Merchant Bankers — Categories and Functions

A merchant banker is the linchpin of the Indian primary market: the registered intermediary that structures, packages, certifies and pilots a public issue from boardroom resolution to listing day. The Securities and Exchange Board of India (Merchant Bankers) Regulations, 1992 began life with a tiered, four-category architecture that graded firms by the breadth of work they could undertake, and was then radically simplified in 1997 into a single Category I gatekeeper carrying the full weight of issue management. Understanding the categories is only half the story; the functions, and above all the due-diligence accountability that attaches to the lead manager, are where examiners and the Securities Appellate Tribunal alike concentrate their fire. This chapter tracks both, anchored to the bare regulation and to the case law that gives the Code of Conduct its teeth.

Who is a merchant banker? The statutory definition

Regulation 2(cb) of the SEBI (Merchant Bankers) Regulations, 1992 defines a merchant banker as "any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management." The centre of gravity of the definition is issue management; the merchant banker is fundamentally a creature of the primary market, distinct from the secondary-market intermediaries dealt with under the Stock Brokers Regulations, 1992.

The companion definition in Regulation 2(ca) treats an issue as an offer of sale or purchase of securities by a body corporate, or by any person on its behalf, to the public or to existing security holders, made through a merchant banker. The two definitions interlock: where there is a public offer of securities, a registered merchant banker must stand behind it. This is why the merchant banker is often described as the "gatekeeper" of the capital-raising process, a role that the entire scheme of registration, capital adequacy and the Code of Conduct is designed to police. The basic licensing logic mirrors the wider scheme discussed in the SEBI intermediaries hub: no registration, no business.

The Section 12 foundation and the no-registration-no-business rule

The regulations do not float free. They are made under Section 30 of the SEBI Act, 1992, and they operationalise Section 12(1), which prohibits any person from acting as an intermediary, including a merchant banker, except under and in accordance with a certificate of registration granted by the Board. Regulation 3(1) carries this through: an application for a certificate is made to SEBI in Form A, accompanied by a non-refundable application fee under Schedule II.

The consequence of acting without registration is not merely administrative. The Supreme Court's treatment of unregistered capital-raising in Sahara India Real Estate Corporation Ltd. v. Securities and Exchange Board of India, (2012) 10 SCC 603, illustrates the breadth of SEBI's reach: where two unlisted companies raised over twenty-four thousand crore rupees through optionally fully convertible debentures issued to roughly three crore investors, the Court held the offer to be a public issue squarely within SEBI's jurisdiction, rejecting the "private placement" label and ordering refund with interest. The case underscores that the public-issue machinery, and the merchant-banker apparatus that is meant to certify and disclose, cannot be evaded by relabelling. The licensing discipline that Sahara vindicates is the same discipline the common framework for intermediaries applies across every SEBI-registered category.

The original four categories (1992)

As originally framed, Regulation 3(2) allowed an applicant to seek registration in any one of four graded categories, each defining the permissible scope of work:

Category I was the fullest licence: to carry on any activity of issue management, which would inter alia consist of preparation of the prospectus and other issue-related information, determining the financial structure, tie-up of financiers, and final allotment and refund of subscriptions; and to act as adviser, consultant, manager, underwriter and portfolio manager. Crucially, only Category I firms could act as lead managers to an issue.

Category II was permitted to act as adviser, consultant, co-manager (not lead manager), underwriter and portfolio manager. Category III could act only as underwriter, adviser and consultant to an issue. Category IV was the narrowest, confined to acting only as adviser or consultant to an issue, with no underwriting or management role at all.

The tiering had a clear logic: the deeper a firm's involvement in capital raising and in handling investors' money, the higher the regulatory bar it had to clear. That bar was set principally through the capital-adequacy norms, examined below, which scaled steeply from Category IV up to Category I.

