Inter Se Promoter Exemption for Takeovers: Computation of Holding Period

A few days ago, SEBI made public its informal guidance issued to Weizmann Forex Ltd. on October 25, 2012. In this case, the target company became listed only in 2011 due to a corporate restructuring process. The question was whether certain shareholders can avail of the exemption for inter se promoter transfer by taking into account the promoter holdings in the previous company from which the business was restructured into the target. Qualifying for the exemption requires that both the transferor and transferee should have been disclosed as promoters of the target company for at least 3 years. SEBI adopted a purposive interpretation to answer in the affirmative thereby making the exemption available in that case even though the parties did not technically satisfy the condition.

Facts

The relevant facts can be gathered from the company’s requestto SEBI. Weizmann Forex Ltd., the target company was previously an unlisted company with the name Chanakya Holdings Ltd. As part of an overall restructuring of the Weizmann group, which involved many other legs that are not directly relevant for our present purposes, the forex business of Weizmann Ltd. (the demerged company), being a listed company, was demerged into Weizmann Forex Ltd. (the resulting company). As part of this restructuring process, Weizmann Forex’s shares were listed on the stock exchanges. The promoters of Weizmann Forex intend to transfer certain shares of Weizmann Forex among themselves and hence approached SEBI for informal guidance.

Under Reg. 10(1)(a)(ii) of the SEBI Takeover Regulations, there is an exemption from a mandatory open offer for transfer of shares inter se among qualifying persons being “persons named as promoters in the shareholding pattern filed by the target company in terms of the listing agreement or [the takeover] regulations for not less than three years prior to the proposed acquisition.”

In the present case, none of the proposed transferors of shares were able to satisfy the requirement of being named as promoters in Weizmann Forex as they acquired shares in that company only under the restructuring process. However, if their shareholding in the demerged company (Weizmann Limited) were taken into account for the purpose of computation of the 3-year period, they would satisfy the requirement. Similarly, the transferees too were unable to satisfy the 3-year period of being named as promoters in Weizmann Forex. While one of the transferees held shares for a 3-year period across the two companies (similar to the transferors), the other transferee did not satisfy the 3-year period across two companies (on a combined basis) either.

The issue for SEBI’s consideration was whether, given these facts, the proposed transfer of shares among promoter was exempt from the mandatory open offer requirements under Reg. 10(1)(a)(ii).

SEBI’s Informal Guidance

In interpreting the Takeover Regulations, SEBI considered the 3-year holding period of the transferors and transferees by looking at their holdings on a combined basis in Weizmann Ltd. and Weizmann Forex Ltd. even though they may not have satisfied the requirement strictly with reference to Weizmann Forex Ltd., which is the target company.

Moreover, as far as the transferees are concerned, SEBI’s guidance goes one step further. Even though one of the transferees has not satisfied the 3-year holding period requirement, the exemption has been made available to it. SEBI reasons as follows: “The condition of 3 years shareholding by the transferees prior to the proposed acquisition would be deemed to be fulfilled in case all the transferees collectively hold shares for a period of 3 years prior to the proposed acquisition provided the other conditions for availing the exemption are fulfilled.”

Analysis

In interpreting the Takeover Regulations, SEBI had adopted a purposive approach in making the exemption available to the parties, as opposed to a literal or technical approach that may have denied this facility to the parties. By taking into accounting the shareholding of the parties in the demerged company, necessary consideration has been placed on the demerger transaction, which is essentially a restructuring of businesses and shareholdings as opposed to a complete transfer or sell-out of the business. In other words, it is considered a purely internal group restructuring.

Such an approach is not unusual. For instance, the Income Tax Act, 1961 considers such demerger transactions (provided certain other conditions are satisfied) as a restructuring (rather than a pure sale) and confers certain benefits in terms of exemptions from capital gains tax. More specifically, for the purpose of computing the holding period, the period of shareholding by a shareholder in the demerged company will be considered at the time of sale of shares in the resulting company. The present interpretation of SEBI brings the holding period under the Takeover Regulations on par with such a regime, which is understandable in the context of restructuring transactions and the purpose of the holding period for purpose of exemption under the Takeover Regulations. The only difference is that the Income Tax Act expressly provides for such treatment, while under Takeover Regulations it is only by virtue of the interpretation adopted by SEBI in this case.

