Sebi flags inflated valuations and shady tactics in SME market

India's markets regulator has raised concerns about questionable practices in the country's small and medium enterprise (SME) market, warning investors about unrealistic projections by some SMEs.

In its advisory, the Securities and Exchange Board of India (Sebi) noted that after listing, certain SME companies or their promoters have been making public announcements that paint an overly positive picture of their operations. These announcements are often followed by corporate actions such as bonus issues, stock splits and preferential allotments.

“Such companies/promoters have been seen making public announcements that create a positive picture of their operations. These announcements are typically followed up with various corporate actions such as bonus issues, stock splits, preferential allotments, etc.,” the two-page advisory stated.

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However, behind this facade of growth, many of these SME companies are engaging in manipulative practices. Promoters often exploit these artificially inflated valuations to divest their holdings at premium prices, leaving unsuspecting investors at a disadvantage.

Concerning pattern

Sebi's advisory comes after its chairperson, Madhabi Puri Buch, expressed concerns in March about instances of price manipulation at IPO and trading levels by some SMEs.

She expressed the regulator's intention to seek more disclosures as a first step to bring more transparency in SME IPOs.

Sebi has previously taken action against such entities, noting that their modus operandi often follows a similar pattern as described above.

For instance, in May, Sebi barred Add-Shop E-Retail Ltd and its promoter and management from accessing the capital markets after finding that over 46% of the company’s sales in the past three years were fictitious, with related-party transactions lacking proper approvals.

In the same month, the regulator also banned Varanium Cloud Ltd from the markets due to the misuse of IPO proceeds.

“Earlier this year, Sebi took action against three other SME companies for similar violations, including the misuse of public funds, misstating facts in offer documents, and manipulating financial statements. These companies had inflated their operations to create false perceptions and boost investor interest, allowing promoters to offload shares at elevated prices,” said Nilesh Tribhuvann, managing partner at White & Brief Advocates&Solicitors.

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Massive growth

Since the 2012 launch of the SME platform on the stock exchanges, the market has seen significant growth, with over ₹14,000 crore raised in the past decade, including approximately ₹6,000 crore in 2023-24, the Sebi advisory note showed.

The BSE SME IPO index has surged to 111,683.62 from 35,558.66 on 28 August 2023—a 140.03% year-on-year increase and a 214.08% increase this year to date. However, this growth has raised concerns about transparency and fair practices.

Sebi has urged investors to exercise caution when investing in SME securities. The regulator advised against relying on unverified social media posts or making investments based on tips or rumours. Instead, investors should conduct thorough due diligence and seek professional advice before making investment decisions.

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Tribhuvan added that Sebi is considering tighter norms, such as raising the minimum size for public offers and requiring more comprehensive disclosures from companies seeking SME listings. “These measures aim to protect retail investors and ensure that only compliant companies access the capital markets, fostering trust and stability within the SME sector."

Amfi vigilance

The Association of Mutual Funds in India (AMFI) has also been talking to asset management companies (AMCs) about implementing mechanisms or measures to curb front running.

Amfi has communicated with AMCs about adopting better practices to prevent front-running. However, a member of the Brokers Committee told Mint that this is considered standard procedure and part of the risk management framework.

Sebi and Amfi have been vigilant over the past few months, especially following Axis and Quant mutual fund front-running cases, said an industry insider on the condition of anonymity. “However, circulars requesting the implementation of institutional mechanisms are not unusual.”