The 1997 reform: collapse into a single Category I

The four-tier model proved unwieldy and was abandoned within five years. By the SEBI (Merchant Bankers) (Amendment) Regulations, 1997, a new Regulation 3(2A) was inserted with effect from 9 December 1997. It provides that, notwithstanding the four-category structure, an application can be made only for carrying on the activities mentioned in Category I. In other words, Categories II, III and IV were closed to fresh registration, and going forward only the full-scope Category I merchant banker survives.

Regulation 3(2A) made a second structural change: the portfolio-management function was carved out. A merchant banker can carry on the activity of portfolio manager only if it obtains a separate certificate under the SEBI (Portfolio Managers) Regulations, 1993. This functional unbundling reflects SEBI's broader move toward activity-specific registration, so that conflict-prone functions are licensed and supervised discretely rather than bundled under one omnibus licence.

For the exam, the takeaway is precise: the 1992 regulations defined four categories, but since 9 December 1997 there is effectively one operative category of merchant banker, Category I, and "co-manager", "underwriter-only" and "adviser-only" tiers are of historical interest only.

Registration: eligibility and the fit-and-proper test

Registration runs through Regulations 3 to 9. Form A is filed with the application fee (Regulation 3(1A)); an incomplete application may be rejected under Regulation 4, but only after an opportunity to cure defects. Regulation 5 empowers SEBI to seek further information, clarification and personal representation.

Regulation 6 lists the matters SEBI weighs in granting a certificate: whether the applicant is a body corporate (other than a non-banking financial company); whether it has the necessary infrastructure, including office space, equipment and manpower; whether it employs at least the minimum complement of qualified persons with experience to conduct the business; whether any associate is registered with SEBI; whether the applicant fulfils the capital-adequacy requirement of Regulation 7; and, importantly, whether the applicant and its principal officer are fit and proper persons. The fit-and-proper criterion, the disqualifying effect of past securities-market litigation, and the infrastructure floor are the same standards that the common framework now applies across intermediaries — and the same standards SEBI invoked when, in 2024, it cancelled a long-dormant merchant banker's registration for lacking office space, the minimum staff and a clean directorial record. A certificate, once granted under Regulation 8, is valid for three years (Regulation 9B) and is renewable on application three months before expiry (Regulation 9).

Capital adequacy and net worth

Regulation 7 sets the capital-adequacy requirement in terms of net worth, defined as the sum of paid-up capital and free reserves at the time of application. Under the historical four-category table, the floors were: Category I, originally one crore rupees and raised to higher figures over time; Category II, fifty lakh rupees; Category III, twenty lakh rupees; and Category IV, nil. With the collapse into a single Category I, the operative figure today is a net worth of not less than five crore rupees, which Regulation 7 now states in unqualified terms.

Capital adequacy is not a one-time entry hurdle. Regulation 9A makes continued compliance a condition of registration: a merchant banker must maintain the Regulation 7 net worth at all times. Regulation 15 requires submission of half-yearly unaudited financial results when called for, expressly so that SEBI can monitor capital adequacy, and Regulation 28(1)(iv) obliges the merchant banker to disclose any breach of the Regulation 7 requirement. The architecture mirrors the capital-adequacy discipline imposed on stock brokers: solvency is treated as a continuing, monitored obligation, not a box ticked at the door.

Functions: what a merchant banker actually does

The functional core, drawn from the Category I description in Regulation 3(2)(a) and from market practice, can be grouped under issue management. Pre-issue, the merchant banker advises on the financial structure and quantum of the issue, undertakes capital structuring, prepares the draft offer document (the draft red herring prospectus), files it with SEBI and the exchanges, ties up underwriters and financiers, appoints registrars, bankers and other intermediaries, and conducts the marketing and book-building of the issue.

Post-issue, it supervises allotment, refund of over-subscription and listing formalities, and certifies post-issue compliance. Alongside issue management, a Category I merchant banker may act as adviser, consultant, manager and underwriter, and (with a separate registration) as portfolio manager. In substance, the merchant banker is the issuer's principal interface with the regulator and the investing public, and the regulatory scheme treats it as accountable for the accuracy and completeness of what reaches investors.

