Sources said that one of the first reform measure on which the MCA is working on is related to the way preference shares are used. Officials said that the ministry has woken up to the need because certain instances have come up that indicate how preferential shares could become a route for invisible promoters to dictate terms to the company, especially when it operates in sensitive sectors like telecom and defence.
The issue is a little complex, as was revealed with the Comptroller and Auditor General report that concluded Anil Ambanis Reliance Telecom Ltd (RTL) had more than the permissible 10% stake in Swan Telecom when the latter applied for telecom licences in March 2007. However, RTL said that its equity was 9.9% and the balance was through preference shares, which cannot be counted as equity.
However, the CAG pointed out that preference shares were counted as equity in this case because R1,002 crore of Swans R1,100 crore equity had been contributed by RTL. The MCA feels that such instances could be tricky in future and, therefore, a clear policy should be put in place to bring more clarity on the ways preference shares can be used. For instance, it feels that a mechanism needs to be evolved wherein majority preferential shareholders be made directly responsible for the affairs of the company and ways devised to link preferential shareholding in such cases with equity shareholding for the purposes of calculating the equity holding. There is little doubt that Indian companies are misusing the preferential share route. It has become a tool for invisible promoters to control a company. We could be starting work to determine how this impacts shareholder democracy, an official said. Officials said that the ministry has for long been concerned about the myriad financial instruments usually adopted by companies. Its a thought that we should govern preferential shares more strictly. We could either lay down stricter regulations or create more transparency, the source added. Experts and analysts have welcomed such a move, saying is was long overdue. Executive director and head (accounting advisory services) at KPMG Jamil Khatri said, Given the complex nature of financial instruments, classification as equity merely based on legal form may no longer be appropriate. He said that the government should draw up a set of strict guidelines that would clearly specify the factors that will determine whether a preference share is to be treated as equity or not. A Delhi-based corporate lawyer said that the government can also consider coming up with a fixed ratio between the preferential share allotted to a single entity and the total value of the company.
For instance, if the total value of the company is R1,000 crore and an individual entity holds preferential shares worth, say, R800 crore, then it cannot be merely seen as an investor, he said, requesting anonymity owing to the sensitivity of the matter. The managing director of Delhi-based Corporate Professionals Capital, Pavan K Vijay recommended a three-pronged strategy to address the issue of invisible promoters. MCA should direct companies to clearly state that who is controlling the company as in who is signing the cheques, making decisions and clearly spell out the equity structure of a company. Any attempt to violate these rules should become a criminal offence, he said. According to current rules, preferential shareholders can get voting rights under extraordinary circumstances, for instance, if a company has not paid dividend for a period of three years. MCA should seriously consider not giving complete voting rights to preferential shareholders but give qualifying voting rights which would have riders and restrictions, he said. Khatri said that the government should also make a distinction between the various types of preferential shares.
To treat every preferential share as an equity is not advisable since they can vary greatly in substance, he said, adding that if a set of preferential shares have to be mandatorily redeemed after a fixed period of time, then it has to be merely seen as debt.
If preferential shareholders can encash their stake at any given time, then it would be more in line with equity, he said. Managing partner of Kesar Dass B & Associates Sumant Batra said the industry ministry had argued how preferential shares would also need to be taken into account at the time of calculating the stake of a promoter so that it does not breach the sectoral cap. A similar solution has to be found in the sectoral policy level. No change is required in the Companies Act, he said.