I. The Reliance Fallacy

For a long time, the working assumption within many merchant banking due diligence teams has been simple: if a regulatory-listed intermediary, issuer promoter, or auditor formally certifies a fact, the lead manager's job is complete upon recording that certificate. However, recent regulatory interventions by the Securities and Exchange Board of India (SEBI) demonstrate that this checklist-driven mindset is no longer legally defensible. The fundamental question a diligence file must now answer is not 'did we receive a confirmation,' but 'can we show that we independently and reasonably tested what we were told?'

As established by the Supreme Court of India in Chander Kanta Bansal v. Rajinder Singh Anand (2008), due diligence is a standard of reasonable care and prudence, not absolute certainty. Merchant bankers are not expected to recreate every corporate fact from first principles. However, reliance has a clear floor. When primary documentation contains visible inconsistencies, or when contradictory information emerges in public, passive reliance on downstream certificates is treated as a regulatory failure rather than a compliance shield.

II. The Veerkrupa Case: Anatomy of a Double Failure

The SEBI Order dated May 29, 2026 in the matter of Veerkrupa Jewellers Limited ("Veerkrupa") provides a concrete warning for merchant bankers. The case arose from a public offering on the BSE SME platform (prospectus dated June 22, 2022) managed by M/s First Overseas Capital Limited ("Lead Manager"). SEBI's enforcement action exposed two separate failures:

1) Visible Defects in Pre-Listing Shareholdings: The Lead Manager disclosed a public shareholder holding 19.84% of pre-issue capital based on depository credits and Registrar and Share Transfer Agent (RTA) confirmations. However, the underlying Form SH-4 (share transfer instrument) was missing the transferee's signature, had no proof of stamp duty, and showed delayed, piecemeal payments. SEBI ruled that downstream depository and RTA confirmations do not excuse a Lead Manager's failure to examine primary documents showing obvious facial defects.

2) The 'Diligence Clock' and Delayed Corrections: Shortly before the issue opened, a paid promotional article and YouTube videos began touting an unofficial 'grey market premium' (GMP). The Lead Manager discovered this misleading publicity on June 23, 2022, but did not issue a public correction until July 5, 2022. SEBI held that once a merchant banker is aware of misleading public information capable of influencing investors, a two-week delay in acting is itself a standalone due diligence failure, independent of who authored the media content.

The consequences were commercially and legally severe. The misleading publicity initially drove a 1.76x oversubscription. Following SEBI and exchanges' interventions, the Lead Manager was forced to offer subscribers an exit option and extend the bidding timeline by 3 days. Due to this disruption, the issue closed undersubscribed, and the Lead Manager had to personally underwrite and absorb 5,04,000 shares, turning a regulatory lapse directly into a substantial balance sheet liability.

III. The Regulatory Warning Wave

The Veerkrupa order is not an isolated event. It represents a systematic tightening of standards across all public issues, including equity, debt, mainboard, and SME offerings. Two recent SEBI warning letters confirm this trend:

Khandwala Securities Limited (June 2026 Warning): SEBI returned the draft red herring prospectus (DRHP) of ArMee Infotech Limited and issued an administrative warning because the 'Financial Information' section omitted an independent auditor's report on the restated consolidated financial statements, violating Regulation 24(3) of the ICDR Regulations.

IIFL Capital Limited (March 2025 Warning): Following an inspection of debt issues, SEBI issued an administrative warning focusing on inadequate disclosures and due diligence surrounding issue-related expenses and intermediary fee payment timelines under the SEBI Non-Convertible Securities (NCS) Regulations, 2021.

IV. The Defensible Due Diligence Matrix

To establish a legally defensible file, lead managers should shift from simple verification checklists to an active evidentiary model. This matrix maps the core areas of vulnerability identified in recent SEBI rulings to the precise evidence your files must contain:

  • Pre-Listing Shareholdings: Contemporaneous logs of direct physical document checks; documented reconciliation of payment records with transfer dates.
  • Bonus Capital Allotments: Independent verification of the company's register of members; corporate records reconciled to verify member eligibility.
  • Third-Party Publicity / GMP: Documentation of when publicity was detected, the prompt internal escalation trail, and the formal written correction strategy.
  • Unreasonable Delays: Detailed logs of the immediate escalation timeline from detection, through issuer communication, to final public correction.

V. Three Pillars of a Defensible File

1) Traceability: Every single disclosure, financial ratio, or capital structure item in the offer document must trace directly to primary, original evidence. The files must contain an intelligible, step-by-step path from representation to raw documentation, ensuring no fact is taken on trust.

2) Challenge: The file must reflect that the lead manager actively tested and challenged management representations. When a red flag or anomaly appears (such as an incomplete transfer form or discrepancies in dates), the file should record how the issue was raised, investigated, and successfully resolved.

3) Responsiveness: The diligence duty is continuous and does not end with the filing of the prospectus. When external market developments or misleading publicity emerge during the offering period, the file must show a rapid, documented path of awareness, legal assessment, issuer communication, and corrective action.

VI. Lead Manager Action Plan: Key Watch Points

Compliance and due diligence committees must incorporate the following operational rules into active mandates:

  1. Intermediary Reliance Has a Floor: RTA or depository records do not cure facial defects in underlying documents. If a physical instrument lacks signatures, stamp-duty proof, or has invalid dates, your diligence trail is broken until that specific defect is resolved.
  2. Manage Underwriting Conflict Risks: When any merchant banking firm underwrites the issue, the economic interest in achieving a full subscription may clash with the gatekeeping duty to correct misleading publicity. Ensure that due diligence and compliance committees operate independently of investment banking teams during crises.
  3. Prepare for the SEBI Repository Mandate: Under the SEBI Circular dated December 5, 2024, lead managers must maintain a complete digital repository of all materials and documents relied upon during due diligence. Ensure the files are structured, easily searchable, and capable of audit under this mandate.