Several ancillary obligations sharpen this accountability. Regulation 14 requires the merchant banker to keep prescribed books of account, the balance sheet, profit-and-loss account and auditor's report, which under Regulation 16 must be preserved for at least five years. Regulation 17 obliges it, within two months of the auditor's report, to take steps to rectify any deficiency the auditor flags. Regulation 26 prohibits the merchant banker, its directors, partners, managers and principal officers from trading in the securities of any body corporate on the basis of unpublished price-sensitive information obtained during a professional assignment — an insider-trading bar built into the merchant-banker code itself. Regulation 27 requires it to report to SEBI, within fifteen days, particulars of any transaction in securities of a body corporate whose issue it is managing, and Regulation 28A mandates appointment of a compliance officer to monitor compliance and redress investor grievances.

The lead manager: responsibilities and demarcation

Where multiple merchant bankers are appointed to an issue, one or more act as lead managers, and Regulation 20 fixes their accountability. No lead manager may agree to manage or be associated with an issue unless its responsibilities, mainly those relating to disclosures, allotment and refund, are clearly defined, allocated and determined, and a statement specifying those responsibilities is furnished to SEBI at least one month before the issue opens for subscription. Where there are several lead managers, the responsibilities of each must be demarcated and a statement filed in the same way.

Two associated guardrails apply. Regulation 21 forbids a lead manager from being associated with an issue if an unregistered merchant banker is also associated with it. Regulation 21A, inserted with the 2009 ICDR reforms, bars a merchant banker from lead-managing or being associated with any issue if it is a promoter, director or "associate" of the issuer, with a fifteen-per-cent voting-rights / common-director test defining "associate"; the only relaxation is for an associate confined purely to marketing the issue. These conflict-of-interest controls echo the broader fairness norms expected of every intermediary under the code-of-conduct regime.

How many lead managers? The old ceiling and its repeal

The 1992 regulations originally capped the number of lead managers by issue size under Regulation 19. The ceiling rose with the size of the offer: not more than two for issues below fifty crore rupees; three for issues of fifty to under one hundred crore rupees; four for one hundred to under two hundred crore rupees; five for two hundred to under four hundred crore rupees; and five or more, as agreed by the Board, for issues above four hundred crore rupees.

Regulation 19 was omitted by the SEBI (Merchant Bankers) (Amendment) Regulations, 2006 with effect from 18 April 2006, and the cognate Regulation 18 on appointment of lead merchant bankers was deleted when the ICDR Regulations, 2009 took over the detailed issue-management rules from 26 August 2009. The numerical ceiling is therefore no longer in force; today the allocation and number of book-running lead managers is governed by the ICDR framework. Examiners still test the old table, so the figures are worth retaining as repealed-but-illustrative law.

The lead manager's minimum underwriting obligation

Regulation 22 imposes a minimum underwriting obligation on the lead manager. In respect of every issue managed, a Category I lead manager must accept a minimum underwriting obligation of five per cent of the total underwriting commitment or twenty-five lakh rupees, whichever is less. If the lead manager cannot accept even this minimum, it must arrange for that portion to be underwritten by another merchant banker associated with the issue, and keep SEBI informed of the arrangement.

A proviso added in 2010 superimposes a higher floor for issues made under Chapter XA of the ICDR Regulations, 2009 (the small-and-medium-enterprise route): there the merchant banker, alone or jointly with others associated with the issue, must underwrite at least fifteen per cent of the issue size. The provision ties the merchant banker's own capital to the success of the issue, reinforcing that it has financial skin in the game and is not a mere paper certifier.

Code of Conduct and the due-diligence command

Regulation 13 requires every merchant banker to abide by the Code of Conduct in Schedule III. The Code is the heart of the regulatory bargain. Clause 1 commands the merchant banker to make all efforts to protect investors' interests; clause 2 demands high standards of integrity, dignity and fairness; and clause 4, the most litigated, requires that the merchant banker "shall at all times exercise due diligence, ensure proper care and exercise independent professional judgment." Clauses 6 and 7 require that adequate, true and balanced disclosures be made to investors without misleading or exaggerated claims, while clause 20 forbids untrue statements or suppression of material facts in anything furnished to the Board.

