Insurance Article, The Insurance Times 2022, The Insurance Times September, 2022

PUBLIC OFFERINGS OF SECURITIES INSURANCE (POSI)

Indian Stock Exchanges (BSE, NSE, SMEs) ranked 12th in the world in terms of the number of IPOs in YTD 2021.

An Initial Public Offer (IPO) is the first sale of shares to the public by a privately owned company. The companies going public raises funds through IPO for working capital, debt repayment, acquisitions, and a host of other uses. An investor can apply for IPO Stocks in India by filling an online IPO application offered by the stockbrokers and banks.

Though India is now more attractive for growth seeking foreign capital given the recent decline in China’s stature as an investment destination, yet volatile market conditions have led to a significant slowdown in the IPO market during the first quarter of 2022. The other factors contributing to the slowdown are geopolitical tensions, price correction in overvalued stocks, growing concerns about a rise in commodity and energy prices, the impact of inflation and potential interest rate hikes, as well as the covid-19 pandemic risk continuing to hold back full economic recovery. Once the current scenario settles, a lot of IPOs may start coming to the markets in the next 3-6 months, especially those who have chosen to park their public offerings until the markets stabilize.

Companies planning to raise funds through IPO are a mix of traditional companies with long track records as well as newer age companies across various sectors such as consumer, pharmaceuticals, technology, logistics and financial services.

IPOs are a marketing event for the issuer. Given the hype pre-IPO with most companies, there is an increased scrutiny and accountability post-raising of capital. Paytm, Zomato, Kalyan Jewellers India, Reliance Power, ABSL AMC are few of the popular IPOs which failed – the stock prices of the company did not meet the valuation at which the stock was listed. More than 40% of IPOs this year have failed in the first half of the year itself, more so, the START-UPs.

Is the management up to such challenge?

POSI is a specialist product which is tailored to indemnify Insured against claims arising from error, omission, misrepresentation, or non-disclosure in the documents issued to potential investors and the costs involved in defending such allegations. Many dreams of taking their company public. Talent and drive transform the dream into reality. But the reality is fraught with risk. Suddenly, company performance and decisions are subject to external scrutiny. Investors who helped to achieve the dream can turn it into a testing reality. Directors of newly floated companies run the ever-increasing risk of being sued or investigated if investor expectations are not met.

The road to a public offering is hazardous. Investors and their advisers must be presented with detailed information with which to judge the financial position and prospects of the company being floated. Directors and others face a difficult task in ensuring that all relevant information and material facts regarding the company are presented accurately. Is it ever possible to be confident of total accuracy? Investors experiencing a loss in the value of their shares will seize upon any mistake and may claim that they relied upon it when investing in the company.

Who can sue?

  • Investors may bring an action against management for an alleged misrepresentation, error, or omission in the prospectus on which they had relied to make their investment.
  • Regulatory bodies have authority to initiate proceedings against the parties to an offering in the event of allegations of wrongdoing or a breach of the listing rules.

Coverages:

  • Protection against potential statutory exposures.
  • Other exposures from the transaction.
  • Protection against the liabilities arising from the issue of the ‘red-herring’ prospectus, the roadshow presentation, and any press releases etc
  • Exposures arising from many overseas jurisdictions.

Pays –

  • Defence Costs.
  • Regulatory investigation costs/Administrative Expenses
  • Reputation and Response Costs (Pro – active forensic service cost, repair of individual and company’s reputation, Notification, Monitoring, Electronic Data)
  • Damages& Settlements.
  • Punitive and exemplary damages, interest on judgements and awards.

POSI should be a pre-requisite for every organization planning to raise capital from the public, be it a public offering of securities, debt, or equity rights issues or private placements.

Difference between D&O & POSI –

  • A POSI policy operates to ring-fence the transaction exposure, leaving the D&O policy to respond to “business as usual” risks faced by the directors. When undertaking a public offering, many organizations purchase a POSI policy alongside their existing D&O policy.
  • The scope of D&O contracts excludes public offerings. Even if the cover is extended by paying an additional premium, there are many benefits of having a stand-alone POSI cover like a broader set of beneficiaries – organization, D&O, controlling/selling shareholders, offering underwriter, etc.
  • POSI are multi-year policies and can be customized to offer protection for multiple years with a one-off premium levied for the full period of the policy. Also, Policy coverage cannot be cancelled by insurers without the insured’s consent.
  • Thepremium for IPO policy can be capitalized as apart of the process of fund raising. It can be claimed as an IPO expense under the Income Tax act.
  • Automatic cover for follow-on offerings, including roadshows, within 12 months of the initial offering and up to 25% of the initial amount raised can be opted for.

Reasons for claims –

  • Receipt of undisclosed commissions, rendering the prospectus false and misleading,
  • Illegal tie-in agreements, between underwriters & some investors in return for receiving a favorable allocation of shares in the IPO.
  • Fraudulent use of money raised.
  • Overcompensated or over matched management.
  • Failure to disclose material information.
  • Forward looking statements.
  • Profile and accuracy of resumes of directors and management.
  • False promises.
  • Quality of investment bank/adviser to the IPO.

Typical Claim scenarios which are covered under POSI –

Failure to adequately inform

A manufacturing company initiates IPO, but its prospectus fails to adequately report the poor quality of their assets. Shareholders who purchase rights based on this information are disappointed when the share price falls following listing. Shareholders take legal action against the company claiming that it failed to ensure that the prospectus information was not misleading and that it did not omit any information reasonably required for a shareholder to make an informed assessment of the company’s financial position.

Overstatement of Financial Information

A company is alleged to have materially overstated its financial position in its IPO prospectus. The regulator obtains an interim court order to freeze the funds raised in the offering. During this time the regulator conducts investigations and concludes that investors in the company should be compensated for the financial losses they sustained for purchasing shares based on the misleading information. The settlement costs reach more than INR 1000Cr.

Redundancy program

Shortly after its IPO, a manufacturing company announces a major redundancy program. The company’s share price falls straight after the announcement, resulting in an immediate loss of value to many of the investors in the IPO. Investors sued the company alleging non-disclosure of this material information in the prospectus and after two years of civil litigation the manufacturer agrees a settlement figure of more than INR 100Cr.

Missed profit targets

A construction company issues a prospectus for an IPO which includes financial forecasts for the forthcoming year. But the company falls well short of its forecasts, issuing several profit warnings and the share price falls dramatically. Investors who purchased shares based on the prospectus pursue legal action to recover their losses, citing, amongst other things, the company, and its directors’ misleading and deceptive conduct.

Legal Disputes not disclosed

A company withdraws its public rights offer shortly before it is due to close after regulators receive a complaint that the company had failed to disclose that it was in substantial legal disputes over terminated contracts. It’s directors and other individuals involved in preparing the prospectus face investigation, legal action and possible civil and criminal liabilities for any false and misleading statements made in its prospectus.

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