Why are RBI and Sebi spooked about JM Financial Products?

Over half of the investors participated through the ICICI Bank branch located at the Free Press Journal branch at Nariman Point in Mumbai. 

On the day of the listing of the NCD (7 November), JM Financial Products bought back all the securities from all the 1,016 investors only to later sell these securities to two corporates and a brokerage firm, resulting in a loss of ₹90 lakh for JM Financial Services Ltd.

This complex transaction, revealed in a probe by the Securities and Exchange Board of India, left the regulators scratching their heads. “It does not make commercial sense for a company driven by profit motive to enter into transactions which resulted in consistent losses,” concluded a Sebi order, dated 7 March.

The Reserve Bank of India and Sebi concluded last week that there was more to this transaction than meets the eye. The two regulators barred JM Financial Products from taking any new mandate for acting as a lead manager to any public issue of debt securities.

According to a review by Mint, the year 2023 saw 44 companies raise funds through NCDs, which is the highest number in a year. In comparison, 30 companies raised money through NCDs in 2022, 28 in 2021, 21 in 2020, and 36 in 2019. 

Piramal Enterprises, a non-banking finance company of Piramal Group, planned to raise ₹1,000 crore through NCDs in October last year. The NCD had a base size of ₹200 crore with an option to increase it by ₹800 crore (greenshoe option).

Non-convertible debentures (NCDs) are fixed-income securities that are listed on the stock exchanges. The process for issuing these securities to the public is similar to how companies offer shares at the time of going public. Potential investors apply for an NCD through a broker, and a portion of NCD is reserved for individuals, high net-worth investors, and institutions.

In the case of Piramal Enterprises’ NCD, which was one of the five fixed-income securities of the size of ₹1,000 crore last year, ₹300 crore each was reserved for retail individual iInvestors and high-net-worth individuals, while ₹200 crore each was earmarked for non-institutional and institutional investors.

Piramal Enterprises managed to raise ₹533 crore. The issue saw retail investors bidding ₹256 crore of securities, translating to 85.3% of the allotment. HNIs bid ₹146 crore and non-institutional investors bid ₹131 crore, implying that 48.7% and 65.5% of subscriptions from the two categories, respectively. Not a single institutional investor bid for the offer.

JM Financial Services Ltd was one of the 54 brokers that acted as banker to the debt issue. JM Financial Services managed to get 1,748 the highest number of subscribers for the debt issue, more than 1,658 and 1,120 applicants by the A.K. Stockmart Pvt. Ltd and Nuvama Wealth and Investment Ltd, respectively.

It is important to mention that 1,748 investors bought ₹199.46 crore worth of securities or about 37.4% of the ₹533 crore raised by Piramal Enterprises.

But before we dwell more on this let us first glance at JM Financial Group, which is among the country’s oldest brokerage and financial groups.

JM Financial was founded in 1973 by cousin brothers Mahendra Kampani and Nimesh Kampani. Later, Mahendra separated and took control of Jamnadas Morarjee Securities Ltd. Last year, the group celebrated 50 years. But financially it was not a great year as revenue totaled ₹3,343 crore in the year ended March 2023, an 11.2% decline from the ₹3,763.2 crore in the previous year. A 19% drop in fees and commission hurt. However, a 69% drop in fair value of assets to ₹183.42 crore hurt the group’s income. Profit tumbled 22.7% from ₹773.16 crore to ₹597.29 crore.

Nimesh Kampani serves as non-executive chairman, while his son Vishal is the non-executive vice chairman. Vishal Kampani is the managing director of JM Financial Products Ltd, which is one of the 15 subsidiaries of the listed entity. Set up in 1984, JM Financial Products offers real estate financing, fixed income division (structured financing), SME financing, and capital market financing. JM Financial Products is the mainstay of the group as it accounted for a fourth or ₹858 crore of parent’s revenue and 44.2% or ₹313.36 crore of profit last year.

JM Financial Group coming under the scrutiny of regulators caught the attention of boardrooms across India. JM Financial is known for being a fundraiser and a go-to investment bank for blue-chip companies and distressed businesses. Their clientele includes prestigious names such as the Tatas, SP Group, Ambanis, and Adanis.

“JM Financial has been synonymous with the Indian financial market development. I appreciate and respect the capacity of JM Financial to deliver fast, reliable, and no complications advice. With JM Financial, you can envision innovative ideas and execute them in an easy and flawless manner,” Gautam Adani, founder and chair of Adani Group, was quoted as saying in JM Financial’s annual report for 2022-23.

Nimesh Kampani, 77, the chairman, is known for his financial acumen, intrepid dealmaking, and conflict-resolution skills, which involve bringing clients who otherwise never see eye-to-eye. It is a “pedigreed firm” and may come out “not guilty” if Sebi’s record of its orders being overturned by the Securities Appellate Tribunal, is anything to go by, said a senior executive of an NBFC.