The standard demanded by clause 4 was authoritatively framed by the Securities Appellate Tribunal in Almondz Global Securities Ltd. v. SEBI (SAT order dated 13 May 2016). SEBI had debarred the merchant banker for five years for "complete failure to carry out reasonable due diligence" in preparing a prospectus. The Tribunal held that a merchant banker is expected to do "everything reasonable, not everything possible" — it is not an investigating agency, it is entitled to rely on auditors' certificates, management representations and legal opinions, and cannot be faulted for matters that no reasonable diligence on the material made available would have uncovered. On the facts the Tribunal found the diligence inadequate but reduced the five-year debarment, which it called "extremely harsh and highly disproportionate", to six months — marrying a rigorous standard of conduct with proportionate sanction.

The principle has been applied repeatedly in SEBI's adjudication of offer-document lapses. In the matter of Medicamen Biotech Ltd., SEBI penalised the merchant banker to an open offer for failing to exercise proper diligence on the promoters' compliance record, in particular for not flagging that the promoters' shareholding would trigger an open offer — a contravention of both the Takeover Regulations and the Merchant Bankers Regulations. The lesson the cases share is that a merchant banker "cannot pick and choose" which material facts to disclose: the duty of true and fair disclosure under Code clauses 6, 7 and 20 is owed to investors, not merely to the issuer who pays the fee.

Enforcement: inspection, default and the no-mens-rea rule

Chapter IV (Regulations 29 to 34) empowers SEBI to appoint an inspecting authority to examine the merchant banker's books, accounts and documents — to verify record-keeping, check compliance, investigate investor complaints, or act suo motu in investors' interest. Notice is ordinarily given (Regulation 30), but may be dispensed with where investors' interests require. The merchant banker must cooperate fully (Regulation 31), and SEBI may appoint a qualified auditor to investigate its affairs (Regulation 34). Regulation 35 makes a contravening merchant banker liable to action under Chapter V of the SEBI (Intermediaries) Regulations, 2008, which now houses the common enforcement, suspension and cancellation machinery.

On penalties, the governing principle is settled by Chairman, SEBI v. Shriram Mutual Fund, (2006) 5 SCC 361. The Supreme Court held that for breach of civil obligations under the securities law, proof of intention or mens rea is not an essential ingredient; once the contravention is established, the penalty under the SEBI Act follows. Applied to merchant bankers, this means that a failure of due diligence or disclosure can attract penalty regardless of whether the firm intended any wrong — the obligation is one of result and reasonable care, not of guilty mind. SEBI has acted on this footing in adjudications against lead managers for offer-document lapses, including penalties on Enam Securities for due-diligence and allotment failures and on PNB Investment Services in the Taksheel Solutions IPO for non-disclosure of inter-corporate-deposit repayments.

Merchant banker distinguished from other intermediaries

It is worth fixing the merchant banker's place in the intermediary ecosystem. Unlike a stock broker or a sub-broker or authorised person, whose business is executing trades in the secondary market on a recognised stock exchange, the merchant banker operates in the primary market: it brings securities into existence in the hands of the public and certifies the offer. Its accountability is therefore front-loaded and disclosure-centric rather than execution-centric.

A further distinction: the merchant banker's portfolio-management arm, if any, must be separately registered under the Portfolio Managers Regulations, 1993, and its underwriting may overlap with dedicated underwriters registered under the Underwriters Regulations, 1993. The unifying thread, captured by the common framework under the Intermediaries Regulations, 2008, is that every category — broker, sub-broker, merchant banker — is bound by registration, a fit-and-proper test, a code of conduct, inspection, and a common enforcement chapter. The merchant banker is simply the variant whose defining function is to stand surety, through diligence and disclosure, for the integrity of the public issue.