However, in the case of the transferee, to the extent that SEBI finds that all the transferees may collectively satisfy the holding period requirement, it is perhaps providing a fairly liberal reading. This seems to suggest that where there is a group of transferees, it might be sufficient if one or more of the transferees satisfy the holding period requirement, and it is not necessary for each one of them to satisfy it. This might provide greater options to structure transfers that may avail of the inter se promoter exemption. At the same time, it may be argued that this is too much of a stretch of the Regulations, and could be subject to potential misuse.

SEBI’s Recent Securities Markets Announcements

Last week, SEBI took certain decisionsin the form of minor reforms to the securities markets, both primary and secondary.

As part of a process that began nearly 3 years ago, SEBI has further liberalized the process for dilution of promoter shareholding in listed companies, since a deadline of June 2013 has been set to ensure minimum level of public shareholding in listed companies. This time, some measures have been adopted to make the “offer for sale through stock exchange mechanism” more efficient. While such measures may make such options more attractive, it is not clear if SEBI’s objective can be achieved within the timeframe given that several companies are yet to comply with the minimum public shareholding norms. It looks likely that SEBI’s enforcement mechanism and its determination in ensuring compliance will be put to rigorous test in a few months.

Some changes have also been suggested to SEBI’s Takeover Regulations that were promulgated in 2011. Several of them are clarificatory in nature or intended to address discrepancies or the lack of clarity that was experienced ever since the new regulations came into effect. However, one of the long standing critiques of the Takeover Regulations pertaining to their lack of appropriate fit with the delisting process has not been addressed in this round despite assurances from SEBI to relook at this issue.

Another announcementthat came last week relates to the implementation of the curbs imposed on acquisition of shares by employee trusts in the secondary markets. SEBI’s decision and rationale were analyzed previously (here). Therefore, now any form of employee stock option or share purchase scheme must necessarily involve the issue of new shares from the company.

SEBI’s Proposal to Overhaul Corporate Governance Norms

SEBI has issued a consultative paper that reviews corporate governance norms in India with a view to overhauling them considering developments in the Indian corporate sector over the last few years. The paper is quite detailed and is expected to generate a great amount of discussion, which would be considered by is SEBI before implementing any revised norms. Suggestions are due on the consultative paper by January 31, 2013.  The purpose of this post is not to consider the detailed recommendations in-depth, but to simply provide some broad observations that would set out the context for a more detailed analysis.

Clause 49 of the listing agreement has been the mainstay of corporate governance in India for more than a decade. Although such norms are expected to be dynamic in nature and consistent with the ever-changing corporate scenario, clause 49 was previously subject to detailed review way back in 2004, even though the revised norms came into effect only in January 2006. Since then, despite significant developments such as the Satyam corporate governance scandal, there was no review of clause 49, and no concentrated efforts were undertaken by SEBI. However, most of the changes or proposals came from the Central Government. Notable among them are the Ministry of Corporate Affairs’ voluntary guidelines of 2009, and substantial insertions on corporate governance issues in the Companies Bill, 2011, which has been approved by the Lok Sabha and is awaiting consideration by the Rajya Sabha. There has been a fear that such a multiplicity in the regulatory process would cause considerable inconsistency between the various regulations regarding corporate governance that have been issued by different regulators.

Given this background, SEBI’s proposals seek to achieve two broad objectives: (i) to bring the provisions of clause 49 on par with the proposals made in the Companies Bill, 2011; and (ii) to make additional recommendations that impose a more stringent regime for listed companies.

On the first count, the consultative paper sets out a detailed comparative analysis of clause 49 and the Companies Bill, 2011, and makes proposals for ensuring parity in the two regimes. It also contains a detailed comparative table, which provides a useful tool to understand the various corporate governance norms in India. Of course, on certain matters the proposed changes go beyond the Companies Bill in the case of listed companies, which is understandable given the large shareholder population in such companies. The proposals, however, proceed on the assumption that the Companies Bill will become operational soon. In case there is any delay on the passage of the Bill, it is necessary to ensure that SEBI’s proposals will be given effect to nevertheless.

