SAT, in the matter of Almondz Global Securities Ltd., recently passed an order on May 13, 2016, which touched upon the long debated question of – What is reasonable due diligence for a merchant banker?

The merchant banker in this case was prohibited by SEBI from taking up any new assignment or being involved in a new issue of capital for a period of 5 years on the ground of “complete failure to carry out reasonable due diligence” while preparing the prospectus of the issuer company. The questions that arose were: a) Were the steps taken by the Appellant towards due diligence of the company sufficient in law?; and b) If not, is the 5 year debarment imposed by SEBI just and proper in the facts of the case?

It was argued that the Appellant, as a legitimate part of its due diligence exercise, had obtained various Statutory Auditors’ certificates and had made its own exhaustive enquiries independently as well with the management. In addition, the Appellant had also obtained due diligence reports of the legal advisor to the IPO. Based on the facts of the case, SAT found, on principle, that the Appellant did not perform its duty properly. However, SAT also opined that “It is settled law that due diligence means reasonable diligence expected from a Merchant Banker. A Merchant Banker cannot be expected to start a due diligence exercise with a presumption of fraud or mischief to be committed by a company whose IPO is to be issued through the Merchant Banker. A Merchant Banker cannot be expected to act like an investigating agency and start with a note of suspicion as regards the bona fides of the company…” Further it was observed that a merchant banker conducts its due diligence based on the material brought before it by an issuer company and it cannot be expected to perform this duty in a vacuum when information is not made available to it.

Relying on Chander Kanta Bansal v. Rajender Singh Anand, SAT held that due diligence in law means reasonable diligence and doing “everything reasonable, not everything possible”. SAT held that a punishment of five years of debarment is extremely harsh and highly disproportionate and hence quashed the remnant punishment. This judgment lucidly provides the necessary jurisprudence for ascertaining liabilities of merchant bankers in the capital raising process and comes as a relief to the merchant banking community.