Examining the contours of Due Diligence by Merchant Bankers in Takeovers

Author: Mansi Avashia is a 3rd-year student of B.A. LL.B. (Hons.) at Gujarat National Law University.

A transaction in the securities market is incomplete without intermediaries. One such vital intermediary is a merchant banker. The Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 define them to mean those “engaged in business of issue management by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service”.[1] The Securities Appellate Tribunal [“SAT”] in the Enam Securities Ltd. order has held that a merchant banker is “an expert body” that acts as the “eyes and ears” for the regulator of the securities market, i.e. SEBI.

Role of Merchant Bankers in Takeovers

In 1992, SEBI laid down regulations solely governing merchant bankers. They are required to abide by the code of conduct laid down in Schedule III of the Regulations. This includes, inter alia, investor protection, proper care, independent professional judgment and disclosure of adequate information.

Regulation 12 of SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 [“SAST Regulations”] mandates an acquirer to appoint a merchant banker as a manager to the open offer. The public announcement of the open offer is also made through the appointed merchant banker.

The rules governing offer price specified in Regulation 8 of the SAST Regulations require determination of the same by the acquirer as well as the merchant banker. The detailed public statement and letter of offer are filed with SEBI by the merchant banker.[2] They also have to provide a due diligence certificate to SEBI.[3]

The SAST regulations also specifically lay down obligations of a merchant banker in an open offer.[4] First and foremost, a merchant banker has to ensure that an acquirer is able to implement an open offer and has made firm financial arrangements to meet its payment obligations. It is incumbent upon them to ensure that the contents of the public documents are true, fair and adequate and that all the intermediaries involved in the transaction are registered with SEBI. The merchant bankers cannot deal on their own account with the shares of the target company during the offer period. Thus, merchant bankers play a pivotal role in case of a takeover in a securities market.

Examining the due diligence Aspect: What is the stance of SEBI and SAT?

An important prerequisite before the takeover offer goes ahead is that due diligence must be conducted by the appointed merchant banker. Often, the question that arises is: how to determine whether a merchant banker has acted in a diligent manner or not? Based on the decisions of SEBI and SAT, it can be said that this mainly depends on the facts of each case.

For instance, in the matter of Medicamen Biotech Limited, SEBI held that the Merchant Banker did not exercise proper due diligence because it did not disclose that the shareholding of the promoter would trigger an open offer. It was highlighted that due diligence was an independent duty of the banker. The arguments that the promoter did not provide them with the requisite information and that this information would have no impact on the open offer were categorically rejected. Since the information was publicly available, it was held that it was reasonable to expect the merchant banker to be diligent about the same.

The SAT while deciding HSBC Securities and Capital Markets Private Limited emphasized on the importance of due diligence by the merchant bankers. HSBC had made a wrong disclosure in the draft letter of offer that the equity shares of the company were listed on 4 stock exchanges. It was held that any wrong information in a document that was issued specifically for the benefit of the investors would lead to a major loss of credibility in the securities market. The merchant banker could not attempt to pass on its due diligence responsibility to any other entity such as the target company or the acquirer. It was necessary for the merchant banker to take proactive measures to verify all available information. Since HSBC presumed that the shares were listed on the respective stock exchanges rather than making specific queries about the same, it had not acted in a diligent manner. A similar stance with respect to the liability of merchant bankers was taken in SEBI v. JM Morgan Stanley Limted.

However, in certain cases, SEBI/SAT have found that the merchant banker acted diligently and exempted them from liability. In Doogar and Associates Ltd., the SAT did not hold the merchant banker liable for a delay in sending the public announcement document to SEBI. As per the facts, the public announcement was not sent on time because an official of the merchant banker was not available due to an unforeseen event and she had not delegated her work to anybody. It was observed that the circumstances were beyond Doogar’s control and they had acted in an honest and diligent manner. There was no objection with respect to the public announcement as a whole and its contents were found to be correct. This delay did not impact the right of the investors/shareholders in any way and hence they were not held liable.

The scope of due diligence was clarified by SEBI in the recent matter of Palred Technologies Limited. It was held that the merchant banker was not supposed to look into every statement with suspicion. Their responsibility would be heightened only if the circumstances mandated it. The merchant banker had checked the shareholdings with the target company, promoters and had also the quarterly shareholding uploaded on the stock exchange website. SEBI held that the reduction in shareholding [which was the dispute in question] could have been realized based on the ‘probability’ that the merchant banker should have looked into the past declarations of the promoters and they cannot be held liable for the same.


‘Due diligence’ is a vague concept which in turn makes it difficult to determine liability. In such cases, courts have to heavily rely on the factual matrix before them. The Apex Court has interpreted it as reasonable diligence that ‘a prudent man would exercise in the conduct of his own affairs’.[5] No entity, howsoever important, can be expected to know and do everything with respect to a transaction.

Understanding due diligence in the context of merchant bankers is of prime importance. Utmost care is required on the part of the merchant bankers. This is because a reasonable/foreseeable lapse in due diligence would lead to dissemination of wrong information to the investors as well as the public. This would impact the very object of the Takeover code which is to protect the investors by allowing them a fair and transparent opportunity to exit from the target company. Thus, full and fair disclosures are required on the part of the merchant bankers because they act as a ‘gateway’ between the investors and the company.

The jurisprudence before us shows that SEBI and SAT have taken a more or less correct stand regarding due diligence by merchant bankers. Their approach is not lenient and neither do they expect the impossible. It has been categorically laid down that merchant bankers are appointed as managers for takeovers since they are professional bodies which must ensure regulatory compliance with respect to the public offer and therefore, “it is expected to carry out utmost care in complying with the Regulations applicable to public offer”.[6]

This approach should be continued in the future and a careful examination of the facts should ensure that no leeway is given to the merchant bankers. Takeovers greatly impact the shareholders of the target company and mistakes in due diligence can lead to a loss of credibility in the securities market.

[1] The Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992, Reg. 2(cb). [2] SEBI SAST, reg. 12; reg. 14. [3] SEBI SAST, reg. 27(3). [4] SEBI SAST, reg. 27. [5] Chander Kanta Bansal v. Rajender Singh Anand, (2008) 5 SCC 117. [6] SEBI in the matter of Palred Technologies Limited.

The opinions expressed herein are those of the author in their personal capacity and are not intended to be construed as legal, financial or investment advice.

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