On the second count, the consultative paper makes some additional recommendations, which are welcome. As some of us have argued in the past, the current governance norms in India have been borrowed from Western jurisdictions where the corporate structure consists of diffused shareholders with no concentration of shareholding. However, the corporate structure that is predominant in India consists of controlling shareholders.  Given the mismatch of corporate structures, it was argued that the current governance norms do little to protect the interests of the minority shareholders. This critique has been given the required attention in the current round of reforms, with proposals specifically being made to address the corporate structure that is replete in Indian companies. Examples of these proposals include minority shareholder participation in the election of independent directors, detailed treatment of related party transactions, and the like. The proposals on this account are fairly radical, and it remains to be seen how much of it will actually be accepted given that there is likely to be tremendous resistance to greater power to minority shareholders to the diminution of power of the controlling shareholders. The novelty of these proposals lies in the fact that this issue has now emerged to the forefront for discussion and deliberation.

There is certainly a lot in the consultative paper, and if accepted, many of these proposals could result in significant change in the manner in which companies are governed. At the same time, it is important to note that such norms would become effective only if they are properly implemented and enforced by the regulatory authorities. 

Proposed modifications to buyback provisions

SEBI has just placed a discussion paper on its website entitled “Proposed modifications to the existing framework for buy back through open market purchase” for public comments. Comments on the discussion paper have been solicited on or before January 31, 2013.

Upon a review of the current regulations and studying the market dynamics, the key recommendations of the discussion paper are set out below:

1. The merchant bankers should be advised to ensure that a minimum of 50% of the maximum buy-back proposed/disclosed to be bought back.
2. It is proposed that companies complete the buy back in 3 months. To ensure that only serious companies launch the buyback program, it is further proposed that these companies be mandated to put 25% of the maximum amount proposed for buyback in an escrow account.
3. It is proposed that listed companies coming out with buyback programs may not be allowed to raise further capital for a period of two years.
4. In order to ensure that the companies do not launch buyback programs for stabilizing the share price, it is proposed that companies who are not able to buy back 100% of the proposed amount (or the proposed maximum number of shares) may not be allowed to come with another buyback for a period of at least one year irrespective of the mode of approval for buy back.
5. It is also proposed that buy-back of 15% or more of (paid up capital + free reserves) must be only by way of a tender offer method.
6. It is proposed that the issuance of shares pursuant to obligations arising out of Employee Stock Option schemes may be allowed during the buy-back period subject to the following: (a) the shares are not allotted to directors and key managerial personnel of the company; (b) there is no acceleration in the vesting period.
7. It is proposed that the companies shall extinguish/ destroy shares bought back during the month, on or before fifteenth day of the succeeding month subject to the companies destroying the bought back shares in the last month within seven days of the completion of the offer.
8. The current regulations prohibit the promoters of the company in dealing in the securities of the company during the period when buy back is open. It is proposed to extend this restriction to dealing in the securities of the company off–market as well.

SEBI penalises front-running again, does not follow SAT’s order

There is yet another Order of SEBI on front running and SEBI holds that transactions in the nature of front running are violative of the PFUTP Regulations. This is close after SAT’s recent ruling (“the Patel Order”) holding that front running cannot be punished, as discussed by me here, and another later ruling by SAT (“the Karkera Order”) as discussed by Mr. V. Umakanth here. By an Order dated 19^thDecember 2012, the Adjudicating Officer levied penalty of Rs. 25 lakhs on the persons who allegedly made profit of Rs. 7.16 lakhs from transactions that fit the description of what are popularly known as front running transactions.

The facts of the present case, being substantially similar as in earlier cases, need not concern us here to avoid repetition. What is interesting is that, despite the parties drawing attention to the ruling of SAT holding that front running does not amount to violations of the PFUTP Regulations, SEBI has held that it is still punishable under the said Regulations.

It may be remembered that SAT quite clearly held that transactions in nature of front running are punishable under the PFUTP Regulations only if committed by an intermediary and not by others. More specifically, it held that, in absence of any specific provision of law in securities laws, such transactions by non-intermediaries are not punishable at all. To quote the Hon’ble SAT from the Patel Order:-

“In the absence of any specific provision in the Act, rules or regulations prohibiting front running by a person other than an intermediary, we are of the view that the appellants cannot be held guilty of the charges levelled against them.”.

This ruling was followed explicitly in the later SAT ruling in the Karkera Order.

