Key Highlights:
- India’s securities regulator is considering shifting its focus from “promoters” to “persons in control”.
- In-house counsel need to understand the proposed changes and consider the implications for their organization.
- New public disclosure rules should be examined by in-house counsel to make sure their organizations’ practices are in line with reporting obligations and are also protecting the company’s assets.
Context of the Proposed Shift
Indian securities law has focused on regulating, holding accountable, and penalizing “promoters” (as defined below), because concentrated family-owned businesses have been the prevailing business model so far in India.
The Securities and Exchange Board of India (the “SEBI”) defines a “promoter” to include any person: (a) who has been identified as a promoter by the company in its offer documents or annual returns; (b) who has direct or indirect control over the affairs of the company whether as a shareholder, director or otherwise; or (c) in accordance with whose advice, directions or instructions, the board of directors of the company is accustomed to act.
As an increasing number of technology start-ups and other professionally-owned and managed companies have been seeking to list on the Indian stock exchanges, the SEBI has recently been working on a regulatory shift away from the concept of promoters, and has issued a consultation paper seeking public views on this issue. As of now, the SEBI’s proposals are restricted to the listing regulations.
Changes in the Listing Regulations
Set out below are the changes proposed by the SEBI in the consultation paper.
1. Shift from promoters to persons in control or controlling shareholders
The most important change proposed by the SEBI is to move away from a promoter-focused framework to one focused on “persons in control or controlling shareholders.” As reflected in the definition above, promoters can include a wide array of persons, and at times, go beyond the persons who are in actual and effective control of the company.
For instance, shareholders who hold a controlling stake at the time of listing are required to be classified as promoters. However, after the company is publicly listed, in many instances, these shareholders are diluted to a minority stake with no controlling rights. While such shareholders are no longer able to exercise any control over the company, they often continue to be classified as promoters due to the disclosures made in the offer documents.
The consultation paper does not specify the manner in which the conceptual change will be implemented, and has invited suggestions from the public on this issue. The SEBI has, however, acknowledged that consequent changes will have to be made to several securities laws, including the corporate governance, insider trading and takeover regulations, all of which are promoter centric, as well as other Indian corporate laws.
For instance, the SEBI imposes a number of onerous periodic disclosure requirements on promoters. Further, from an enforcement perspective, the SEBI imposes liability on promoters for several types of non-compliance of a listed entity. Therefore, a shift in focus away from promoters will require in-house counsel of listed Indian entities to reassess the incidence of a number of key requirements under India’s securities regime, and to identify the persons who will be subjected to the additional liability and obligations by virtue of their control over the listed entity.
If a shift is implemented, in-house counsel must liaise with the persons identified by the SEBI and the company’s management, in order to apprise them of the additional obligations. Such an approach will help to ensure that the company complies with its legal obligations and prepare the persons in control for a change in their responsibilities.
2. Reduction of the lock-in periods for pre-issue capital
Currently, the promoters of a company proposing to list its shares are required to hold at least 20% of the post-issue capital as the minimum promoters’ contribution (the “MPC”). Further, promoters and other persons who own shares of such company since prior to the initial public offer (the “IPO”) are subject to post-issue lock-in restrictions.
The SEBI has proposed a reduction in the lock-in periods as described below.
- MPC, if the object of the public issue involves an offer for sale or financing requirements other than capital expenditure for a project: Lock-in period of three (3) years to be reduced to one (1) year from the IPO. Further, if the company is unable to meet its minimum public shareholding requirements, the lock-in period will be further reduced to six (6) months to permit promoters to dilute their holdings below the MPC solely to enable the company to meet the minimum public shareholding requirements; and
- Promoter’s shareholding in excess of MPC and pre-IPO shares held by persons other than promoters: Lock-in period of one (1) year to be reduced to six (6) months from the IPO.
If the SEBI implements this change, in-house counsel of entities proposing to list in the Indian market must liaise with the board of directors, the promoters and other key shareholders and inform them of the reduced lock-in requirements. Such an approach will help to ensure that if pre-IPO shareholders seek to exit the entity soon after listing, the company is able to prepare for the impact of their exit on its operations and management.
3. Definition of “promoter group”
The SEBI proposes to reduce the scope of the “promoter group” concept and, consequently, the disclosure obligations in relation thereto. In this regard, the listing regulations currently define the term “promoter group” to include, inter alia, any corporate entity in which a group of individuals, companies or combinations thereof, acting in concert, holds at least 20% of the equity share capital, and such group, acting in concert, also holds at least 20% of the equity share capital of the company proposing to list its shares. In its consultation paper, the SEBI has proposed to exclude the foregoing category of corporate entities from the definition of promoter group.
The revised definition of promoter group will have an impact on the disclosure requirements of the listed entity, such as the periodic disclosures of shareholding and of transactions entered into by the listed entity with such corporate entities. Therefore, in-house counsel of listed Indian entities will need to guide their clients through the revised disclosure obligations, and assist in amending their corporate governance policies to ensure that the listed entity is complying with the revised requirements.
