Unlisted securities: The high-stakes gamble luring India’s retail investors

The interest is climbing. Monthly trading volumes of unlisted securities in 2024 have surged to $300 million from $50-60 million last year, according to an analyst. Reason: all-time returns from the Primex 40 Index, which tracks top private companies, reached 25.85% compared to the Nifty 500’s 15%. However, over the past three years, the Primex 40 has lagged, delivering 12.62% versus the Nifty-500 Multicap's 17.91%.

The top three companies in the unlisted space by market capitalization are NSE, Tata Capital, and Nayara Energy, while BIRA and NCDEX languish at the bottom.

This is how it works. Wealth platforms help ESOP holders or early investors sell their shares before a company goes public. They do this by buying shares from the investors and selling them to other investors.

Arjun Jaiswal, an equity investor of four years, exemplifies this growing trend. Frustrated by limited opportunities in the listed market, he recently ventured into unlisted securities. “I wanted to catch some companies early in the unlisted space for better returns," he said. Despite the risks—including whether these stocks will ever list—he remains undeterred, allocating a small portion of his portfolio while continuing to scout for more opportunities.

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Sandeep Nirvan, an Ahmedabad-based investor, applied for over 100 initial public offerings (IPOs) and secured allotments in only three. He then turned his attention to the unlisted space. His portfolio spans investments in Swiggy, Five Star Business Finance, Ixigo, Capital Small Business Finance, OYO, API Holdings, Metropolitan Exchange, and NSE.

“Out of the over 100 applications, I got allotted only three, and one of them is listed at a premium. That's the biggest reason I started investing at the pre-IPO stage," Nirvan explained. 

The potential for substantial returns keeps him invested in this space. “Swiggy almost doubled, Five Star is up by 40%, Ixigo is showing a 60% gain, and OYO is at a 70% gain. Only API (PharmEasy) is trading 40% lower than my purchase price," he added.

Lower brokerage fees and stamp duties add to the appeal of pre-IPO investments, Nirvan pointed out.

The pre-IPO segment has been a significant driver of this surge, as investors flock to companies preparing for public listings, drawn by the potential for lucrative returns, Mint reported in August.

Regulatory heat on platforms

However, the market’s rapid expansion has not gone unnoticed by regulators. Over the past two months, Sebi has ramped up scrutiny of platforms facilitating unlisted securities trading.

In November, the regulator flagged three platforms for offering non-convertible debentures (NCDs) in violation of the Companies Act. By December, it issued a broader warning, highlighting the lack of investor protections—such as grievance redress mechanisms and dispute resolution—on unregistered platforms.

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“The unlisted space has attracted a significant number of investors over the last three years, driven by the wave of exits through IPOs. Investors feel that if they can't access IPOs directly, they can still tap into opportunities through pre-IPO investments," explained Narinder Wadhwa, managing director of SKI Capitals, a brokerage house.

“This space is gaining traction, partly due to the sense of FOMO (fear of missing out) as investors see others getting involved. There is considerable trading activity in the stocks of companies like NSE, NSDL, and OYO, particularly those that have filed their DRHPs and are awaiting IPO launches," Wadhwa said.

Suvajit Ray, head of product & distribution at IIFL Capital, emphasized that large brokerage houses refrained from advising investors to trade in unlisted securities because of low liquidity and high risks, but added there were a few websites which offer these services.

What the platforms say

Platforms play a pivotal role in the unlisted securities market, acting as intermediaries that provide liquidity to early investors or Esop holders in companies gearing up for public offerings. These platforms enable investors to purchase shares from these early stakeholders and sell them to others who anticipate gains post-IPO.

Kashish Sharma, chief executive of Equity List, a platform for cap table and stock options management, noted that many venture capital-backed companies leverage these secondary trading platforms to gauge IPO readiness, functioning somewhat like a pre-roadshow.

However, “there are no clear accreditation checks, which reduces barriers to entry", he explained, underlining the lack of oversight compared to other investment platforms.

Wadhwa of SKI Capitals pointed out that platforms associated with regulated entities, such as brokerage firms, tend to inspire greater investor confidence. Investors feel reassured that their commitments will be honoured when platforms have ties to regulated activities, he said.

Amid growing demand, Sebi has cautioned investors against trading on unauthorized platforms and urged them to exercise caution. Some platforms, however, argue that the current regulatory vacuum requires a more structured framework to address market needs.

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Precize, an unregulated platform, has sought Sebi’s guidance on obtaining regulatory authorization. “Getting regulatory approval for operating as a trading platform for unlisted securities presents significant challenges. We welcome Sebi's clarity and guidance on navigating this process and will adapt as the regulatory landscape evolves," the platform said in a statement.

Sebi’s recent advisory underscored the illegal nature of trading on unregistered platforms, emphasizing that only recognized stock exchanges are permitted to facilitate trading of “to-be-listed" and “listed" securities.

Ketan Mukhija, senior partner at Burgeon Law, described the advisory as a clear warning for unauthorized platforms to halt operations and seek proper authorization.

Wadhwa noted that this is not Sebi’s first intervention. A similar advisory was issued in 2016, yet many investors continued using these platforms despite the risks. Sebi’s latest warning highlights the challenges in regulating this unstructured space, he said.

Unlisted Kart, another unregulated platform, argued that India could adopt practices from the US pre-IPO market, where accredited investors are allowed to trade shares before companies go public. It suggested that off-market transactions, where buyers and sellers connect directly, could mitigate regulatory concerns.

“In case of fraud, investors may lodge complaints with the police, but there is no guarantee of protection," it warned, advising investors to deal only with trusted dealers.

Debt securities

Sebi’s recent surveillance revealed that some unregistered platforms were soliciting and selling unlisted non-convertible debentures (NCDs) to retail investors, violating the Companies Act, 2013. 

The regulator stressed the distinction between public issues and private placements, warning that unchecked operations by these platforms expose the public to significant risks. Sebi also highlighted the lack of investor protections such as grievance redressal mechanisms and online dispute resolution, making these transactions particularly risky.

Persons who list securities on unauthorized platforms could face significant penalties under both the Securities Contract (Regulation) Act and Sebi regulations, according to Damodar Desai, partner at Little & Co. Penalties include fines of up to ₹25 crore or imprisonment for up to 10 years.

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Several companies whose shares are traded on these unregulated platforms have distanced themselves from such activities. Consumer electronics unicorn boAt, for instance, clarified it has no connection to any platform or involvement in the listing of its shares on such platforms. “Those who participate on these platforms do so at their own risk," a spokesperson for boAt stated.

Raja Singh Bhurji, chief executive, The StepUp Ventures, noted that while pre-IPO trading offers early access to high-growth companies, it also poses risks for employees in startups, who often sell their ESOPs on unregulated platforms due to the lack of buyback options.

While Sebi’s warning may initially reduce liquidity for such employees, Bhurji believes that a focus on compliance and investor protection will ultimately lead to safer alternatives, such as trading through recognized exchanges.

Looking ahead

Legal experts predict that Sebi will intensify surveillance, tighten regulations, and enforce penalties against unauthorized activities in the unlisted securities space.

Sanjay Israni, partner at Desai & Diwanji, advised platforms to comply with Sebi’s guidelines, which include proper registration, disclosure requirements, and grievance redressal systems. He also recommended robust cybersecurity measures and regular audits to maintain compliance.

As the unlisted securities market continues to grow, Sebi’s evolving regulatory framework will play a pivotal role in balancing investor protection with fostering a more transparent and secure environment for secondary trading.

And read | IPOs to get larger after average size more than doubles to ₹2,000 crore this year: Kotak’s S Ramesh