The Due Diligence Dilemma: The Role Of Intermediaries As Fact Verifier Or Forensic Investigator ?

As an intermediary, what do merchant bankers actually owe to investors?

The regulatory answer is thorough scrutiny and identification of the red flags and potentials risks through the process of Due diligence. “Due diligence” the term elucidated by Hon’ble Supreme Court of India, in the matter of Chander Kanta Bansal V. Rajinder Singh Anand (2008) 5 SCC 117, as per Black’s law Dictionary (18th Edn)-  “Due Diligence” means the diligence reasonably expected from, and ordinarily exercised by, a person who seeks to satisfy a legal requirement or to discharge an obligation.’ According to Words and Phrases by Drain-Dyspnea (Permanent Edn. 13-A) -“due diligence”, in law, means doing everything reasonable, not everything possible. “Due Diligence” means reasonable diligence; it means such diligence as a prudent man would exercise in the conduct of his own affairs…..¹

 The next critical question is: to what extent?

Pragmatically, due diligence has become an elastic phrase with no scope defined and stretched across two very different exercises. One is mechanical and involves ticking the check boxes of a lengthy checklist, confirming that a transaction happened, a register was updated, and a filing was made. The other is independent enquiries and examination by digging into facts, evaluating whether the transaction is authentic, whether a relationship, once confirmed, amounts to control, or to a related party, or to a ‘material fact’ requiring disclosure. The regulators expect intermediaries to not only mechanically check the information provided but to exercise the diligence beyond the ticking of check boxes by verifying the legality of the transaction and source. Regulation 64 of the ICDR Regulation, 2009² imposes the responsibility on the lead merchant bankers to exercise due diligence and satisfy themselves about all the aspects of the issue, including the veracity and adequacy of disclosure in the offer documents. Additionally, the Code of Conduct given under Schedule III read with regulation 13 of Merchant Bankers Regulations provides that Merchant bankers shall maintain high standards of integrity, shall make all the efforts to protect the interest of investors and ensure that the investors are provided with true and adequate information without making any misleading or exaggerated claims or any misrepresentation and are made aware of the attendant risks before taking any investment decision.

While the authorities treat this as a strict regulatory and fiduciary obligation of Merchant bankers,  they do not possess any subpoena powers, yet in ex-post adjudication, they are penalised when documentary records conceal complex legal gaps. By analysing some pivotal rulings by SAT and SEBI, this article examines the due diligence obligations on intermediaries that have gradually shifted from mere verifier to an investigator.

I. When Multi-Layered Verification Fails

In the matter of Saffron Capital Advisors Pvt. Ltd. v. SEBI³, the Prospectus disclosed a ₹20 crore bridge loan from United Bank of India, with one portion earmarked for construction and the balance for working capital. It later emerged that the construction tranche had in fact been transferred to Equastone, an undisclosed related party, while the remaining amount had been transferred offshore without an adequate explanation.

Although Saffron in its defence stated that it had applied five levels of diligence by reviewing five years of audited annual reports, board and shareholder minutes, and the shareholding matrix; obtained written declarations (MBP-1) from management and directors confirming that no undisclosed related-party contracts existed; and relied on AS-18 certifications, none of which disclosed any connection with Equastone. There was no documentary trail through which Saffron could reasonably have identified the relationship.

The Adjudicating Officer nevertheless characterised these steps as merely a "primary level" of due diligence, holding them insufficient despite its five layers of verification undertaken. Saffron was found to have violated Regulation 60(7) (a), which requires truthful, fair, and non-misleading disclosure, and Regulation 64(1) of the ICDR Regulations⁴, along with several provisions of the Merchant Bankers' Code of Conduct. A penalty of ₹5, 00,000 was imposed.

The decision raises a more fundamental question about the boundaries of intermediary responsibility. The issue, therefore, is not merely whether verification was adequate, but how an intermediary is expected to identify relationships concealed beyond the documentary record available to it.

