What is a Deemed Prospectus?

The foremost goal to ensure investor protection must take precedence in the dynamic landscape of India's capital markets. While investor protection falls mainly within the purview of the Securities and Exchange Board of India (SEBI) and partially that of the Companies Act, 2013, the regulatory framework has an emphasis on transparency and complete disclosure. At the center of those rules, and this chapter, is the prospectus, a formalized statutory document which actually invites the public to subscribe for a company's securities, and provides crucial information for buyers to make an intelligent investment decision.

However, the sophistication of corporate finance and inventiveness of funding has allowed companies to sometimes circumvent the spirit of the law. It is here that the term "deemed prospectus" comes into play—a legal mechanism that is intended to plug such loopholes and maintain investor protection even in the absence of an explicit prospectus.

What is a Deemed Prospectus?

A deemed prospectus, by the name itself, is a document that is statutorily "deemed" to be a prospectus but is not necessarily so. The notion is a statutory one and can be traced to the Indian Companies Act, 2013, more particularly Section 25. The underlying aim is to ensure that a company does not circumvent its statutory requirement of filing a prospectus by utilizing an intermediary to issue its securities to the public.

To better understand this, take the case of the classical method of public offering. A company determines to raise funds by offering shares to the public. It makes a detailed prospectus, which is a detailed document with details regarding the financials of the company, its management, risks, and the offer terms. The prospectus is then submitted to SEBI and offered to the public.

When is Deemed Prospectus Issued?

Yet a business could try to avoid this rigorous process. Rather than issuing a public offer directly, it might assign a large block of its securities to an intermediary, a merchant bank or an underwriting firm. This intermediary would subsequently offer these securities for sale to the public. Without the deemed prospectus provision, the original company would be able to argue that it never issued a "public offer" and hence was under no obligation to issue a prospectus. This would deny investors their right to obtain essential information and hold the company liable for any misstatements.

The legislation, under Section 25 of the Companies Act, 2013, formally shuts this window of opportunity. It provides that the document of the intermediary's "Offer for Sale" will be a deemed prospectus of the original company, subject to the fulfillment of certain conditions. This ensures that all of the disclosure obligations of a formal prospectus, as well as the legal liability for any misstatement, are equally applicable to this document and to the original company.

When is a document treated as Deemed Prospectus?

The two primary conditions on which a document is to be treated as a deemed prospectus are:

• Six-Month Sale: If the securities are issued by the company to an intermediary, and the intermediary sells those shares to the public within six months of the allotment date, the offer document will be considered a deemed prospectus. The law will assume that the intention of the company was to raise public money, and the intermediary was only a conduit to complete the transaction.

• No Consideration Given: If, when the intermediary issues the public offer, the original company has not been paid in full (consideration) for the securities distributed to the intermediary, the "Offer for Sale" document is considered a prospectus. This stipulation is intended to avoid a company making a "backdoor" public offer without going through the formal prospectus procedure and being paid the full amount of its securities.

In effect, a deemed prospectus is a fiction in law that guarantees the essential overriding of protecting investors, irrespective of whether the company is accessing the public market directly or otherwise. It is an effective tool that subjects an indirect public offer to the same quantum of legal and regulatory examination as a direct one.

Importance of A Deemed Prospectus

Deemed prospectus provision is an essential part of modern Indian company law as it provides one of the vital protections that can uphold market efficiency, transparency and accountability.

a) Providing for Transparency and Disclosure:

The main purpose of a deemed prospectus is to shut legal loopholes that may allow companies to dodge disclosure requirements. This law ensures that investors are not deprived of true information (i.e., issuer's financials, management, risk factors, and how funds will be used) by requiring that the offer document being used by an intermediary must include the same information required in a normal prospectus. Investor protection is necessary for investor confidence and, ultimately, a sound financial system. 

b) Creating Liability and Accountability:

As a system of accountability, the deemed prospectus is significant. Even where an intermediary issues the document, the liability becomes the original company (Which has assigned the securities). In this way the company is liable with its directors and management for the representations given in the offer document. The company is liable for any misstatement or omissions, and made in a deceitful manner could incur civil and/or criminal penalties. This liability structure supports honesty, creates disincentives for intermediaries to be misused, and also protects investors from misleading disclosures.

c) Safeguarding Investor Interests:

Fundamentally, the deemed prospectus safeguards investors. It means all public offers—direct or indirect—are held to the same standard of scrutiny and disclosure principles. This facilitates well-informed decision-making based on reliable information. Otherwise, investors would be buying securities without legitimate guarantees from the issuing corporation in ignorance.

