory Oversight

Issue management is the process by which a registered corporate entity raises capital from the primary market through the issuance of specified securities (equity shares and convertible instruments). This process is highly structured and governed by the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (SEBI ICDR Regulations) and the SEBI (Merchant Bankers) Regulations, 1992.

The Role of Category I Merchant Bankers

Under the SEBI (Merchant Bankers) Regulations, 1992, only a Category I Merchant Banker is permitted to act as a lead manager or manager to manage public issuances. Their duties encompass:

• Managing the public issue of securities and underwriting.
• Formulating financial structures and tying up financiers.
• Preparing the draft offer documents, prospectuses, and other informational literature.
• Finalizing allotments and processing subscription refunds.

2. The Core Principle of Due Diligence

What is Due Diligence?

While there is no formal legal definition of "due diligence," it is universally recognized as an essential process of inquiry, verification, and independent professional judgment in investment-related transactions.

Under the SEBI Regulations, the Code of Conduct for Merchant Bankers mandates that a Lead Manager must:

1. Exercise due diligence to collect, verify, and verify disclosures.
2. Ensure proper care is taken during the entire compilation of data.
3. Exercise independent professional judgment without being influenced by the issuer's self-reporting.

Objective of the Due Diligence Process

The primary objective of due diligence is to collect accurate, complete, and verifiable information about the issuer company. This information enables the lead merchant banker to assess whether the disclosures made in the offer document are true, fair, and adequate, helping them comply with their statutory obligations under SEBI and Companies Act provisions.

3. Role of External Parties in the Due Diligence Process

Due diligence is a multidisciplinary exercise. The Lead Merchant Banker and the issuer company are actively assisted by external professionals who bring specialized expertise to ensure compliance with the SEBI ICDR Regulations, the Companies Act, 2013, and other applicable legislations.

A. Legal Counsels

The legal counsel plays a pivotal role in mitigating legal risks and ensuring structural compliance. Their responsibilities include:

• Legal Documentary Due Diligence: Reviewing all historical and current corporate documents, agreements, material contracts, and property titles to confirm legal ownership and rights.
• Offer Document Preparation: Assisting the issuer and Lead Manager in drafting the Draft Red Herring Prospectus (DRHP) and Prospectus in compliance with the SEBI ICDR Regulations and the Companies Act, 2013.
• Advising Lead Managers: Providing legal opinions on regulatory matters, structure, and transaction-related legalities.
• Litigation Review: Assisting the Lead Merchant Bankers to assess the litigation history of the company, its promoters, and group companies. The issuer must immediately inform the Lead Managers of any new litigation or developments on existing matters.

B. Statutory Auditors & Financial Accountants

Financial due diligence requires strict audit checks of the issuer's books. Statutory auditors and accountants assist by:

• Reviewing and auditing historical financial statements.
• Preparing restated financial statements and certificates as prescribed under the SEBI ICDR Regulations for inclusion in the Offer Document.
• Verifying promoter contributions and certifying financial parameters (e.g., net worth, track record).

C. Specialised Industry Experts

For companies in highly technical fields (such as biotechnology, engineering, or mining), merchant bankers consult independent industry experts to verify technical claims, project timelines, and raw material access, ensuring that disclosures are not misleading.

4. Primary General Obligations of Merchant Bankers (Part A)

To protect investors and maintain clean, competitive markets, SEBI imposes strict obligations on how merchant bankers and associated intermediaries manage issues.

A. Strict Prohibition of Payment of Incentives

To prevent artificial demand creation and market distortion, SEBI prohibits the payment of unauthorized incentives:

• The Rule: No person connected with the issue shall offer any incentive, either direct or indirect, in cash, kind, services, or otherwise, to any person to induce them to apply for allotment of specified securities.
• The Exception: This prohibition does not apply to legitimate fees or commissions paid for services rendered in relation to the issue (such as underwriting commissions or brokerage).

B. Regulatory Restrictions on Public Communications and Research Reports

During the "quiet period" surrounding a public issue, public communications are heavily restricted to ensure retail investors are not influenced by unverified forecasts:

• Estimate and Projection Ban: Any intermediary concerned with the issue is strictly prohibited from issuing any public communication, advertisement, research report, or publicity material containing projections, estimates, or conjectures.
• Compliance Verification: Any advertisement or research report issued by an issuer, intermediary, or their associates must strictly comply with SEBI regulations and undergo lead manager oversight to prevent misleading messaging.

C. Consistency in Publicly Available Documents

With the rise of digital portals, SEBI enforces absolute consistency across physical and digital platforms:

• The Rule: The Lead Merchant Banker, along with the issuer, must ensure that the contents of the offer documents hosted on their websites (as required by regulations) are completely identical to the printed copies filed with the Registrar of Companies (RoC), SEBI, and the stock exchanges.

D. Age Limits of Financial Disclosures (The Six-Month Rule)

Financial data must remain fresh and relevant for investors to make accurate judgments:

• The Rule: The merchant banker must ensure that all information contained in the offer document, including the particulars as per the audited financial statements, is not more than 6 months old from the date the issue opens for subscription.

5. Summary Table: Core Diligence & Obligations

6. Key Terms & Concepts for the Exam

• Lead Merchant Banker: The principal merchant banker registered with SEBI who leads the coordination, due diligence, and statutory submissions of a public issue.
• Due Diligence Certificate: A formal certificate submitted to SEBI by the Lead Merchant Banker confirming that they have verified the disclosures in the offer document and that they comply with SEBI requirements.
• Six-Month Financial Validity: The maximum allowable duration between the last date of the audited financial statements included in the prospectus and the actual opening date of the public subscription.
• Intermediaries: Registered market participants (e.g., underwriters, registrars, bankers to an issue) appointed to facilitate the issue process under lead manager supervision.

7. Key Takeaways for Students & Professionals

1. Due diligence is not merely a checklist; it is an ongoing, rigorous process requiring independent professional judgment. Lead managers cannot simply accept issuer statements on face value; they must seek independent verification.
2. No Projections Allowed: Public communication, advertisements, or research reports released during the issue period cannot present estimations or future projections. All information must be grounded in historical, audited facts.
3. Audit Freshness: If the audited financial statements in the prospectus are even a day over 6 months old relative to the issue opening date, they must be updated with fresh audited figures before the issue can proceed.