II. "Exercising" Due Diligence, the Ambiguous Obligation

The ambiguity lies in the regulation itself. Regulation 64(1) of the ICDR Regulations, 2009 and Clause 5.1.1 of the erstwhile DIP Guidelines, 2000 use almost identical language where the lead merchant banker to “exercise due diligence and satisfy himself about all the aspects of the issue, including the veracity and adequacy of disclosure in the offer documents”. Conversely, Clause 1.3 of the Code of Conduct under the SEBI (Intermediaries) Regulations, 2008, requires an intermediary to "exercise due skill and diligence… ensure proper care and exercise independent professional judgment"⁵. This language treats fact-verification and merits-adjudication as a single, undifferentiated exercise.

In the matter of Keynote Corporate Services Ltd v. Securities and Exchange Board of India⁶, BRLM failed to disclose Inter-corporate deposits (“ICDs”) availed by the Issuer Company and some purchase orders issued to certain entities in the Prospectus. To which BRLM argued in their defence that they were just pre issue BRLM and they were not aware about the fact that those ICDs amounting to four crores were already repaid out of public issue proceeds. Moreover, a statement with respect to “no bridge loan taken……” was mentioned in RHP/Prospectus based on declarations received from the MD of Issuer Company. Further, they agreed that during any IPO assignment, they conduct random checks to verify the authenticity of entities mentioned in the Prospectus. The SAT penalised BRLM for not carrying out due diligence and relying on passive declarations, as they have a solemn duty to check for adequacy and veracity of all disclosures in all documents pertaining to the issue of IPO. It is their fiduciary duty to bring out information to the knowledge of investors so that they can take judicious and informed decisions on subscription to IPO. SAT dismissed the appeal, and a monetary penalty of Rs. 1 crore was imposed for failure to exercise due diligence under Section 15HB of the SEBI Act, 1992.

This judgment makes it clear that due diligence must extend beyond this baseline.⁷ The decision establishes that the obligation to issue a fresh due diligence certificate at each stage of the IPO requires the merchant banker to independently verify the issuer's disclosures rather than merely rely on management's representations. A merchant banker who accepts board-approved declarations without independent verification, however facially plausible those declarations may appear, has not discharged its obligations under Regulation 64(1).

III. The DLF Paradox and Conflicting Understandings of "Control"

On the other hand, the limit of documentary verification was elucidated in the matter of DLF Limited v. SEBI (SAT Order, 13 March 2015).In 2006, DLF filed DRHP, and a complaint was made that they had suppressed material facts and misstated subsidiaries/related parties. As per the factual position, three subsidiaries of DLF (Sudipti, Shalika, Felicite) sold their entire shareholding in three entities to third parties who happened to be the wives of DLF's senior managers. Share registers updated, and merchant bankers treated the deal as closed. However, none of the three companies were recorded as a subsidiary, a related party, or an entity requiring disclosure. SEBI took a substance over form view, finding that former DLF employees continued to sit on the boards of all three companies, that the same individuals remained bank signatories, and that payments between the companies had not stopped. On this basis, SEBI concluded that DLF had never genuinely relinquished control for disclosure purposes and treated the omission as a material misstatement in the Prospectus.⁸

SAT disagreed It held that control of a board flows from the power to appoint or remove directors and from shareholding rights, and not from informal influence over who happens to occupy those seats. DLF held no shares and exercised no voting power in any of the three companies, and there was no evidence that DLF had attempted to reconstitute their boards. SAT found nothing in law to sustain SEBI's characterisation.⁹

Both bodies heard the identical facts but reached opposite conclusions on how to characterise the legal relationship, specifically, whether continuity is established by payment flows and shared personnel, or by a transfer of shares, and which of the two should prevail where they conflict. This raises the real question for practice. If two apex authorities could not agree on whether control subsisted, what does that mean for a merchant banker who was asked to verify and certify the same facts in advance? Was the banker expected to anticipate a characterisation that a tribunal would only settle years later, and even then, not unanimously? A banker's formal obligation is to confirm that a deed was executed, shares were transferred, and a register was updated. No provision addresses what a banker must do when the documents are, on their face, in order, but the underlying relationship between the entities is legally contestable. The intermediary's difficulty does not begin only once a negligence allegation arrives. It begins earlier, because the nature of such relationships often cannot be settled by documentary evidence alone. Once every available document has been reviewed, the harder question remains: was there more that the intermediary should have known?

