Wednesday, January 21, 2009

SEBI decides to make disclosure of pledged shares by Promoters mandatory

SEBI has finally decided to make disclosure of shares held by Promoters in listed entities owned by them mandatory (see the press release). The relevant paragraph reads as under:-

To enhance the disclosure requirements, SEBI Board, in its meeting held today, decided to make it mandatory on the part of promoters (including promoter group) to disclose the details of pledge of shares held by them in listed entities promoted by them. Such disclosures shall be made as and when the shares are pledged (“event based disclosure”) as well as by way of periodic disclosures. Necessary steps to amend the relevant regulations and the listing agreement are being taken.

Details of pledge of shares and release/ sale of “pledged shares” shall be made to the company and the company shall in turn inform the same to the public through the Stock Exchanges.

Some quick comments while we await the formal amendments to law:-

-       It is presently only a decision. The amendments will be made to “Regulations” and the Listing Agreement. Let us see which of the Regulations are amended.

-       The disclosure appears to be required only by the Promoters and not by directors, officers, etc. I highlight this particularly to contrast Indian requirements with those in the West and also since the intention appears to be to curb insider trading.

-       There will be event-based disclosures and also periodic disclosures. This is consistent with existing disclosure requirements for sale/purchase under the SEBI Takeover Regulations and under the Insider Trading Regulations. However, under these Regulations, there is minimum particular threshold that is specified and disclosure is required from reaching that threshold. Let us see what the disclosure for pledge is for even any quantity of shares pledged or only if certain minimum shares are pledged or additionally pledged.

The shareholding of Promoters and disclosure of pledge of Promoters’ holding is fraught with complexities of facts and law. Let us see the actual wording of the Regulations and the Listing Agreement and see how well these complexities are covered.

Requiring disclosure of shares pledged by Promoters is certainly a forward step and desirable. At the very least, shareholders can know how much stake the Promoters really have in the Company. There are other advantages too.

However, critical also is that the pledges are fairly disclosed so that the public understands the nature of the pledge, the amount of monies raised, the use to which the monies raised are put to, etc. One will need to see whether the information required to be disclosed alongwith is sufficient so that readers can understand the context well. I believe that even if there are no additional informational requirements, Promoters can and should give additional disclosures to put the pledge in context.

Also, one wonders whether this will prevent the lacuna allegedly exposed by the Satyam episode of Promoters’ pledged shares being sold out and raising concerns of Insider Trading. The argument is that if there was such a requirement, then the gradual reduction of holding of Promoters of Satyam from 25% to 8% and then finally to 3% would have been known to the public. One does not know the real facts in Satyam’s case. However, it is apparent that there are already requirements under the Takeover Regulations and the Insider Trading Regulations for periodic disclosure of sale of shares. The disclosure is, inter alia, at every 2% sale. Thus, Promoters of Satyam were already required to disclose at every stage from 25% viz., 23%, 21%, 19% and so on. Were these disclosures made? Were they made in time? And if they were made, then the public already knew about it. But, the most important question is, did they make these disclosures?! And if they did not, even if they were legally required to do so, would they have made such disclosures even under the new law? A person bent on committing a big crime would not hesitate to commit smaller crimes.

Be as it may be, this is a step forward. Let us see the actual law and see how good the coverage is.

-       Jayant Thakur

14 comments:

Renu Gupta said...

This is certainly a welcome move. But as you rightly said, whether disclosures under existing laws are being made by companies like Satyam and whether new laws would offer any incentive or disincentive for making/not making disclosures, is to be seen.

Renu Gupta said...

Although additional disclosures would help public in idenitifying the actual promoter stake in the company, I believe it is equally important to ascertain the individual promoters behind corporate entities. In most companies it is difficult to ascertain the actual people (individuals) behind the company, since the shareholding is disguised in numerous layers of corporate shareholding. Thus, for any violation of the law at the parent level, it would be difficult to track and even punish the actual individuals who are behind such multiple layers of companies.

Renu Gupta said...

Shedding more light on the proposed regulations, SEBI has proposed both "event based" and "performance based" disclosures of pledged shareholding.

See this newspaper report at : http://timesofindia.indiatimes.com/Business/Sebi_clamps_down_on_promoters/articleshow/4013758.cms

Anonymous said...

By the way this should have been done immediately after Jan 7, 2009 or may be much before that, when it was an open secret that promoters are pledging shares.

At one place we are still in the process of amending listing agreement and on the other hand, Apple Inc. for example is facing a government review of its disclosures about Chief Executive Officer Steve Jobs’s health problems to ensure investors weren’t misled because Steve Jobs is considering a liver transplant as a result of complications after treatment for cancer and because of this Investors have been pressing for information on Jobs’s health since June, when he appeared thinner at an Apple event. Apple stock has dropped 2.9 percent since the company disclosed Jan. 14 that Jobs, 53, would be on medical leave through June.

I think this is called true "corporate governance".

So cutting the long story small, time is an essence in such matters. It's too late, damage has already been done. We will get to see the details of pledge of shares only after 70 to 90 days from now (i.e. 31 march shareholding pattern as per clause 35 of listing agreement, which logically needs to be amended).

Anyways.......

Regards,

Laki said...

