Yesterday’s board meeting at SEBI was not expected to generate any substantial decision owing to the impending change of guard at the regulatory institution. True to expectations, key matters such as amendment to the Takeover Regulations and implementation of the Jalan committee report on stock exchanges and other market infrastructure institutions were deferred. However, SEBI expressed its policy stance on a significant matter, which, if accepted, will denote a paradigm shift in Indian corporate jurisprudence.
The relevant paragraph of the press release of SEBI’s board meeting is as follows:
However, the current legal regime appears to focus almost entirely on disclosure of RPTs. For example, there is great emphasis on disclosure of related party transactions in financial statements of companies, and most of the detail regarding disclosures is governed by the relevant accounting standards. There is little prohibition or restriction on the ability of companies to carry out RPTs. Moreover, there are arguably inherent deficiencies in current law being able to capture RPTs, and particularly with controlling shareholders. First, controlling shareholders are not subject to conflicts of interest. Unlike directors, company law allows controlling shareholders to vote on resolutions even in situations involving conflicts. Second, company law does not foist controlling shareholders with duties (such as fiduciary duties). In that sense, they can exercise their voting powers in their own interests rather than in the interest of the company, as they are not in any fiduciary capacity.
SEBI’s proposal in yesterday’s board meeting seeks to address the first issue above, i.e. to impose conflict of interest on shareholders. This is a welcome move because it addresses the realities of Indian corporate ownership structures where RPTs are rampant. In the post-Satyam scenario, the issue of RPTs has perhaps received less attention than it deserves. Spotlight has been thrown on other matters of corporate governance such as board independence, and role and liability of auditors. The proposals have arguably resulted in a scenario by which, if the recommendations of the Task Force are accepted, there would be regulatory micromanagement of corporate boards in India. SEBI’s current proposal does well to renew the focus back to the issue of RPTs.
Of course, like any legislative proposal, the devil lies in the detail. Questions will arise as to how to define an “interested shareholder”, “related party transactions” and whether there should be thresholds of materiality, and the like. If the proposal is accepted, these issues will have to be carefully framed and legislated.
Curiously enough, the impetus for introducing the concept of an “interested” shareholder has emanated from SEBI (as the securities regulator) rather than at the legislative level (involving company lawmakers). SEBI’s efforts have been consistent even in past practice where it required interested shareholders to abstain from voting: e.g. when it granted certain exemptions under the Takeover Regulations, when it issued the Delisting Guidelines (which require 2/3rds majority of disinterested shareholders), and in certain other orders it has passed where it expressed the desire to see disinterested shareholding voting (see one instance here). While SEBI possesses the power to regulate listed companies (and has been exercising this power as indicated above), its plea to the Ministry of Corporate Affairs signals an interest in universal applicability of the rule to even unlisted companies.
This proposal raises interesting issues involving corporate jurisprudence, but whether it will pass muster in Parliament is yet another matter.
(Update - February 18, 2011: Please also see Somasekhar Sundaresan's column in the Business Standard)
The relevant paragraph of the press release of SEBI’s board meeting is as follows:
4. Recommendation to MCA on related party transactions:Following the Satyam episode, numerous recommendations were made for strengthening the regime governing “related party transactions” (RPTs), particularly in listed companies. This is not surprising given the corporate structure of Indian companies, where group holding structures, pyramiding and tunneling are commonplace with significant influence wielded by controlling shareholders (or promoters). Given such structures, RPTs are inevitable.
SEBI will recommend to the Ministry of Corporate Affairs to suitably amend Clause 166 of the Companies Bill, 2009 to disallow interested shareholders from voting on the special resolution of the prescribed related party transaction. This will protect small and diversified shareholders in listed companies from abusive related party transactions. This view was taken based on the learning from the investigation in the matter of Satyam Computer Services Limited.
However, the current legal regime appears to focus almost entirely on disclosure of RPTs. For example, there is great emphasis on disclosure of related party transactions in financial statements of companies, and most of the detail regarding disclosures is governed by the relevant accounting standards. There is little prohibition or restriction on the ability of companies to carry out RPTs. Moreover, there are arguably inherent deficiencies in current law being able to capture RPTs, and particularly with controlling shareholders. First, controlling shareholders are not subject to conflicts of interest. Unlike directors, company law allows controlling shareholders to vote on resolutions even in situations involving conflicts. Second, company law does not foist controlling shareholders with duties (such as fiduciary duties). In that sense, they can exercise their voting powers in their own interests rather than in the interest of the company, as they are not in any fiduciary capacity.
SEBI’s proposal in yesterday’s board meeting seeks to address the first issue above, i.e. to impose conflict of interest on shareholders. This is a welcome move because it addresses the realities of Indian corporate ownership structures where RPTs are rampant. In the post-Satyam scenario, the issue of RPTs has perhaps received less attention than it deserves. Spotlight has been thrown on other matters of corporate governance such as board independence, and role and liability of auditors. The proposals have arguably resulted in a scenario by which, if the recommendations of the Task Force are accepted, there would be regulatory micromanagement of corporate boards in India. SEBI’s current proposal does well to renew the focus back to the issue of RPTs.
Of course, like any legislative proposal, the devil lies in the detail. Questions will arise as to how to define an “interested shareholder”, “related party transactions” and whether there should be thresholds of materiality, and the like. If the proposal is accepted, these issues will have to be carefully framed and legislated.
Curiously enough, the impetus for introducing the concept of an “interested” shareholder has emanated from SEBI (as the securities regulator) rather than at the legislative level (involving company lawmakers). SEBI’s efforts have been consistent even in past practice where it required interested shareholders to abstain from voting: e.g. when it granted certain exemptions under the Takeover Regulations, when it issued the Delisting Guidelines (which require 2/3rds majority of disinterested shareholders), and in certain other orders it has passed where it expressed the desire to see disinterested shareholding voting (see one instance here). While SEBI possesses the power to regulate listed companies (and has been exercising this power as indicated above), its plea to the Ministry of Corporate Affairs signals an interest in universal applicability of the rule to even unlisted companies.
This proposal raises interesting issues involving corporate jurisprudence, but whether it will pass muster in Parliament is yet another matter.
(Update - February 18, 2011: Please also see Somasekhar Sundaresan's column in the Business Standard)