4. Disclosure of group companies in offer documents
Currently, a company seeking to list its shares is required to disclose extensive details of the largest group companies (in terms of turnover/topline), including the nature of the business, equity capital, reserves, sales, profit after tax, earnings per share, net asset value, and pending litigation involving the group company which has a material impact on the listing entity.
In addition to the concept of the promoter group, the SEBI is also proposing to do away with the extensive disclosures required to be made in respect of group companies in the IPO offer document. Therefore, a company will only have to disclose the name and registered office address of all its group companies in the offer document, and other details can be made available on the website of the company.
The revised disclosure norms will have an impact on the offer documents filed by a company proposing to list its securities in the Indian market with the SEBI. In-house counsel of such entities will need to guide their clients through the revised structure of the offer documents. They will also need to liaise with the entity’s management to identify such group companies accurately, and to ensure that the client complies with the listing obligations.
Questions Raised by the Proposed Changes
The consultation paper raises a pertinent question. Has India’s securities market and investors matured enough to accommodate this change? The SEBI appears to be in favour of this change and has cited several reasons in the consultation paper.
First, the SEBI has suggested that the broad definition of promoters results in regulatory obligations for persons who may no longer be in control of the listed entity. Further, institutional investors who acquire control of the listed entity may not be clearly categorized as promoters. This observation by the SEBI is correct: Listed companies in India focus on disclosing the majority owners (and not persons in control) as the promoters even though the definition of promoters currently focuses on both, ownership and control.
At the same time, the SEBI has recently declined to define or lay down parameters for the term “control” on any objective basis, and therefore, identification of persons in control and the controlling shareholder is subjective. Hopefully, the SEBI will consider providing an objective test for “control” if the focus has to be shifted from promoters to persons in control or controlling shareholders. Else, listed companies will stand to be questioned by the SEBI.
In the absence of an objective test, in-house counsel of entities listed in India will have to consider the subjective standards for control adopted by the Indian judiciary and regulators, and assist their clients in identifying the relevant persons who will be deemed to be in control of the company.
Second, the SEBI has also questioned the relevance of promoters, given the rise in institutional investments that has led to a shift towards more professionally run businesses in India. For this, the SEBI has cited that promoter shareholding in the top-500 listed companies fell from 58% in 2009 to 50% in 2018 and institutional investor stake increased from 25% to 34% in the same period. In the authors’ view, these statistics do not indicate a change significant enough to do away with the concept of promoters.
In India, professionally managed companies form a small percentage of the total number of companies seeking to list, which are largely family-owned and controlled at the time of listing and for a couple of years thereafter. While Indian business are moving toward governance standards seen in the West, the Indian market today remains a hybrid of both worlds. As mentioned above, a shift in focus away from promoters will require in-house counsel of listed Indian entities to reassess the incidence of a number of key requirements under India’s securities regime.
Third, the SEBI has suggested a change in the lock-in requirements due to the change in the nature of businesses that have listed in recent years. Historically, companies raised public capital for financing greenfield projects. In contrast, companies listing in recent years have been well-established mature businesses with pre-existing institutional investors. The SEBI has also observed that a majority of promoters do not materially sell their shares even after the expiry of the lock-in period.
However, the authors believe that a blanket reduction of lock-in requirements may not be appropriate for the Indian market, as it will incentivize pre-issue shareholders to reduce their shareholding on the basis of their listing gains. The lock-in requirements ensure that promoters continue to have a stake in the company after raising public funds and to ensure confidence among public shareholders. As such, the reduction of the lock-in period may not give comfort to public shareholders and prospective Indian investors, who often look to the founders of the company to continue to have a substantial shareholding post-listing.
In-house counsel of entities seeking to list in the Indian market must therefore advise the promoters regarding the lock-in requirements prior to making an application for listing the company’s securities. This approach will help to ensure that if the promoters are planning to reduce their shareholding soon after listing, they are able to plan their exit in a manner that mitigates the risk of a negative perception amongst prospective investors regarding the company’s business prospects.
The dilution of the requirement of disclosure of group companies in the IPO offer document seems to be irrelevant, as these details will have to be made available on the website of the company seeking to list. Moreover, it is important for investors, specifically at the IPO stage, to understand not only the company seeking to list but also the entire group, in order to make an informed decision.
Conclusion
Overall, the Indian securities market may not as yet be ready to adopt the proposed changes. Besides the concerns above, at first, it would be beneficial if the SEBI and other Indian regulators, such as the Ministry of Corporate Affairs, the Reserve Bank of India, and the Competition Commission of India, worked in tandem to provide a uniform and objective definition of “control.” If the definition adapts and works to identify key persons in control, the SEBI would then be in a better position to look towards moving away from a regime focused on the promoter concept to a regime based on the notion of persons in control.
Authors: Rukshad Davar, Partner, Kritika Agarwal, Associate Partner and Rahul Datta, Associate, Majmudar & Partners, India
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