Infrastructure Development Fund

The Ministry of Finance has issued a press release that paves the way for setting up  “Infrastructure Debt Funds (IDFs) in order to accelerate and enhance the flow of long term debt in infrastructure projects for funding the government’s ambitious programme of infrastructure development.” IDFs are envisaged to be suitable vehicles that enable raising debt to finance infrastructure projects.

The Ministry’s proposal contemplates two organizational structures for IDFs. The first is a vehicle in the form of a mutual fund using the traditional trust structure. The second is a company structure that is established in the form of a non-banking finance company (NBFC). Due to the nature of regulation governing the two types of entities, an IDF set up as a mutual fund (trust) will be regulated by Securities and Exchange Board of India (SEBI), while an IDF set up as an NBFC will be regulated by the Reserve Bank of India (RBI).

Although the proposal to set up IDFs is laudable and could result in obtaining the require finance to develop infrastructure, the nature of dual regulation could result in problems in implementation and also regulatory arbitrage. Past track record also indicates that overlapping jurisdiction of multiple regulators could cause confusion, as we have witnessed last year in the ULIP saga. Unless any other alternative is pursued, the Financial Stability and Development Council (FSDC) established a few months ago would have to bear the burden of coordinating policy-making among the different financial sectors regulators.

UK Bribery Act: Impact on Indian Companies

The UK Bribery Act 2010 is scheduled to become effective July 1, 2011 following the issuance of detailed guidance in March. This is expected to have a significant impact on Indian companies having a demonstrable business presence in the UK.

In this behalf, an article in the VC Circle by Saionton Basu and Tom Clark details the various steps to be taken by affected Indian companies to “review or implement anti-bribery procedures and policies”.

Discussion Paper on FDI Equity Caps

Continuing with its practice of engaging in public consultation before announcing changes to the FDI policy, the Department of Industrial Policy and Promotion (DIPP) has issued a discussion paper on “FDI Policy-Rationale and Relevance of Caps”. The discussion paper introduces the possibility of abolishing all sectoral caps for foreign equity shareholding below 49%.

Before dealing with the rationale of discussion paper, it would be necessary to identify the various rights available to shareholders at the different equity caps that currently operate under the FDI policy (which are identified in the discussion paper itself).

26% - ability to block special resolutions;

49% - shareholding falling short of control;

51% - availability of control rights (i.e. ability to appoint and remove directors); and

74% - inability to pass special resolutions (as remaining shareholders collectively hold the right to block).

The discussion paper provides a number of reasons for the move to abolish caps up to 49%. These require further consideration:

First, the paper relies on aspects of interpretation of the FDI policy. Specific reference is made to Press Notes 2, 3 and 4 of 2009 (discussed here and here) which permit Indian companies with ownership and control remaining with Indian hands to make downstream investments. In other words, an Indian company with 49% foreign investment can make downstream investments without restrictions on further equity holding. The current discussion paper adopts the stance that if foreign investment is indirectly permitted up to 49% in the holding company (where control remains with Indian hands), there is no reason to restrict direct holding in Indian companies to the extent of 49%. If something is permitted indirectly, there is no reason why it should not be permitted directly. The logic of this approach is that with a 49% cap on foreign shareholder, there is no “control” available to foreign investors under company law.

The above reasoning arises from an interpretation of previous policy established in 2009, rather than by way of any independent analysis. It flows from the viability or otherwise of previous policy. From a conceptual standpoint, the reason for limiting the analysis to 49% and below is not clear. The discussion paper seems to proceed on the basis that any shareholding up to 49% would provide same rights in respect of the company (i.e. the lack of control). If that logic were to be accepted, there is no merit in retaining separate caps and 51% and 74%, because the control rights at both those levels too are the same – namely that ordinary resolutions may be passed, but not special resolutions. It remains to be seen whether such differentiation in shareholding above 49% will be considered.

Second, the discussion paper seeks to reduce the effect of sectoral caps as they “also provide an opportunity for arbitrage to unscrupulous Indian partners, which certainly has a cost for the consumer and comes in the way of the country deriving optimal benefit of the FDI”. Interestingly, reliance in placed on a couple of newspaper editorials which make a case for removal of caps as they provide the Indian shareholders with distinct advantages.

Even here, the limitation of the discussion to caps up to 49% is not clear. In fact, the issue of sleeping partners deriving undue advantage will have greater play when the foreign shareholder has a higher stake than 50% and therefore is in control. Minority Indian partners in that scenario only make passive investments without participation in the management.

