Wednesday, July 22, 2009

SEBI prohibits issue of shares with "superior" rights

SEBI has issued a circular dated July 21, 2009, to make amendments to prohibit issue of shares with superior voting rights by listed companies. This is pursuant to SEBI announcement discussed by Mr. Umakanth earlier in this blog here and that post makes an interesting analysis of the term "superior voting rights", particularly in comparison with the existing term "differential voting rights".

Incidentally, the actual amendment covers all superior rights as to voting as well as dividends. The original decision as per the Press Release read that "No listed company can issue shares with superior voting rights.".

The amendment is by way of insertion of a new clause 28A to the Listing Agreement. The amendment is to come into immediate effect though because of the peculiar status of Listing Agreement, one will also have to wait for amendment of the Listing Agreement by respective stock exchanges.

The new clause is brief and is reproduced for ready reference:-

"28A. The company agrees that it shall not issue shares in any manner which may confer on any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares that are already listed."

Quick comments:-
- the prohibition is on issue of shares with "superior" rights and not on "inferior" rights.
- corollary from the earlier point, if a company issues shares with "inferior" rights, those shares will then become the new benchmark. If one takes this further logically, then, thereafter, even "normal" equity shares cannot be issued since these normal shares would have "superior" rights as compared to the existing shares with "inferior rights" assuming such latter shares are also listed!
- Can the amendment affect issue of preference shares which have priority of dividends and at times even rights of sharing further dividends? Or can one say that the intention is to cover issue of equity shares only since the comparison is made to existing equity shares?
- To bring the change into effect, the Listing Agreement is amended. This is curious. One would have thought the SEBI DIP Guidelines could have been a better place.
- Would special rights given to certain investors/promoters under the Article of Association such as veto rights, special rights, etc. be deemed to be "superior rights as to voting"? Can it be said that the ban applies only where the superior rights are given to the "shares" and not to the "persons" holding such shares?


- Jayant Thakur

8 comments:

Lawman said...

Dear Jayant.

Thank you for your post. You have raised some interesting issues. Indeed, it is to be seen how this whole issue is interpreted and taken forward.

However, as regards, application to prefernce shares - i think it can be argued that since this change is brought into by an amendment to listing agreement, and the benchmark is equity shares which are already listed, this rule will apply vis-avis equity shares only.

Also, in my humble view, the bigger question is - is this within the powers of SEBI's rule making? . Issue of shares with differential voting rights is permitted under the Companies Act, 1956. How can a regulator put such fetters to a statute permitted instrument which effectively takes away the entire provision.

Regards,
Lawman

Jayant Thakur, CA said...

Thanks, Lawman,

I agree - both are valid points.

On preference shares, concern is more of drafting. Intention may be to compare similar things.

Regarding powers of SEBI, though one can appreciate the potential of misuse, the absolute ban is a disturbing feature.

Just to share one more thought, the ban is only when there are equity shares already listed. There is no ban on a company having a category of shares at the time of IPO that have superior voting/dividend rights. Thus, investors subscribing to the IPO would be well aware of this category. In this sense, also, then a strong restriction on a fresh issue after listing of shares with superior rights would be logical though, as I said earlier, not an absolute ban.

- Jayant Thakur

Umakanth Varottil said...

Mr. Thakur, thanks for highlighting the issues that emerge out of the recent amendment to the listing agreement. As regards the second bullet point under your comments, the key issue arises because SEBI has not clearly identified “superiority” in a case where shares with different rights as to voting and dividend are already listed in a company, and this could lead to some absurdities as you have pointed out. It seems that the only way to overcome such a situation is by interpreting the expression “rights on equity shares that are already listed”, which is the benchmark to determine “superiority”, as the then existing shares with the highest rights (and not the lower rights). Going by this scenario, the following position would emerge:

1. In a company which has not issued shares with differential voting or dividend rights in the past, the “normal” shares would be the benchmark to determine superiority. Most Indian companies (barring a few exceptions) will fall within this category. “Normal” shares would mean shares with (i) voting rights of (x) one vote per shareholder in case of voting by show of hands, and (y) one vote per share in case of voting by poll, and (ii) pro rata dividend entitlement (i.e. same dividend rights on all shares).

2. In a company that has issued (or will issue) shares with “inferior” voting rights, then the shares with the highest rights, being the “normal” shares would continue to operate as the benchmark.

3. In a company that has in the past issued shares with higher rights than “normal” shares, then that higher entitlement will constitute the benchmark.

This interpretation may require reading into the listing agreement clause (as it is not evident from the text itself), but it may provide some logical matrix to work with.

Jayant Thakur, CA said...

Hi Umakanth,

Very fine distinction and analysis you have made! Perhaps I am missing something, but can I respectfully request you to reconsider the conclusion you have reached that it is the category of listed shares with the most superior rights that is to be seen as the “benchmark” category and not the one with the least rights (or most inferior).

