What is a Deemed Prospectus?

Introduction

The primary purpose of the Securities and Exchange Board of India (SEBI) is to protect investors' interests and ensure complete transparency in securities trading. Therefore, it enforces various regulatory and compliance requirements to safeguard investor rights.

The deemed prospectus is a reporting requirement mandated by SEBI for companies aiming to raise capital from the securities market.

Section 2(70) of the Companies Act defines a prospectus as a legal document that describes the shares or securities of a company offered to the public. The document may be a notice, circular, advertisement or manuscript. The purpose of a prospectus is to raise capital and invite the general public to purchase shares or securities.

A company is legally bound to disclose relevant information for the sale of securities through a prospectus. Some companies may use loopholes and sell securities through an intermediary. In such cases, a deemed prospectus is of relevance.
 

What is a deemed prospectus?

Typically, the deemed prospectus meaning a detailed document addressed to the public with an offer for the sale of securities by a company. Section 25(1) of the Companies Act enforces the same. By itself, the document is not a prospectus but is deemed as one due to its characteristics and content. A deemed prospectus is also known as an abridged prospectus.

The concept of a deemed prospectus is especially useful if the company intends to issue securities through an intermediary and bypasses the compliance requirements of SEBI. Deemed prospectus ensures that market participants are fully aware of the sale. Also, it improves the efficiency of decision-making by investors.

Whenever a company issue shares to the general public, it submits an offer for sale called the prospectus with SEBI. If the company allows securities to an intermediary to offer those securities for sale eventually, then the intermediary or issuing entity releases an offer for sale. The intermediary may be a merchant bank, financial institution, another company, or an issuing house.  

The offer for sale is a deemed prospectus if it fulfils one of the two conditions below:

Condition 1 – Sale within six months

The offer for sale is a deemed prospectus if the intermediary makes the offer to the general public on or before six months from the date of allotment of securities by the intermediary. SEBI assumes such a sale as the issuing company's plan to raise capital directly from the public. In such a situation, the intermediary or issuing company must release all the information about the issue to the SEBI and investors and issue a prospectus.

Condition 2 – No consideration for the sale

The offer for sale is a deemed prospectus if the company that allots shares to the intermediary does not receive any consideration for the securities until the intermediary makes the offer for sale. SEBI views it as an attempt by the company to issue shares to the public through an intermediary without filling out a prospectus. Therefore, the law requires the intermediary to file an offer for sale or a deemed prospectus in this case.  

Suppose any of the two conditions is true. In that case, the document used by the intermediary to present the offer for sale is automatically the deemed prospectus of the company that allotted its securities to the intermediary. The rules and regulations that apply to the company's prospectus also extend to the deemed prospectus. Even though the intermediary issues the offer for sale, the deemed prospectus expands responsibility to the original issuer of shares.
 

Understanding what has been deemed a prospectus with the help of an example

For example, XYZ Ltd plans to raise capital through a public issue but wishes to avoid the rules and regulations concerning public offerings issued by SEBI. 

In January 2020, XYZ Ltd decided to issue shares through an intermediary, ABC Ltd which is a merchant bank. They buy a sizeable number of shares from XYZ Ltd. The sale transaction does not require a prospectus since the offer is not to the general public. The pretext of the transaction is that ABC Ltd can sell the stock to the general public, transfer the proceeds to XYZ Ltd, and charge a fee for their services. XYZ Ltd aims to sell its shares to the public through ABC Ltd without filing a prospectus. 

Suppose ABC Ltd offers the shares of XYZ Ltd to the general public for sale. However, there are limitations to protecting investor rights in such situations. If ABC Ltd offers the shares for sale within six months of the initial sale, then ABC Ltd must furnish an offer for sale containing all the details of the issue. The offer for sale document is the deemed prospectus for XYZ Ltd. In this case, if ABC Ltd offers shares of XYZ Ltd to the public on or before June 2020, the offer for sale is the deemed prospectus for the transaction. 

Suppose ABC Ltd issued shares to the public in October 2020, then one must evaluate the second condition. The second condition focuses on the receipt of consideration by XYZ Ltd. If XYZ Ltd does not receive any consideration till ABC Ltd offers the shares to the public, then the second condition is applicable. In this case, if XYZ Ltd does not receive any consideration for the transaction till October 2020, the offer for sale issued by ABC Ltd is the deemed prospectus for XYZ Ltd. The second condition safeguards the interest of investors since the security price may fluctuate with time, and intermediaries are unlikely to agree to future payment in such a situation. 
 

Importance of deemed prospectus

A deemed prospectus legally binds the issuer to submit relevant details of an investment offering to the general public to the concerned authority. It enables investors to evaluate the risk associated with the investment. The issuer must furnish material information that impacts its financial stability and obligations.It helps to maintain complete transparency. If an issuer uses gaps in the law not to file a prospectus, then the deemed prospectus comes to the rescue.  

Other types of prospectuses

Every security sale requires the issuing company to release information to the general public and release a prospectus. Each type of issue has a different prospectus. These include

●    Red Herring Prospectus – A red herring prospectus is applicable for the first public issue of a company or an IPO. It does not contain all the relevant details about the price and number of securities offered. 

●    Shelf Prospectus – An entity uses a shelf prospectus when it issues one or more securities to the public. The issuing company provides a validity period of the prospectus subject to a maximum of one year. The validity period starts with the first offer, and there is no requirement for a year for a prospectus on other offers. 
 

Conclusion

The purpose of a deemed prospectus is to eliminate ambiguity concerning who is responsible for the terms and conditions mentioned in the prospectus. It pinpoints accountability to the intermediary and the issuing company for the contents in the offer for sale.

A deemed prospectus protects the interest of the investors. Therefore, investors must thoroughly analyse the terms and conditions of the prospectus and do their research before investing. Additionally, the investment must also be in line with the investor’s objectives and time horizon.