The parties accused in this case did cite the Patel Order before SEBI. However, interestingly, SEBI did not accept this ruling to give relief to the accused on the following ground:-

“The Noticees have even produced the judgment of the Hon'ble Securities Appellate Tribunal in Dipak Patel Vs. The Adjudicating Officer (SAT Appeal No. 216 of 2012 decided on 09/11/2012) in which Regulation 4(2)(q) of PFUTP Regulations, 2003 has been interpreted by the Tribunal. However, the present case does not deal with the violation of the said Regulation but Regulation 3 (a), (b), (c) & (d) and 4(1) of PFUTP Regulations, 2003. The CBI deals in shares on its own account and on behalf of its customers. CBI is a publically listed company and any loss incurred on its investments adversely would affect the interests of its own shareholders and customers. Therefore, the fraudulent and manipulative activities of the Noticees fall upon the CBI and its customers and ultimately on the investors of the securities market. In other words, the undue profits earned by the Noticees are nothing but the losses to them.”

Though not specifically made clear, it does appear that Central Bank of India (the employer of one of the noticees) is not an intermediary. If this is the case, then the SAT rulings would directly apply. The statement of SEBI that “the present case does not deal with the violation of the said Regulation” (i.e., 4(2)(q)) is not valid, in context of the SAT rulings as a whole, particularly the words reproduced earlier.

Moreover, the Patel Order did cite and discuss the provisions of Regulation 3(1) (a) to (d) of the PFUTP Regulations.

The point of SEBI that CBI is a publically listed company and so loss incurred by it would be borne by its shareholders may sound valid but this may imply that if there were no such public shareholders, front running would not be a violation. Same concern can be raised for the point that such transactions affect the interests of its customers. Also, to reiterate, this still does not deal with SAT’s ruling that in absence of specific provisions for non-intermediaries, front running cannot be punished.

An opportunity was thus lost to discuss and analyse the provisions individually and in detail relating to fraud and unfair trade practice in the PFUTP Regulations and apply the same to such cases. Instead, as in earlier case, several provisions were merely cited together and the noticees held to have violated them.

This decision also raises again a long standing concern about the non-binding nature in law of SAT decisions as precedents on SEBI. This concern particularly arises because the next appeal after SAT is straight to the Supreme Court.

The ruling of SAT in the Patel Order (and, so, the Karkera Order too) is of course dissatisfactory, and the concerns it raises have already discussed earlier here. One hopes that this issue is resolved soon by appeal to the Supreme Court and/or amendment to the law. For such Orders as the present one are satisfactory neither as practice, nor as precedents for other cases in other contexts.

Another SAT Order on Front Running

Last month, Mr. Jayant Thakur had discussedan order of the Securities Appellate Tribunal (SAT) in the case of Dipak Patel where SAT interpreted the SEBI (Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Markets) Regulations, 2003 (the “PFUTP Regulations”) to mean that front running is not a crime unless it is committed by an “intermediary”. Mr. Thakur’s post points to the difficulties in interpreting the PFUTP Regulations. There has been a significant discussion of this decision, and examples include Yash Bansal & Sandeep Parekh, Professor J.R. Varma and Mobis Philipose.

Earlier this week, the SAT has followed an identical approach in another case pertaining to Sujit Karkera, Shilpa Kotak and Purushottam Karkera. The facts are that parties traded in 3 scrips through B P Equities Pvt Ltd in advance of trades by Citigroup Global Markets in those scrips. Evidence suggests that the parties had prior knowledge of the Citigroup trades that was obtained from a trader of Citigroup, Suresh Menon. The facts clearly suggest a case of front running, and SAT is unequivocal regarding the factual circumstances:

5. … The facts on record establish that there was constant flow of information to the appellants from Mr. Suresh Menon and the telephonic conversation related specifically to the order, place, time and quantity of the scrips transacted. On a consideration of the facts on record and the material relied on by the adjudicating officer we have no hesitation in holding that the alleged transactions of the appellant are in the nature of “front running”.

However, SAT was hamstrung by the technicalities of its previous decision in Dipak Patel, and quashed SEBI’s imposition of fine because the parties involved were not “intermediaries” under the PFUTP Regulations. SAT simply followed its own precedent.

Despite the critique of this approach, it appears that SAT would be constrained from making any departures considering that this technicality is well entrenched in its reasoning given these precedents. Hence, any departure to a wider interpretation could only come by way of an appeal by SEBI to the Supreme Court, or alternatively an amendment by SEBI to the PFUTPRegulations to clarify the position.

