SEC issues fresh directive to protect investors

•  Requires firms to disclose basis of offer price at IPO

The SEC has recently issued a directive to be included in the CSE listing rules, which will further strengthen the SEC’s mandate for protecting investors. Prior to this, entities were not required to disclose the basis of the ‘IPO Price’, and as a result in some limited instances entities were criticised due to overpricing without a justifiable basis at the expense of the investors. The new directive has simplified and standardised the presentation of useful information in the prospectus in a more investor friendly manner, whilst facilitating a means for entities and investment banks/IPO managers to maintain credibility by engaging competent experts throughout the process. This is achieved by mandating to incorporate an opinion of an independent, competent party on the fairness of the IPO price whilst substantiating the claim. An analysis of IPO prices in recent years has indicated that some IPOs traded below the issue price since the first day of trading, highlighting the need for the SEC to strengthen the disclosures relating to IPO pricing. An overvalued IPO price negatively impacts investor appetite and confidence in IPOs, as well as on interest for listing on the CSE by new entities due to poor market performance and negative public sentiment of the entity. Furthermore, this has a negative impact on the future development and growth of the Sri Lankan capital market. The SEC considered the above circumstances, even though the occurrences were limited and initiated evaluating measures for minimising the above effects. Subsequent to much deliberations and public consultation, the SEC has issued a directive mandating that the ‘IPO price’ be supported by a valuation opinion/research report prepared by an independent, competent third party. The SEC noted that there were no requirements to disclose the basis of the offer price for entities listing via IPO mechanism where entities seek to raise funds from the general public, although the same was a prerequisite for the ‘introduction’ method of listing. The lack of a provision in the CSE Listing Rules which requires disclosing the basis upon which the IPO price is determined, has led some entities to decide the offer price in an arbitrary manner, which may have resulted in an ‘overvalued IPO Price’. Consequent to observing the impact of having a valuation opinion for the ‘Introduction reference price’, and the positive response received from investors and stakeholders, the SEC, upon public consultation, extended the concept of ‘validating the IPO Price’ for equity listings with effect from 1 January, 2015. The requirement for a competent Valuer or Investment Bank/IPO Manager to provide a rationale for the IPO Price is expected to enhance the transparency of the IPO pricing process and strengthen the IPO market. Experts who value shares when the entity is preparing to list, may adopt various valuation methodologies to arrive at the IPO price, such as Price Multiples, Net Assets Value, Capitalisation of Future Earnings, etc. Hence among others, knowledge of the methodology used to arrive at the IPO Price, is of paramount importance to an investor to make an informed decision about a potential new investment in an entity. Main features of the new rule Option 01: 1. The entity to obtain a competent, independent valuation justifying the IPO Price/Price Band, and to disclose a meaningful summary of the valuation report in the Prospectus, together with the certain minimum disclosures with respect to the independent valuer’s credentials; OR   Option 02: 2. The entity to publish the Research Report prepared by the investment bank/IPO manager for justifying the IPO Price together with the Prospectus. The said Report should contain at minimum, a section which covers the basis and methodologies used to determine the IPO Price/Price Band, whilst requiring to host the same on the CSE website and the entity’s own website. And together with either option 1 or 2 above, simplified disclosure requirements to enhance clarity, the entity must also mandatorily disclose in the Prospectus in a consistent format, at minimum, the basis of IPO Price/Price Band as per the format given in Schedule 1 to the SEC Directive.