I think the ban is for unfair dilution of rights of existing shareholders. If I have invested in a Company, I take the Company as is – with say one group having superior rights and I having lesser rights. But my rights get diluted not merely when fresh shares are issued with rights that are better than the existing shares with the most superior rights. My rights get diluted even when shares are issued of an intermediate category.

Let me illustrate with a slightly extreme example. I invest in shares of a company where there is already a category of shares having 10 votes for each share while my shares get one vote per share. Now the Company wants to issue shares having 9 votes per share. Should such issue be banned? Clearly my interests get diluted and therefore, at least by intent, the ban should protect me. In fact, I would even argue that the ban is meant to protect the shareholders with the least rights since, if an intermediary category of shares are issued, the superior shares’ rights become actually even better vis-à-vis the investment they had made.

Do the words used in the clause - “equity shares that are already listed” – permit such an interpretation? I respectfully submit that they do. Very fairly, as usual, though, you have said that taking the interpretation you suggested would require reading some words into the clause.

On another note, wouldn’t you agree that the real intention is to protect the public shareholders from the Promoters – as SEBI itself had said that the ban is to “avoid the possible misuse by the persons in control to the detriment of public shareholders”? In such a case, the logical solution would have been to simply ban a fresh issue of shares with superior rights to the Promoters. This is already done for issue of ESOPs, though not, unfortunately, for Share Warrants.

Further, the problem is not with shares with superior rights per se. The problem is that they are issued without fair compensation for the extra rights. To give an example that may be easier to relate to, if a fresh category of shares provides for dividends 3 times the dividends to the existing category, there cannot be a serious objection if the issue is priced taking the extra dividends into account. Pricing would be relatively easier as existing share valuation methods do provide for estimation of dividends. Of course, valuing the extra voting rights is little tougher and not as easy to relate mathematically though it is done.

However, perhaps SEBI finds – and rightly so – that the Indian capital market is not mature enough to be given freedom in some areas – the maturity lacking is not merely in the Promoters but even in the shareholders who don’t protest and also in the system that does not help them to effectively protest. Another reader has, in a preceding comment, rightly questioned the power of SEBI to make an absolute ban; but perhaps in a practical sense, to protect the public shareholders taking the Indian reality into account, an absolute ban may be the only way – though as discussed earlier, the ban could have been only on issue to the Promoters since that is the stated intention.

Thanks!

- Jayant Thakur

Lawman said...

Dear Jayant and Umakanth:

I present the following situation:

Suppose a company is coming with an IPO (i.e. first time when the shares get listed). There are two categories of shares in the offering:

Category 1: One share will entitle the shareholder to 10 votes but dividend of 25% less than what would be given to shareholders of Category 2.

Category 2: One share will entitle the shareholder to 1 vote and usual dividend declared by the company.

Is this possible in light of the new provision?

I think - yes. The text of the new provision is -

"The company agrees that it shall not issue shares in any manner which may confer on any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares that are already listed."

In my humble view, the benchmark is the shares that are already listed (and not the usual one share one vote norm). In case of an IPO, this benchmark is not available, and therefore, usual provisions of DVR as contained in Companies Act will apply. As long as I am within the provisions specified in the Companies Act, I think one can issue any kind of DVR (superior or inferior) that one wants.

The problem - What should be the benchmark for further issue of shares. Category 1 or Category 2? I think going by the intent and keeping shareholders' interest in mind, one should take the conservative view that Category 2 shares should be the benchmark for voting and Category 1 should be benchmark for dividend. Is it absurd?

Comments solicited.

Regards,
Lawman

Jayant Thakur, CA said...

Hi Lawman, thanks for keeping up with the discussion.

On the issue of IPO, I agree and with and as I also mentioned in my revert to your earlier comment, there is no bar on having shares with superior voting rights at the time of an IPO.

As regards your second point, it does present an absurdity and also arises out of the interesting combination of voting and dividends that you have presented. And if my view that one has to take the shares with most inferior rights as the benchmark is correct, then a company can issue only such new shares that have rights at par or lower than its existing shares with most inferior rights.

Going by this, in your example, one view could be that the company would be able to issue fresh shares whose voting right cannot be better one vote per share and whose dividends have to be 25% less than the normal dividends. This is taking the most literal view and it has the only other advantage of being implementable.

The other more reasonable, but difficult to implement, view could be that each share's rights of dividends and voting should be considered as a package and one would need to work out, from the facts and circumstances, which one's rights are "inferior". That category of shares would be the benchmark!!! Tough to work out!

Fortunately, since such instances are rare, this discussion may be academic. For all practical purposes, I think, the situation may be that a company would have only one category of "normal" equity shares that are listed. So they wont be able to issue shares that have better voting or dividend rights.

- Jayant

anand said...

dear jayant
can you tell me something about the role of sebi in regulation of share.
thanking you

my mail id is anandverdhan@gmail.com

dewangr said...

sir,

Re: issue of preference shares

1. is there any specific formula or ratio one must look at ?

For eg. In what ratio one can issue Pref shares (ie can i issue all preference shares or a component of equity issuance is a must and in what ratio?)

Does one also look at debt : Equity ratio etc ?