Monday, June 22, 2009

SEBI’s Recent Primary Market Reforms

SEBI last week announced a slew of reforms to the primary capital markets. The key reforms are as follows:

Anchor Investors

The concept of “anchor investors” has been introduced in public issues whereby 30% of the institutional (QIB) portion will be allocated to anchor investors on a discretionary basis. This is to ensure minimum commitments from key investors that not only boosts the prospects of the offering, but also acts as an indicator to retail investors whose decisions to bid (or not) will follow. Anchor investors are required to bring in a 25% margin along with their application, while the balance 75% of the issue price is required to be paid within 2 days of closure of the public issue. There is also a 30-day lock-in on shares issued to anchor investors to ensure that the stock is not volatile immediately upon listing and trading.

Rights Issues

Historically, the offering process in a rights issue for a listed company was far simpler compared to a full-blown public issue such as an IPO. There is some logic to this position because shares of such a company are already traded on a stock exchange and information about the company is available in the public domain. However, over a period of time, the disclosure norms for rights issues were progressively strengthened, so much so that rights issue documents began resembling public issue documents both in content and size. More recently, there has been a call for simplifying the rights issue process in terms of disclosure requirements as well as the process (please see previous discussion on this Blog). Towards that end, SEBI has now decided to streamline the disclosures for rights issue, and does away with disclosures such as “summary of the industry and business of the issuer company, promise vs. performance with respect to earlier/ previous issues, ‘Management discussion and analysis’”. Other disclosures have been streamlined. This will help companies tap the rights issue avenue for raising funds in a more efficient manner.

Superior Voting Rights

SEBI has prohibited the issue of shares with “superior voting rights” by listed companies, in order to “avoid the possible misuse by the persons in control to the detriment of public shareholders”. The key question that arises is how different the shares with “superior voting rights” are from shares with “differential voting rights”, as it is the latter term that has attained some measure of popularity under Indian law and practice.

The term “differential voting rights” emanates from its usage in Section 86(a)(ii) of the Companies Act. The validity of such shares has also been subjected to judicial determination. In Anand Pershad Jaiswal v. Jagatjit Industries Limited, MANU/CL/0002/2009, the Company Law Board (CLB) upheld the validity of issue of shares with differential voting rights as being valid under Section 86 of the Companies Act as well as the Companies (Issue of Share Capital and Differential Voting Rights) Rules, 2001. Unfortunately, the CLB did not have the opportunity do delve into the details of the issues raised in that matter because it was settled through a consent order.

With the current suggestion by SEBI, it appears that while the expression “differential voting rights” is more generic in nature, “superior voting rights” means any rights that give the shareholder more than one vote per share on a poll, which is the usual norm. This is to prevent persons in control of a company from issuing shares to themselves which provide equal economic benefits with other shareholders (thereby requiring equal outflow of financial resources to obtain those shares), but one which gives greater voting rights and hence better control. Hence, while it is possible for listed companies to issue shares with differential voting rights which provide voting rights below the normal “one-share-one-vote” rule, conferring voting rights greater than that is proscribed.

In a sense, SEBI’s current pronouncement goes beyond the general rule of “differential voting rights”. Even in the Jagatjit case where differential voting rights were approved, the shareholders were conferred rights greater than the “one-share-one-vote” rule. Hence, while listed companies will now be allowed to issue differential voting entitlements only with rights inferior to one vote per share, unlisted companies will still be governed by Section 86 and the law laid down in Jagatjit whereby they have greater flexibility in issuing shares with differential voting rights, both superior and inferior.

Other Reforms

1. An unlisted company making an IPO should list on at least one stock exchange providing nation-wide trading terminals, in order to provide a liquid trading platform to investors.

2. The holding period of one year for an offer for sale of shares will include the period when fully-paid convertible instruments have been held prior to conversion into equity shares.

3. No entry load for mutual fund schemes.


Anonymous said...

I find it difficult to understand your distinction between a superior right and a right that you characterise as less than one share-one vote. If, as you argue, the later is possible, it only ends up resulting in the shareholder having one vote per share holding a superior right. How do you justify this classification

Trips Anon said...

Yes I agree the portion on "superior voting rights" will create a lot of confusion.
One way of reading it would be to say that such restriction would only apply to granting of superior voting rights to "persons in control" of listed companies.

Hence, public shareholders / persons not in control may be given more than one vote per share.

By way of clarification, may I ask what is the legal force / binding effect of a press release of SEBI. or Does is become law only when a notification is brought out by SEBI on the subject. Thanks in advance.
Trips Anon

Umakanth Varottil said...

Thanks for the interesting comments.

The difficulty arises due to the use of the word “superior” which introduces an element of qualitativeness and comparison. In the absence of any explanation as to the meaning of this expression or any other reference point, it seems likely that the optimal way to deal with it is to judge or compare it against the basic norm of the “one share one vote” rule. Further, what seems to be prohibited is the “issue” of shares with superior voting rights, which would imply that the shares being issued cannot have superior voting rights over existing shares. The fact that existing holders end up holding superior rights over the new shares may not matter. But, this approach does have one drawback, which is that if a company already has existing shares with less than normal voting rights (e.g. Tata Motors), then is arguable that the company cannot issue any shares carrying more voting rights than the existing shares even though those may carry less than one vote per share.

As of now, this only seems to be a press release, and it is necessary to await detailed guidelines, which will hopefully clarify these issues, before the rule can be implemented.