“No one lost money, and so what’s the crime,” he asked, requesting not to be quoted.

So what happened?

Remember, investors applying through JM Financial Services bid ₹199.46 crore of the ₹533 crore raised by Piramal Enterprises. This was more than three times the ₹65.53 crore and ₹64.40 crore put by subscribers of A.K. Stockmart and Nuvama Wealth and Investment Ltd.

JM Financial Products gave loans worth ₹141.40 crore to 1,016 investors who applied through JM Financial Services. But it was not just this scheme of offering loans that made the two regulators uncomfortable. A Sebi probe found that 47 investors, who declared an annual income of less than ₹5 lakh, were given a loan of ₹9,80,000 by JM Financial Products. Additionally, 10 investors, who also earned less than ₹5 lakh a year, were each given a loan of ₹98 lakh.

Sebi found that of the 1,013 retail investors that got loans from JM Financial Products, 772 submitted their bids at 4:47:35 on 19 October, the day the NCD issue opened.

On 7 November, within two hours of listing the NCD, JM Financial Products bought back securities from 993 investors, worth ₹100 crore at an average price of ₹1,002.5. Subsequently, an hour later, JM Financial Products sold ₹80 crore of debt securities to two corporates, Cyient Ltd and Chaitanya India Fin Credit Pvt Ltd, and to Om Scrip Trading Pvt Ltd, a broker, at an average price of ₹994.

Sebi found that on the day of the listing, an overwhelming majority of the investors who had exited on the listing day had applied through JM Financial Services.

It thus concluded that JM Financial Group got individual investors, who would otherwise not have participated in the issue, to make applications not just by providing funds to them but also by assuring them an exit at a profit on the listing day.

“This action is necessitated due to certain serious deficiencies observed in respect of loans sanctioned by the company for IPO financing as well as NCD subscriptions,” RBI said in a press release dated 5 March.

“Some of these practices are sharp for sure but not illegal per se,” said Chirag M. Shah, counsel – Securities Law, Arbitrator. “They will continue unless these regulatory gaps are tightly plugged and they are statutorily declared to be illegal. RBI and SEBI working in tandem and co-operating is a good sign, the Financial Stability and Development Committee seems to be working at last. It will be a dampener for sure, in the short term, but no one can wish away Regulatory Arbitrage or sharp business practices”

“You outlaw some of them, new ones will emerge,” said Shah.

RBI, based on the Sebi probe said, that JM Financial Products had repeatedly helped a group of its customers to bid for various IPO and NCD offerings by using loaned funds.

“The credit underwriting was found to be perfunctory, and financing was done against meagre margins. The application for subscription, the demat accounts and the bank accounts, all were operated by the company using a power of attorney (POA) and a Master Agreement obtained from these customers without their involvement, whatsoever, in the subsequent operations. Consequently, the company was able to effectively act as both lender as well as borrower,” said RBI.

“The company also acted as the arranger of bank account opening as well as operator of the said bank accounts using the POA. Apart from being in violation of regulatory guidelines, there are serious concerns on governance issues in the company, which in our assessment are detrimental to the interest of the customers. Regulatory violations and deficiencies, if any, on the part of the bank(s) in this regard is being examined separately,” said RBI.

“The evolution of technology has made spotting violation of regulations much easier, be it of RBI, Sebi or ED regulations,” said corporate lawyer HP Ranina . “One can’t work that everybody is doing it so I can get away with it. Because if you’re caught violating or falling foul of regulatory compliance, you will have to face the music.”

Sebi believes “market integrity” and “fair price discovery” were the causality and that this episode was not an isolated incident.

“The applications of investors were punched on the same day, the loans were disbursed on the same day (November 1, 2023), the exits were provided on the first day of listing, the exit price for most of their customers were common and the counterparty in all the transactions of funded investors was JM Group company itself,” said the Sebi order. “Such synchronization cannot happen serendipity. The series of transactions appear to have been planned and executed meticulously”

JM Financial Services disagrees with the conclusion made by the two regulators.

“JMFPL believes that there have been no material deficiencies in their loan sanctioning process and has not violated the applicable regulations,” JM Financial told the exchanges in a filing on 6 March.

“JMFPL further reaffirms that there have been no governance issues whatsoever and the conduct of all its business and operational affairs are in a bonafide manner and shall continue to service its existing customers as advised by the RBI. JMFPL will fully cooperate with RBI in their special audit initiative and also explain its position to RBI,” said JM Financial.

“JMFPL has been in the business of funding IPOs over the last two decades. In the context of IPO funding, the power of attorney (POA) is taken as a risk containment measure only. The practice of taking POA is prevalent across the industry and is perfectly legal. 

The net total income from the IPO Financing business for the 9M FY 23-24 is around Rs. 7 crore which constitutes ~1.5% of the net total income of JMFPL and ~ 0.3% of the consolidated net total income of the company. Accordingly, the impact of the above RBI order on the company in monetary terms is not expected to be material.”