Deferred public disclosure of RHP in IPO/filing of pre DRHP in confidential mode

– Anushka Vohra, Manager | corplaw@vinodkothari.com

SEBI vide its notification dated November 21, 2022 has come up with SEBI (Issue of Capital and Disclosure Requirements) (Fourth Amendment) Regulations, 2022 (“Amendment”), effective immediately, making changes in the existing SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”) w.r.t. Initial Public Offer (“IPO”). The Amendment has introduced an alternate method for filing the draft IPO document, known as draft Red Herring Prospectus (DRHP).

Pursuant to this alternate method, the issuer will have the option to keep the information-rich DRHP confidential from the public at large until the issuer is sure to proceed with IPO i.e after receiving observation from SEBI on the draft RHP (“DRHP”) filed. Until such time, the issuer can interact with the QIBs only to gauge the market. Any kind of marketing of IPO apart from interacting with the QIBs is prohibited during this period.

Extant framework:

1. filing of DRHP through lead manager with SEBI, stock exchange(s) ;
2. SEBI and stock exchange(s) host the same on their websites for public comments within 21 days from the date of filing of draft RHP;
3. issuer required to make public announcement within 2 working days filing DRHP as point 1 above;
4. SEBI to provide observations within 30 days from the receipt of:
   • DRHP;
   • satisfactory response from lead manager, where clarification has been sought from SEBI;
   • clarification from any regulator or agency, where sought from SEBI;
   • In-principle approval from stock exchange(s)

          whichever is later

5. Upon receipt of observation, lead managers to share updated DRHP

Alternate framework as per the Amendment:

1. filing of DRHP through lead manager with SEBI, stock exchange(s);
2. issuer required to make public announcement within 2 working days filing updated DRHP as point 1 above- only mentioning that draft RHP has been filed with SEBI;
3. SEBI to provide observations within 30 days from the receipt of:
   • a to d mentioned in point 4 of Extant framework;
   • intimation of completion of interaction with QIBs;
   • intimation about the conversion of outstanding convertible securities

          whichever is later

4. upon receipt of observation, lead manager to share DRHP-I, the same shall be available to public

Rationale discussed in PMAC and SEBI Board Meeting

As per SEBI Consultation Paper on pre-filling of offer document in case of IPO, issued on May 11, 2022, Primary Market Advisory Committee (“PMAC”) deliberated on the matter favorably in view of the following concerns:

1. Disclosure of sensitive information without surety of IPO:

After filing draft RHP, not all proposed issuers execute the IPO. The DRHP, which as per the Extant framework is made available to the public, contains detailed disclosures viz. internal business risk, capital structure, financial information, information about shareholders’ agreement etc. and there is an apprehension in the mind of the issuers that peer competitors may take advantage of the information disclosed.

Financial Year (1)	Number IPO offer document filing (2)	Number of Issuers from column 2 who did not proceed with IPO (3)
2018-19	65	41
2019-20	33	10
2020-21	31	6
Total	129	57

The above table shows that for the three financial years (as mentioned above), 57 issuers executed the initial public offer as against 129, who filed draft RHP.

2. Market conditions:

The proposed issuer would have started with the roadshows post filing of draft RHP. The delay in process would impact the pricing and decision of potential institutional investors.

The issue was further deliberated at the SEBI Board Meeting held on September 30, 2022.

Guesstimating the investors – limited marketing in pre-filled option

As per the extant provisions where marketing of an IPO can be started from the date of filing DRHP, the same has to be done as per Sch. IX of ICDR which requires the public communications made by the issuers to contain only such information which has been disclosed in the DRHP.

If pre-filing of DRHP is opted, upon filing of DRHP:

1. the issuer will make a public announcement stating that it has filed DRHP with SEBI, without giving any further details. As per Reg. 59C of ICDR, introduced by the said Amendment, the proposed issuer has to state in the public announcement that, the pre-filing of offer document shall not necessarily mean that the issuer shall undertake the initial public offering;
2. during the period between the pre-filing of DRHP with SEBI and receipt of observation from SEBI – the issuer may engage in limited marketing only with the QIBs;
3. upon closure of the interaction with QIB, the proposed issuer has to intimate to SEBI;
4. seven working days cooling off period of minimum 7 working days between the date of intimation

This concept of limited marketing is inspired from the regulatory framework in US and Canada and the same is termed as ‘testing the waters.’ In the US and Canada, the issuers are allowed to have limited marketing i.e. engaging into interaction with QIBs.

Global framework:

Canada: The regulatory framework in Canada allows for “quiet filing”^[1] under which a company can make requests to the regulator to pre-file prospectus on a confidential basis, which is granted by the regulator after analysing whether it is necessary for the company to maintain confidentiality.

USA: As per U.S. Securities Act of 1933, pre-filing of prospectus is allowed for “Emerging growth companies”. As per sec. 6(e);

(e) EMERGING GROWTH COMPANIES.—

(1) IN GENERAL.—Any emerging growth company, prior to its initial public offering date, may confidentially submit to the Commissiona draft registration statement, for confidential nonpublic review by the staff of the Commission prior to public filing….

Further, sec. 5(d), provides for interaction with QIBs, which states that:

(d) LIMITATION.—Notwithstanding any other provision of this section, an emerging growth company or any person authorized to act on behalf of an emerging growth company may engage in oral or written communications with potential investors that are qualified institutional buyers or institutions that are accredited investors,….

Relaxation w.r.t. eligibility criteria

As per Reg. 5 of ICDR, one of the pre-requisite as on the date of filing of draft RHP was that the proposed issuer should not have any outstanding convertible securities or any other right which would entitle any person with any option to receive equity shares of the issuer.

The newly inserted Reg. 59E, allows the issuer who has opted for pre-filing DRHP to convert outstanding securities anytime before the observations are received from SEBI. With this relaxation, the issuers will not have to necessarily convert securities at the time of filing DRHP; they get time to test the potential success of IPO by interacting with QIBs and only if they are sure to go ahead with the IPO, the pre-IPO capital is frozen by converting all outstanding convertible securities.

Conversion of outstanding securities still remains a pre-requisite as SEBI would not provide its observation until the proposed issuer has intimated SEBI about the conversion of outstanding convertible securities.

Concluding remarks:

The alternate process though seems to elongate the entire process, it would be interesting to see issuers opting the alternate route of “pre-filing” and whether there would still be instances of withdrawal.

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^[1] https://www.torys.com/-/media/files/insights/trends-and-guides/initial-public-offerings-in-canada.pdf

Read our related resources :

1. IPO draft documents may be kept away from public view until SEBI/stock exchange observations, Issuers may choose an opportune time for public view
2. Monitoring Agency now mandatory in case of Preferential Issue & QIP | ICDR Amendment