Shedding The Promoter Tag: To What End?BloombergQuintOpinion
Concentration of shareholdings is the norm in Indian companies. It is, therefore, not at all surprising that the concept of ‘promoter’ has a special significance from legal and regulatory perspectives. Promoters carry specific obligations such as disclosure and share lock-in during capital market transactions such as initial public offerings. They also bear significant governance responsibilities in listed companies, for example in the case of related-party transactions. At the same time, the definition of a promoter has invited a great deal of consternation, thereby causing uncertainty in the financial markets. The nature of shareholding in Indian companies has undergone a metamorphosis too, lately.
Promoters And The Capital Markets
The developments in the market have prompted the Securities and Exchange Board of India to issue a consultation paper to review the framework concerning promoter, promoter group, and group companies.
On the capital markets front, the SEBI consultation paper seeks to lighten the obligations of promoters. For example, it proposes to reduce the lock-in period following an IPO on the shareholding of promoters as well as that of non-promoters. Moreover, SEBI aims to reduce the burden of issuers in disclosing information relating to the issuer’s promoter group and other group companies.
These measures are welcome, as they streamline the Indian capital markets disclosure requirements with international standards, as the current regime relating to disclosures of the group is excessive and acts as a disincentive from companies initiating capital markets transactions. Moreover, it is not altogether clear whether the additional quantity of information unloaded on investors necessarily makes the disclosure-based approach more meaningful.
Promoter To Controlling Shareholder
It is a related suggestion in the consultation paper that serves up a regulatory hot potato.
SEBI calls for transitioning from the concept of ‘promoter’ to the concept of a ‘person in control’. At one level, this might appear to be a mere labelling change. But, that would be too myopic a view, as there are larger implications that the regulator must account for before implementing it.
The current regulations define a ‘promoter’ to include three sets of persons.
- The first is a person who is named as such in an offer document or annual return of the company.
- The second is a person who has control over the affairs of the issuer in any capacity, generally referred to as a ‘controlling shareholder’.
- The final category is a person according to whose instructions the board of the issuer is accustomed to act which, under company law, is the definition of a shadow director.
The proposal at hand seems to narrow the obligations of a promoter to that of the second category, where a person is said to be in control of the company.
To be sure, there are a number of advantages of this approach. The concept of control is the most significant measure of determining the type of shareholder upon whom the law may impose a specific onus, given the influence such shareholder is able to exercise on the affairs of the company, including its board of directors. Moreover, control is a dynamic concept, and the company’s reins may change hands from time to time. Consequently, the onus too must shift accordingly. The current definition of ‘promoter’ may have the effect of being unduly static in nature, thereby leading to what SEBI has referred to as the scenario of ‘once a promoter, always a promoter’.
Decoupling Governance From The Primary Markets
If one were to view the definition of a promoter from the purview of SEBI’s regulations on the issue of capital and disclosure requirements, the need for such a shift is entirely understandable. However, as SEBI’s consultation paper itself admits, the transition from promoter to controlling shareholder has myriad other implications. Its impact extends to the regulations governing takeovers, to the governance norms prescribed under SEBI’s regulations on listing obligations and secondary market disclosure requirements, as well as the regime surrounding insider trading.
Hence, unless executed with precision, mending such a sensitive concept as ‘promoter’ in the context of regulations relating to primary market transactions could have inadvertent consequences on other regimes.
From a governance perspective, the concept of a promoter or controlling shareholder has enormous significance, especially in jurisdictions such as India where there is a concentration of shareholding. Controlling shareholders wield significant influence, and must hence be subject to concomitant burdens to ensure the protection of the interest of minority shareholders. This is particularly the case in significant transactions such as related party transactions and squeeze-outs where, unless carried out at arm’s length and on fair terms, the controlling shareholders are likely to benefit at the cost of minority shareholders.
Furthermore, controlling shareholders are able to exercise their power to control the board, including the appointment and removal of independent directors. It is befitting, therefore, that SEBI is consulting separately on means to extricate the appointment and removal of independent directors from the dominance of controlling shareholders. Hence, while SEBI’s current efforts to rationalise the identity of controlling shareholders are understandable, there must be no dilution in the roles and responsibilities of such shareholders under corporate law and securities regulation.
Also read: Independent Directors: SEBI Has Another Go
Although it is unclear whether SEBI’s definitional exploration would alter its primary philosophy surrounding persons in control of companies, there is reason to believe a dilution may be in the offing.
SEBI has sought to rationalise its views by highlighting some empirical trends.
First, it notes that business families have given way to founder-owned and financier-backed companies. While this is true anecdotally, there seems to be no empirical evidence to support this conclusion on a large enough scale.
Second, SEBI finds a decline in promoters’ shareholding in the top 500 listed companies to 50% in 2018 and an increase in institutional investor shareholding to 34% in the same year. This suggests that there is a loosening of concentration in the shareholding of large Indian companies, but this represents only an average shareholding. Moreover, a 50% concentration is robust enough to suggest a significant influence of controlling shareholders.
Third, SEBI relies on the greater focus thrust on boards and the responsibilities and liabilities of directors as a means to deflect from the significance of promoters. While it is hard to argue against the fact that board norms and responsibilities in Indian companies have witnessed considerable enhancements in recent years, they are nevertheless inadequate to justify a light-touch approach towards controlling shareholders. SEBI’s intentions are yet unclear about whether the transition from promoter to controlling shareholder would be accompanied by tempered obligations on such a shareholder.
‘Control’: The Elephant In The Room
Finally, the current exercise is incomplete unless SEBI also addresses another longstanding question head-on: the definition of ‘control’. Given the expansive definition of control under the Companies Act as well as SEBI’s takeover regulations, the judiciary has had to undertake the task of providing a suitable interpretation of the term.
This relates specifically to whether the protective rights, including board nomination and veto rights, available contractually to financial shareholders such as private equity and venture capital investors amount to their exercising control over portfolio companies.
Since the tenor of SEBI’s current proposal seems to be to make dispensations to accommodate the needs of such financial investors, the task would be incomplete without a more definitive approach towards the meaning of ‘control’. SEBI had previously undertaken a consultation on this matter way back in 2016, but matters remain at naught.
Perhaps it is time for SEBI to revisit the issue, without which the transition from promoter to controlling shareholder is unlikely to fetch the desired results.
Umakanth Varottil is an Associate Professor of Law at the National University of Singapore. He specialises in company law, corporate governance and mergers and acquisitions.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.