The idea of control, as viewed by Sebi, seems to be moving away from rights tied solely to the holding of equity
Into the muddied waters of ‘control’ in the listed space, the Indian securities regulator, Sebi, has fired another shot in the form of a discussion paper on ‘reclassification of promoters as public’. The discussion paper follows from one of the key recommendations of the Financial Sector Legislative Reforms Commission (FSLRC), which Sebi had decided to open up for public consultation. While the discussion paper merely puts forward a skeletal framework, and leaves much to be finalised—including its interplay with existing regulations, it does provide fodder for discussion and insight into the regulator’s thought process.
Hitherto, Sebi had been more concerned with the idea of control as applicable to an acquirer or investor in a company, including the contractual management and voting rights such an acquirer could receive, without falling foul of the requirement to make an open offer to public shareholders under the Substantial Acquisition of Shares and Takeovers Regulations (SAST). The securities appellate tribunal in one of its orders in 2009 (which had reached the Supreme Court with an inconclusive result) indicated that there were certain ‘negative control’ or veto rights, an acquirer could take without being ‘deemed’ to be in control. Conversely, Sebi’s informal guidance in January 2014 declared a shareholder, who acquired over 30% equity in the open market, to be classified as a ‘public shareholder’ and be not able to exercise control as he was distinct from the promoter group and did not enjoy any special contractual rights.
The paper extends the above debate from an acquirer to a promoter/promoter group that fully or partially exits from a company or otherwise seeks to be declassified as ‘promoters’. The definition of promoter/promoter group is contained in the Issue of Capital and Disclosure Requirements Regulations (ICDR) to which the SAST also refers to. As pointed out in the paper, this definition currently includes “…persons named in the offer document as promoters”. A literal read of this provision leads to the result that a person once declared as a promoter would continue to remain a promoter.
The Sebi intends to remedy the criteria by providing a mechanism upon fulfilment of which the stock exchanges can update the list of promoters. The proposed scenarios where Sebi would permit such changes are: (i) pursuant to an open offer or an exemption granted under the SAST; (ii) in the case of a registered/disclosed separation agreement between the promoters; and (iii) where the shareholding of the relevant promoter/promoter group is below 5%.
In the first instance, a re-classification of promoters pursuant to an open offer under the SAST is to be the least-regulated. The erstwhile promoter/promoter group, once an open offer by a third-party acquirer is complete, must be able to demonstrate that they do not exercise any direct or indirect control over the company from which they are exiting (or over any of its subsidiaries or affiliates). Thus, what the Sebi requires is that there cannot be any subsisting shareholder or other contractual arrangements and that the exiting promoters cannot hold any ‘key management positions’. In essence, the erstwhile promoter group must be akin to, and on a par with, the common public shareholders in terms of the rights they hold.
But it must be noted that no maximum shareholding limit and no cooling off period has been prescribed in the above scenario. Thus, theoretically, a promoter whose shareholding in company reduces from, say, 60% to 30% pursuant to a sale to an acquirer, could be considered as a public shareholder immediately upon the acquirer completing the open offer! Consequently, it would mean that the requirement for the company to maintain a minimum public float under the Securities Contracts (Regulation) Rules, 1957 (currently 25%) would continue to be met even if the general public shareholding (other than the erstwhile promoter) falls below 25% pursuant to the open offer. While this would be a welcome step, it remains to be seen what the regulator notifies finally!
The other two scenarios, i.e., a separation agreement between promoters and a reduction in shareholding below 5% are far more regulated like a cooling period of three years for separating promoters to be counted towards the 25% public float requirement. In addition to this, promoters/promoter groups whose shareholding falls below 5% must have been declared to be promoters for a minimum of three financial years prior to date of reclassification and must not form part of the ‘promoter group’ of the continuing promoters. The stringency of these requirements can be understood, given the potential for abuse in a situation where promoters/promoter groups use the above relaxations to structure and disaggregate their promoter group shareholding to reclassify certain members as public shareholders. That being said, the cooling off periods suggested significantly deincentivise the reclassification in these scenarios.
The larger idea of control as viewed by Sebi also seems to be moving away from rights tied solely to the holding of equity. Regressively though, the discussion paper does not permit for any shareholders agreement or arrangement, which would be typical for a shareholder holding a significant chunk of equity. What this would imply for an acquirer’s negative/veto rights remains to be seen.
The regulators efforts are commendable and, provide a clear road for the transition. What will be interesting to see is the view the regulator will take where all conditions may not be satisfied and, discretion may be required for dispensation of the requirements!
Assisted by Rishabh Gupta, associate, J Sagar Associates, Advocates and Solicitors
The author is Partner, J Sagar Associates, Advocates and Solicitors. Views are personal