This provision maintains financial system integrity by avoiding companies' raising capital outside regulatory standards. It shuts the door to the existence of a shadow market and imposes moral practices, which results in long-term economic stability and fair capital market conditions.

Understanding Deemed Prospectus Through an Example

An Example will make this aspect clear. 

Situation: 

A firm by the name of "Tatkoo Ltd." wants to raise ₹1,000 crore from the public for its expansion proposals. Rather than undertaking the long and expensive exercise of a direct public offer (IPO) with a formal prospectus, Tatkoo Limited finds a willing intermediary, " Friends Merchant Bank."

The Indirect Offer: 

Tatkoo Limited offers 10 million shares to Friends Merchant Bank at ₹100 per share, for ₹100 crore. There is a promise that Friends Merchant Bank will subsequently offer these shares to the public for a higher price, say ₹120 per share, and profit from it. Friends Merchant Bank draws up an "Offer for Sale" document, which it distributes among the public, inviting applications to purchase Tatkoo Limited shares.

The Loophole:

Without the provision on deemed prospectus, Tatkoo Limited might contend that it distributed its shares merely to Friends Merchant Bank, one entity, and hence did not make a "public offer." In which case, it will not have to submit a prospectus to SEBI, and investors will have only the intermediary's document at hand, which may not have important details and legal authority.

The Role of Deemed Prospectus: 

The provision for deemed prospectus shuts this loop. As Friends Merchant Bank is selling the shares of Tatkoo Limited to the public within six months of acquisition, Friends Merchant Bank's "Offer for Sale" document is legally treated as a deemed prospectus of Tatkoo Limited Ltd.

The Consequences:

• Disclosure: The report is to include all the disclosures required by a formal prospectus, such as Tatkoo Limited's accounts, business plan, risk factors, and information on its management.

• Liability: Tatkoo Limited Ltd. and Friends Merchant Bank are now jointly and severally liable for any misstatements or omission in the deemed prospectus. If an investor incurs a loss as a result of misleading information, they can sue the two parties.

• SEBI Scrutiny: The whole transaction falls within the ambit of SEBI, as would a normal IPO.

This example shows very well how the deemed prospectus provision sees that the intent behind the law—to safeguard investors by providing transparency and accountability—is served, irrespective of the way a company might raise public money.

Other Types of Prospectuses

Though the deemed prospectus is an important instrument for indirect public offerings, the Companies Act, 2013, makes specific provisions for a number of other prospectuses, each having a specific role to play in the process of raising capital.

• Shelf Prospectus (Section 31): 

This prospectus permits a company to issue securities in several tranches within a year without filing a new prospectus for each one. It is especially advantageous for public financial institutions or companies that will most probably enter the market repeatedly in order to raise funds. After a first-time shelf prospectus has been lodged, only an "information memorandum" needs to be filed by the company in respect of subsequent offers.

• Red Herring Prospectus (Section 32): 

The phrase "Red Herring Prospectus" or RHP is the name given to a company's preliminary document presented to the regulators when the firm aims to go public with an initial public offering (IPO).An RHP provides prospective investors with comprehensive information on the company, its business and also its IPO except for the final issue price and number of shares. The RHP is critical to help investors determine the financial position, risk profile and outlook of the company, which can help the investor make an investment decision

• Abridged Prospectus (Section 33): 

An Abridged Prospectus is a condensed version of the prospectus. It includes all the material information as stipulated by SEBI but in a condensed and simplified form. An abridged prospectus is a mandatory document to be submitted along with each application form for securities.

Conclusion

The deemed prospectus is an essential legal instrument that deepens the strength of the Indian capital market's integrity. In securing responsibility for companies and intermediaries to the information they furnish in an indirect public offer, it protects the investing public interest and reinforces the pillars of transparency and full disclosure, which are necessary for maintaining stability and trust in the market.

Also Read | What is DRHP?