IV. Related-Party Transactions and the Limits of Documentary Verification

These cases substantiate that an intermediary cannot discharge its related-party disclosure obligations by treating them as a fixed checklist of documents to be reviewed. SEBI has found violations not only in the documents themselves, but also in the adequacy of the information considered and the manner in which the resulting impact was quantified. Yet the eventual relief in DLF came only after proceedings had already been initiated against DLF's CFO and directors, offering limited comfort to an intermediary seeking, ex ante, to determine the extent to which its inquiry must extend. Every intermediary will eventually reach a limit to what can be verified from available information. Beyond that point, the uncertainty is no longer factual but concerns the extent of the legal duty imposed on the intermediary. Beyond that point, it becomes unclear whether an intermediary can continue to certify the transaction when the scope of its due diligence obligations remains legally uncertain.

V. The Unacknowledged Evolution of Due Diligence

What unfolds is a doctrinal narrative built on two distinct duties that have been treated throughout as one. The deeper problem is that intermediaries lack the tools to conduct the second inquiry at all. Regulation 64 (1) permits a banker to request documents for the purpose of verifying the statements in a Prospectus; it does not extend further. At its outer limit, this power allows an intermediary to demand additional documents, but it does not permit the intermediary to compel cooperation from the company or third parties, or to independently investigate government records that may take years to uncover. The tribunals themselves took seven years to reach a conclusion in the DLF case¹⁰. Where intermediaries have been penalised for relying only on prima facie evidence, the cases discussed above show attempts to exercise heightened caution through random checks and multiple layers of review, directed precisely at relationships that documentary records may not reveal. Conversely, where documentary verification has been accepted as sufficient, SEBI has implicitly recognised that regulatory characterisation alone cannot always determine the adequacy of due diligence. No legislation or judicial order directly addresses this tension. Instead, each decision resolves a particular dispute without fully confronting the broader conflict underlying it.Until SEBI draws an explicit line between where each obligation begins and ends, "due diligence" will continue to describe two irreconcilable duties: one that an intermediary can meaningfully control, and another that it cannot fully determine.

VI. Conclusion

 Under securities law, "due diligence" has fractured into two divergent duties. A certificate confirming that a disclosure is supported by valid underlying documents falls squarely within an intermediary's professional capacity. However, a certificate declaring that no complex legal relationship, such as hidden "control" or an undisclosed "related party", has been concealed compels merchant bankers to act as investigative adjudicators without giving them statutory powers to compel third-party evidence.

Until SEBI explicitly defines where factual verification ends and legal characterisation begins, intermediaries will remain exposed to penalties based on ex-post regulatory hindsight. To resolve this doctrinal standoff, SEBI should amend the ICDR Regulations to introduce a “Defence of Reasonable Reliance”, where an intermediary conducts multi-layered verification relying on statutory filings, audited financials, and certified management declarations, it should be presumed to have discharged its due diligence obligation—unless SEBI can affirmatively prove actual knowledge of fraud or gross negligence. Without such a boundary, "due diligence" will remain less a standard of care and more a rule of strict liability.

Footnotes

^{1 Chander Kanta Bansal V. Rajinder Singh Anand (2008) 5 SCC 117}

^{2  SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009, regs 60(7)(a), 64(1).}

^{3 Saffron Capital Advisors Pvt. Ltd. v. SEBI}

^{4 Securities and Exchange Board of India Act 1992, s 15HB; SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009, regs 60(7)(a), 64(1).}

^{5 SEBI (Intermediaries) Regulations 2008, sch III (Code of Conduct), cl 1.3.}

^{6 Keynote Corporate Services Ltd v. Securities and Exchange Board of India}

^{7 Keynote Corporate Services Ltd (n 6).}

^{8 DLF Limited v Securities and Exchange Board of India [2014] Order of the Whole Time Member, SEBI, CO/IVD/ID2/2014/10 (13 October 2014).}

^{9 DLF Limited v Securities and Exchange Board of India [2015] SAT Order, Appeal No 331 of 2014 (13 March 2015).}

^{10 DLF Limited (n 2).}

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