Amidst the landscape of the capital market, the issuance of securities has a key role in raising capital for companies. “The Companies Act, 2013,  led to  substantial reforms in the security market by introducing provisions with “the intent of guaranteeing transparency and safeguarding investor interests.”  One of the Provision Section 32 of Companies Act says about “Red Herring Prospectus (RHP)” which governs the preparation and filing of it. In the said provisions we are going to discuss the implications.

Scope

“Section 32, Red herring prospectus.-

(1) A company proposing to make an offer of securities may issue a red herring prospectus prior to the issue of a prospectus. 

(2) A company proposing to issue a red herring prospectus under sub-section (1) shall file it with the Registrar at least three days prior to the opening of the subscription list and the offer. 

(3) A red herring prospectus shall carry the same obligations as are applicable to a prospectus and any variation between the red herring prospectus and a prospectus shall be highlighted as variations in the prospectus. 

(4) Upon the closing of the offer of securities under this section, the prospectus stating therein the total capital raised, whether by way of debt or share capital, and the closing price of the securities and any other details as are not included in the red herring prospectus shall be filed with the Registrar and the Securities and Exchange Board. 

Explanation.—For the purposes of this section, the expression “red herring prospectus” means a prospectus which does not include complete particulars of the quantum or price of the securities included therein”

Analysis of Section 32 of Companies Act

The  “Red Herring” prospectus is a preliminary prospectus that does not contain the final offering price or the number of securities being offered along with it provides key information about the company and the proposed offering that allows investors to make informed decisions.

• Mandatory Contents to be included in Red Herring Prospectus:  RHP shall contain all mandatory information regarding the company, its promoters, objects of the issue, risk factors, financial statements, and other relevant details to ensure transparency. The intent is it help investors analyse the risk of the investment opportunity.

• RHP Filing Requirements: Companies are required to file the RHP with the Registrar of Companies (RoC) and the Securities and Exchange Board of India (SEBI) before making a public offer of securities. To avoid penalties and legal actions compliance with the filing requirement is important.

• Limitation on RHP Amendments: Once RHP  filed with the RoC and SEBI, any changes to the RHP are subject to strict scrutiny. Section 32 has prescribed limitations on the extent to which companies may modify the contents of the RHP only after its filing. Any changes made in RHP must be duly disclosed to investors to maintain transparency and integrity.

Instances for the object of the RHP Issue:

• If the company intends to expand manufacturing facilities to meet increasing demand.
• If the company has a plan for Investment in research and development to encourage product innovation.
• Repayment of outstanding debts to minimise the interest load.
• Other general corporate goals or purposes.

Important factors to be analyzed by Investors

An Initial Public Offering (IPO) allows investors to evaluate a company’s potential, a process that involves extensive scrutiny of various parameters including its business model, market competition, and financial standing. Analysing given factors, investors can understand an RHP effectively, empowering themselves to make informed investment decisions aligned with their financial goals and risk factors.

Outlined below are key pointers to analyse an RHP effectively and make informed investment decisions:

• Objects of the Offer to the company’s utilisation plan for IPO, giving importance to growth strategies and capital allocation priorities.
• Industry and Business Overview to acquire insights into the broader economic landscape and the company’s status within its industry, considering factors such as GDP growth, market fluctuation, and business operations.
• Understand the company’s operational structure including manufacturing processes, pricing  and marketing strategies to understand its business operations broadly.
• Assess the Regulations and Policies made for the the company’s operations, which includes environmental, tax, and employment regulations, to ensure compliance and risk associated to it.
• Understand the company’s action plans  for product innovation, market penetration, and demographical expansion to convert its profit-generation capabilities.
• Research  on the company’s previous  years development about its growth and performance track record.
• Identify the unique selling points (USP) that  company  has differentiate from its rivals, which is converting into opportunities  for its growth potential.
• Evaluate the company’s board of directors, the structure and function of it which provides highlights into market leadership competence and best corporate governance practices.
• Probe into all details about the company’s Promoters and Promoter group involved in it.
• To reward shareholders, review what kind of commitments the company has towards its dividend Policy.
• Trigger the  potential risk factors before investing in the company, which will help in reducing the risk factor of investment and helps in informed decision-making.
• Study and understand the  key points of the IPO, including share allocation, pricing, and subscription categories, to understand the different offering structure and involvement of investors.
• Analyze the company’s capital structure and  previos years shareholding trends to know dynamics of ownership along with promoter interests.
• Examine the financial Information like audited financial statements and key performance indicators (KPIs) to encourage  the company’s continuous financial health and growth prospects.
• Legal Information disclosures regarding litigation and regulatory proceedings to assess legal risks and potential liabilities.
• Examine all factors informing the offer price, helping in valuation analysis and investment decision-making.
• Offer Information including terms and conditions of the offer, including payment mode, shareholder rights, and offer procedures.

Precedent pertaining to Section 32 of Companies Act: SAHARA INDIA REAL ESTATE CORP. LTD. v. SECURITIES AND EXCH. BOARD OF INDIA (K.S. RADHAKRISHNAN, J.)

This precedent says  that an obligation which are applicable in the case of a RHPs prospectus shall carry Information Memorandum (IM) and (Red Herring Prospectus).There is no specific direct case laws or precedents on Red Herring Prospectus (RHP), it’s important to consider broader legal principles and some important cases related to companys  disclosures and securities regulation to focus on the advantage of accurate and transparent disclosure in offering documents. In the said case, a judgement on the RHP (Red Herring Prospectus) compliances emphasised  on legal compliance and transparency while issuing securities to the public. It also focuses on the requirement for companies using a shelf prospectus for multiple securities offers to file an Information Memorandum (IM) under certain circumstances and before subsequent securities offerings. The shelf prospectus main objective is to focus on raising funds through bond sales, offering transparency and protecting the rights of published investors. The vital role of investors examined within the document pertaining to all relevant information consists of financial health, risk factors, current and future financial plans, use of proceeds, and any important material changes made from the initial offer. Companies had urged  to consider potential challenges led by the one-year validity of the shelf prospectus and to file information memoranda disclosing updates on company finances, changes in  content, and new risks before subsequent offerings. 

The said precedent  highlights the need of diligence of regulatory authorities to ensure adherence to disclosure norms in the protection of investors interest. 

Conclusion

Section 32 of the Companies Act, 2013 emphasises the companies adhering to compliances when they offer securities to the public. RHP mandates to furnish all essential information of this company to the Investors. Providing fundamental information by the company RHP shall be a prerequisite and any deviation from accurate information in the document can face consequences like resulting in heavy penalties and losses for the company and stakeholders due to misrepresentation or dissemination of required information. The importance of this provision ensures the objective of the protection of investors’ rights and the prevention of financial nuisances in the issuance of securities by Companies.

FAQs

1. How does Section 32 of the Companies Act, 2013, regulate the contents of the Red Herring Prospectus?

Section 32 of the Companies Act, 2013, mandates important disclosure in the RHP to provide investors with accurate information about the operations, finances, and risks of the company.

2. What are the important provisions in Section 32 regarding the modification of the Red Herring Prospectus after its filing?

Section 32 provides important provisions that require companies to promptly disclose any material changes to the RHP through an Abridged Prospectus, ensuring transparency to investors.

3. What are the potential effects for companies that fail to comply with the requirements outlined in Section 32 when drafting their Red Herring Prospectus?

Consequences for Non-Compliance with Section 32 may result in regulatory sanctions, legal liabilities, and reputational damage for companies, which leads to breaking investor confidence and market integrity.