Provision to make Disclosures by Promoters and persons/entities covered under Insider trading would be step in the Right direction.
But to seek information on the money received on pledge and its usage would be excessive oversight . How/ why/ where The promoters/insiders use their money received upon pledge may not be neccessarily a relevant information to the investor. Moreover it is the Prerogative of the Promoter who has invested in a company to buy/sell shares as long as disclosures are made and the quantum is within the prescribed limits.

Renu Gupta said...

Sandeep Parekh's view on this subject is also worth a read.

Link is at http://blogs.livemint.com/blogs/initial_private_opinion/archive/2009/01/22/improved-disclosure-on-pledged-securities.aspx

Jayant Thakur, CA said...

Thanks, Renu, for your various useful and relevant comments and inputs.

- Jayant

Jayant Thakur, CA said...

Thanks, Anonymous, on your comment about timing of the release of information and the matter of Apple.

One point I want to add is that it appears from Bhave's interviews to the press that the proposed law will make a one-time immediate disclosure requirement and thereafter there will be periodic and event-based disclosures. In that case, we may not have to wait after 31st March 2009. Of course, even in the interview, he mentioned that he would need to give some time for the first disclosure and hence it is unlikely that the first disclosure will be particularly quick.

- Jayant

Jayant Thakur, CA said...

Hi Laki, thanks for your comments.

I agree with you. If promoters sell their shares, it is their business where they used the monies and to a large extent this principle may apply also to monies raised through pledge of shares. I wondered though whether promoters should have an option to give further disclosures about where they used the monies. At least in the initial phase, it is possible that information about pledged shares may cause confusion amongst shareholders (Consider a headline in ET - "62% listed companies have 90% promoter shares pledged!"). It may be valuable for individual Promoters if they had the option to disclose the productive purposes for which they use the monies raised, as compared to some Promoters who may have simply taken the monies and ran!!

- Jayant

Umakanth V said...

Newspaper reports suggests that structures are already being conceived to overcome the bit of this new regulation. One of those is for promoters to make investments in listed companies through intermediate unlisted investment companies whose shares will be pledged, rather than the shares of the listed companies. The newsreport is available at http://www.business-standard.com/india/news/promoters-may-use-holding-firmsas-escape-route/18/31/346848/. This appears to be just an indirect way of overcoming the new requirements, and SEBI will likely cover these types of situation while pronouncing the detailed regulations on pledge disclosures.

Jayant Thakur, CA said...

Thanks, Mr. Umakanth. 2 comments.

Firstly, you have pointed out the creative Indian mind at work! - as the Indian saying goes, "chor police se do kadam aage rahta hai" (the thief is always two steps ahead of the police)!.

Secondly, but for some unwarranted comments of SEBI Chairman which I give later herein, I would have been hesitant in taking a view that pledge of shares in Holding Company would be automatically out of the purview of the new disclosure requirement. I would have preferred a purposive and substantive view saying that one cannot simply use a company solely to avoid a law, more so securities laws. Of course, the actual wording of the law would have also mattered.

But the SEBI Chairman was unduly quick in answering to certain queries of reporters and he himself opined that he would not consider that pledge of holding company's shares would require disclosure. See the report in Business Standard as per the following link:-

http://www.businessstandard.com/india/news/promoters-must-disclose-pledged-shares-sebi/01/30/346809/

Note the following comments ascribed to him:-

"Bhave, however, clarified that promoters do not need to disclose whether they have pledged shares of the holding company of a listed entity. Promoters will, however, need to make adequate disclosures if the lenders sell the pledged shares in the open market."

Thus, it was not as if it was left to clever legal advisors to find a loophole - the solution was given at the outset! And I am sure that such parallel comments can be legally relied on.

Having said that, I do not think that the holding company route is a glaring loophole as so made. There are problems. For example, in my personal experience, I have found that lenders are not comfortable solely with the pledge of shares of the holding company. In fact, they want security of both shares - shares of the listed company AND of the holding company.

Pledge only of the holding company leave a risk to them of the shares of the listed company being still under control of the holding company controlled otherwise by the Promoters. Lenders have been found to prefer the pledge of shares of the listed company better - which can be recorded in the demat account in accordance with law.

I personally feel that, howsoever desirable disclosure of pledge of shares maybe, it will face tremendous resistance since the revelation of skeletons in many companies could lead to fall in their prices. See the other report of Business Standard as follows:-

http://www.business-standard.com/india/news/pledged-shares-news-pulls-down-united-spirits-stock-23/01/40/346883/

In essence, the report says that, without any disclosure and merely by reports of analysts that shares of United Spirits were under pledge resulted in the share prices going down by 23%.

All in all, if the whole intention and consequence is to allow such a gaping loophole expressly, the new requirement hardly serves much purpose. Let us in the meantime, await the amendment.

Thanks again!

- Jayant

Renu Gupta said...

Interesting developments. I also agree with the view that merely creating a holding company structure and permitting pledge of such holdco without disclosures is not going to serve any purpose. In the spirit of the scheme of things, by creating an intermediate layer of a corporate entity, doing away with the disclosure requirements seems illogical.

I actually cannot ascertain the rationale for this. "A" owning "B" and "B" owning "C" means "A" indiretcly owns "C". Am i missing the point?

Anonymous said...

Will Pledge of Shares by a promoter amount to financial assistance under Section 77(2) of the Companies Act? If not, why?

V. Umakanth said...

@ Anonymous. Pledge of shares by promoters does not violate the rules against financial assistance. Those rules apply only when the company provides financial assistance for purchase of its own shares.