Regulatory Double Blow: JM Financial Debarred by SEBI and RBI Over Public Debt and Financing Against Shares

In a significant regulatory development, JM Financial finds itself facing dual prohibitions from two key financial regulatory bodies in India. The Securities and Exchange Board of India (SEBI) has barred JM Financial from serving as a lead manager for any public debt issue. Concurrently, the Reserve Bank of India (RBI) has prohibited JM Financial from extending financing against shares and debentures. These actions come in response to the identification of major deficiencies in JM Financial’s operations, raising concerns about compliance and regulatory adherence within the firm.

The market regulators, has taken a decisive step by barring JM Financial from undertaking any new mandates as a lead manager for public debt securities issuances.

On March 5, the Reserve Bank of India (RBI) swiftly enacted a prohibition against JM Financial Products Ltd (JMFPL), prohibiting the extension of loans against shares and debentures. This encompassed the sanction and disbursement of loans related to Initial Public Offerings (IPOs), effective immediately.

In its announcement, the RBI clarified that its decision stemmed from the identification of significant deficiencies within JM Financial’s loan procedures. Notably, the central bank underscored concerns regarding governance issues within the firm, alongside breaches of regulatory directives.

“The necessity for this action arises from the detection of critical deficiencies in the loans extended by the company for IPO financing and Non-Convertible Debenture (NCD) subscriptions,” the RBI stated.

The Reserve Bank of India (RBI) conducted a limited review of the company’s records based on information provided by the Securities and Exchange Board of India (SEBI), which culminated in the current regulatory action, RBI stated. During the review, it was uncovered that JM Financial repeatedly facilitated a group of clients in participating in various IPO and NCD offerings through borrowed funds. The credit underwriting process was found to be inadequate, with financing extended against minimal margins, the RBI disclosed on Tuesday.

Furthermore, the RBI highlighted that the company managed the application for subscription, demat accounts, and bank accounts using a Power of Attorney (POA) and a Master Agreement obtained from these clients without their subsequent involvement in the operations. “Consequently, the company effectively operated as both lender and borrower, RBI concluded.

The Reserve Bank of India (RBI) has outlined that the current business restrictions imposed on JM Financial will undergo review subsequent to the completion of a special audit to be conducted by the RBI. This review will occur once deficiencies are rectified to the satisfaction of the RBI. The central bank clarified that JM Financial can continue servicing its existing loan accounts through the regular collection and recovery process.

In response to the announcement, JM Financial released a statement asserting, “After careful and detailed review of the RBI’s order regarding the action against JM Financial Products Ltd, we strongly assert that there have been no significant deficiencies in our loan sanctioning process. Additionally, the Company maintains it has not violated any applicable regulations. We also reaffirm that there have been no governance issues, and all business and operational affairs are conducted bona fide. The company will continue to serve its existing customers in accordance with RBI guidance.

We are committed to full cooperation with the RBI throughout their special audit initiative and will diligently present our perspective to the RBI, the company added.

In today’s interim order dated March 7, the Securities and Exchange Board of India (SEBI) has permitted JM Financial to retain its role as a lead manager for public debt securities issuances for a duration of 60 days from the issuance date of this order. SEBI clarified that the observations outlined in the order are founded on the available records, with an assurance that the investigation into this matter will conclude within six months.

Let’s explore how JM Financial Debarred by SEBI and RBI Over Public Debt and Financing Against Shares:

These proceedings commenced with the regulator’s routine examination of public issues of non-convertible debentures (NCDs) in 2023. The scrutiny focused on the involvement of three distinct entities— the parent company and merchant banker JM Financial Limited, its wholly-owned subsidiary and broker JM Financial Services (JMFSL), and its subsidiary, a non-banking financial corporation (NBFC), JM Financial Products Limited (JMFPL)—in a particular debt issue.

The issue, representing the initial tranche of non-convertible debentures (NCDs) issued under a shelf prospectus dated October 16, 2023, boasted a base issue size of Rs. 200 Crore, with an accompanying green shoe option of Rs. 800 Crore.

JM Financial played a pivotal role as the lead manager for this issue. However, upon examination, it was revealed that its NBFC arm, JMFPL, not only financed the investors subscribing to this issue but also facilitated their exit, incurring losses in the process. Simultaneously, its brokerage, JMFSL, facilitated the investors’ trades.

In its order, SEBI remarked, “we can also conclude from the data with us that JMFPL-NBFC was the seller, buyer, and then a re-seller of the NCDs of which JM Financial Limited was the Merchant Banker. They were able to seamlessly pull this off because they were the PoA (Power of Attorney) holders for many of the investors in question.”

The regulatory body expressed astonishment at the manner in which subscriptions were managed in a public issue of debt instruments. It noted that transactions at every stage of the public issue appeared to have been conducted in a predetermined and premeditated manner, executed meticulously to ensure subscription and success.

This orchestrated process, according to the regulator, compromised market integrity and fair-price discovery, raising serious concerns about the integrity of the public offering.

While JM Financial and its group companies assert that they have adhered to the letter of the law, the SEBI order contends that their actions, when viewed collectively, demonstrate ‘a complete disregard for restrictions imposed by SEBI on providing incentives to investors for subscribing to debt securities.’

The order highlights, ‘The attempt has been to wrap their actions with the cloak of formal legality.’

Furthermore, the order suggests a potential contravention of regulatory mandates. While the Sebi (Issue and Listing of Non-convertible Securities) Regulations, 2021, explicitly prohibit providing incentives for making applications in any issue of securities, JM Financial and its group companies purportedly offered assured returns to certain investors at a profit, effectively incentivizing their participation in the public issue.

The order outlines a scheme whereby individual investors, who may not have otherwise participated in the issue, were encouraged to make applications not solely by providing funds, but also by assuring them an exit at a profit on the listing day. It emphasizes that investors typically seek trading gains in equity markets post-listing, facilitated by price movements. However, such trades are less common in the debt segment, where investors typically seek fixed returns from coupon rates and hold the instrument till maturity.

Moreover, the order underscores the rarity of leveraged bets in the debt market, given the limited trades observed, and highlights the importance of liquidity in the instrument. It suggests that investors would not typically engage in leveraged bets unless they are assured of exiting their positions immediately on the listing day.

Prima facie, the regulator’s examination suggests incentivizing investors to subscribe to the issue with the promise of an assured exit, potentially contravening the law.

In conclusion, the regulatory scrutiny on JM Financial and its group companies sheds light on the intricacies and potential pitfalls surrounding public issues of securities. The order reveals a scheme aimed at enticing individual investors into participation through promises of profitable exits, a practice that appears to contravene regulatory guidelines. Moreover, the examination underscores the fundamental differences in investor behavior between equity and debt markets, emphasizing the importance of transparency and adherence to regulatory mandates. This case serves as a reminder of the critical role of regulators in ensuring market integrity and fair practices, ultimately safeguarding investor interests and maintaining trust in the financial system.

For Reading Press Release issue by RBI Click here.