Third, the partial removal of equity caps is linked to ebbing FDI flows into India in the year 2010. Among several countries in a study cited by the discussion paper, India “is the only major country in South Asia where FDI inflows have fallen during 2010”. This concern has been significant in policy making even in liberalizing other aspects of the FDI policy.

Overall, the partial removal of sectoral caps will result in streamlining the FDI policy. Other areas where the discussion paper seeks to remove ambiguities relate to the requirement for foreign investors to offload equity within a stipulated period and in addressing the question as to whether the caps should (or should not) include investments by foreign institutional investors (FII).

Rule 10b-5 and the "Maker" of a statement: Janus Capital v. First Derivative

Last week, in a 5-4 verdict, the US Supreme Court once again narrowly interpreted Rule 10b-5, this time holding that only the “maker” of a false statement could incur 10b-5 liability: “maker” in this context being defined as “person or entity with ultimate authority over the statement.” The case, Janus Capital Group Inc. v. First Derivative Traders, reversed the Fourth Circuit's holding that liability under Rule 10b-5 could be more expansive. Justice Thomas delivered the majority opinion, with a strong dissent by Justice Breyer.

Briefly, the facts were that Janus Capital Group, Inc. (JCG) was a publicly traded company which created the Janus family of mutual funds. These funds were organized in a business trust, the Janus Investment Fund (JIF). JIF retained Janus Capital Management (JCM) to be its investment adviser and administrator. JCM was a wholly owned subsidiary of JCG. The issue before the Court was whether JCM could be liable in a private action under Rule 10b-5. The plaintiffs alleged that JCM had substantially caused the prospectuses issued by the Janus mutual funds to contain misleading statements, and on this basis argued that JCM could be liable under Rule 10b-5. The Fourth Circuit held in favour of the plaintiffs, holding that “[JCG and JCM] by participating in the writing and dissemination of the prospectuses, made the misleading statements contained in the documents.” [Emphasis in original] It was found that a reasonable investor could easily have inferred that “JCM played a role in preparing or approving the content of the Janus fund prospectuses.”

Rule 10b-5 makes it unlawful for “any person, directly or indirectly…  to make any untrue statement of a material fact”. By majority, on the basis of a literal reading of the word “make”, the Supreme Court reversed the Fourth Circuit. The majority opinion states:

“One “makes” a statement by stating it… For purposes of Rule 10b–5, the maker of a statement is the person or entity with ultimate authority over thestatement, including its content and whether and how tocommunicate it. Without control, a person or entity canmerely suggest what to say, not “make” a statement in its own right. One who prepares or publishes a statement on behalf of another is not its maker… This rule might best be exemplified by the relationship between a speechwriter and a speaker. Even when a speechwriter drafts a speech, the content is entirely within the control of the person who delivers it. And it is the speaker who takes credit—or blame—for what is ultimately said…”

Arguments based on the close relationship of the investment adviser and the funds were also rejected:

“For its part, [the plaintiff] suggests that the “well recognized and uniquely close relationship between a mutual fund and its investment adviser” should inform our decision… It suggests that an investment adviser should generally be understood to be the “maker” of statements by its client mutual fund, like a playwright whose lines are delivered by an actor. We decline this invitation to disregard the corporate form. Although First Derivative and its amici persuasively argue that investment advisers exercise significant influence over their client funds… it is undisputed that the corporate formalities were observedhere. JCM and Janus Investment Fund remain legally separate entities, and Janus Investment Fund’s board of trustees was more independent than the statute requires… Any reapportionment of liability in the securities industry in light of the close relationship between investment advisers and mutual funds is properly the responsibility of Congress and not the courts.”

Thus, only JIF was the maker of the statement in its prospectus, and its advisers, including advisors from within the same corporate group, could not be treated as “makers” according to the majority. Thus, Rule 10b-5 will not render third party advisers liable – the only liability is on the “maker” of the statement, being the person with ultimate responsibility for the statement.

[Justice Breyer’s dissent is based on a more contextual understanding of the word “make”: “… the majority has incorrectly interpreted the Rule’s word “make.” Neither common English nor this Court’s earlier cases limit the scope of that word to those with “ultimate authority” over a statement’s content. To the contrary, both language and case law indicate that, depending upon the circumstances, a management company, a board of trustees, individual company officers, or others, separately or together, might “make” statements contained in a firm’s prospectus—even if aboard of directors has ultimate content-related responsibility. And the circumstances here are such that a court could find that Janus Management made the statements in question.”]

The Harvard Corporate Governance Forum has a note on the ruling here. Race to the Bottom has a three-part critique of the ruling – Part 1, Part 2, and Part 3.