SEBI Mandates Transparency In Promoter Pledges
Promoters can no longer escape disclosures on pledges using creative structures.
Promoters raising funds from mutual funds or non-bank lenders through structured obligations, pledge of shares, non-disposal undertakings, corporate or promoter guarantees and various other complex structures will now need to disclose these transactions to the stock exchanges and specify the reasons for doing so if a certain threshold is crossed, the market regulator said.
The SEBI board, in its meeting on Thursday, approved two changes to the Takeover Code—expansion of the definition of ‘encumbrance’ and mandating the need for detailed reasons when encumbrances cross the prescribed threshold.
Encumbrance: Definition Expanded
The Takeover Code requires promoters of listed companies to disclose the details of their encumbered shares. Encumbered has been defined to mean a pledge, lien or any such transaction.
A more detailed explanation on what would constitute as an encumbrance can be found in SEBI’s FAQ issued in 2015, Sandip Bhagat, founding partner at S&R Associates, pointed out. But since the definition in the Takeover Code wasn’t prescriptive, certain encumbrances created by promoters on their shares weren’t being disclosed, he added.
“The promoters have to understand the nature of encumbrance and those encumbrances which entail a risk of the shares held by promoters being appropriated or sold by a third party, directly or indirectly, are required to be disclosed to the stock exchanges.” —SEBI’s 2015 FAQ
Bhagat said that inspite of this clarification by SEBI, some market participants took a view that certain encumbrances need not be disclosed. For instance, there is a holding company which owns the listed company’s shares. If the promoter goes ahead and pledges the shares of the holding company, technically there is no pledge on the listed company’s shares. Would such an encumbrance be covered by the Takeover Code?
There have been examples of people saying this is indirect and need not be disclosed—these are the situations which SEBI is now addressing by expanding the definition of ‘encumbrance’ in the code, Bhagat explained.
SEBI had noted that there were cases where private companies—controlled by promoters of listed companies—would issue non-convertible debentures backed by the promoters either in the form of pledge of securities of a group company or through other form of encumbrances like covenants, non-disposal undertakings, a lawyer told BloombergQuint on the condition of anonymity. To bring such transactions under the disclosure net, SEBI decided to expand the definition of ‘encumbrance’.
The expanded definition will include:
- any restriction on the free and marketable title to shares, by whatever name called, whether executed directly or indirectly;
- pledge, lien, negative lien, non-disposal undertaking;
- any covenant, transaction, condition or arrangement in the nature of; encumbrance, by whatever name called, whether executed directly or indirectly.
This definition is broad enough to now cover any third-party interest that’s created on the promoter’s shares in the listed company, Vaibhav Kakkar, partner at L&L Partners, said. The aim is to curb any creative or complex structures where parties were willing to take a liberal view on what the term ‘encumbrance’ means and not disclose it, Kakkar added.
Encumbrances: Requirement Of Reasoning
SEBI said if the combined encumbrance by the promoters and persons acting in concert crosses 20 percent of the total share capital in the company or 50 percent of their shareholding in the company, detailed reasons will need to be given. Additionally, on an yearly basis, promoters will have to declare to the audit committee and stock exchanges that they, along with persons acting in concert, have not made an encumbrance—directly or indirectly—other than what’s been disclosed during the financial year.
This would mean that any past transactions that promoters weren’t treating as an encumbrance will need to be scrutinised through the lens of the expanded definition and if it meets the criteria, detailed disclosures will need to be made to the audit committee and the exchanges at the end of the financial year, Bhagat explained.
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