RTI Act and SEBI Investigations

This is a bit dated (academic duties prevented regular blogging over the last few weeks), but on November 6, 2012, the Chief Information Commissioner (CIC) passed an order requiring SEBI to provide information regarding its investigation “into allegations of insider trading and short sale of shares pertaining to the shares of Reliance Petroleum in 2007”. The order was passed in response to an application in public interest by Mr. Arun Kumar Agrawal.

The key questions pertained to whether any such obligations would interfere with the regulatory and investigative functioning of SEBI and how these would pan out in the context of SEBI’s consent order process. The CIC was unconvinced by SEBI’s arguments on this count and rationalized his decision as follows:

After carefully considering the facts of the case and the submissions made before us, we are inclined to agree to the demand of the Appellant that the disclosure of this information would serve a larger public interest. If as a regulator, the SEBI took cognizance of allegations of any breach of law, rules or regulations by one or more entities for unlawful private gain, the information generated in the process of its investigation needs to be disclosed in the public domain. Such disclosure would keep the general public informed and educated about the risks they may confront in making investments in the market. It would also prevent many entities from adopting shortcuts to make profit through unlawful means. The argument that at the end of the quasi-judicial proceedings, the charged entities may be found innocent cannot be an argument against disclosing the information. This becomes especially important as the SEBI has also initiated consent order mechanism on the request of party involved and the breach and violations found in the investigation could be settled through a consent order thereby nullifying the likely penalty which would have visited the party involved at the end of the quasi-judicial proceedings.

There is a dichotomy in terms of the concerns this raises. On the one hand, it is clearly in public interest that the process is carried out in a transparent manner. On the other hand, it is equally important that the process is carried out smoothly in the interests of justice in a given case without excessive interference. Moreover, the consent order norms have been recently revised (as discussed here) and would in any case induce greater certainty and transparency in the process and eschew a possibility of arbitrariness.

These are important questions, and will likely be considered when they are taken up by the Delhi High Court and the Bombay High Court, where appeals have been preferred against the orders of the CIC. In the meanwhile, there is an interesting conversationon this issue in the recent episode of The Firm.

Should Government Companies Be Exempt From the Takeover Regulations?

Today’s Business Standard carries a reportindicating that SEBI is in the process of considering a general exemption to the Government from making a mandatory open offer under SEBI’s Takeover Regulations 2011. This comes in the wake of two specific exemptions granted by SEBI this year in the case of IDBI Bank and IFCIwhereby the Government was given special dispensation from making an open offer when it increased its stake in the companies due to conversion of securities into equity shares.

Currently, under the 2011 Regulations, SEBI has the power to grant exemptions on a case-by-case basis, which it has exercised in the two cases mentioned above. But, any grant of blanket exemptions to the Government would be a retrograde step. There is no compelling reason for the Government to be treated on a special footing compared to private acquirers because the Regulations are in the end analysis concerned with the protection of minority shareholders in a listed company. By creating such an exemption, SEBI would be discriminating against shareholders of government companies, as they would lack an exit opportunity through an open offer that is available to shareholders in non-government companies.

Moreover, the grant of such dispensation to the Government does not augur well in terms of ensuring compliance with securities regulation in the interest of investors. The Government ought to be setting an example by undertaking the obligations under securities regulation such as the Takeover Regulations and paving the way for ensuring compliance by private acquirers, thereby protecting the interests of minority shareholders in public listed companies. This method of carving out special provisions for government companies, that began with the lower minimum shareholding of 10% rather than the larger 25% limit for other companies, stands no reason when judged against the purpose of the Takeover Regulations, which is to provide an equal exit opportunity to minority shareholders when there is a change in control of the company.

Such moves could give rise to governance implications in a broader sense. For example, there is already a dispute over the governance matters in Coal India Limited between the Government, which is the controlling shareholder, and a minority shareholder, which has also resulted in litigation that is pending before the Indian courts. Such matters could also be significant in the context of the government disinvestment programme where the limitation of protection to minority shareholders in listed companies substantially owned by the Government could impact the success (or otherwise) of such programme.

It would therefore be preferable for SEBI to exercise the power of exemption on a case-by-case basis as per the current practice. That would not only provide the flexibility to deal with specific circumstances such as those that arose in the IFCI and IDBI Bank cases, but at the same time it would require SEBI to apply its mind to individual cases rather than to deal with them on an overall basis as proposed.