Monday, August 3, 2009

Warrants and Voting

My friend Jayant Thakur posted a critique on July 31 on the recent SEBI Order in the case preferential allotment of warrants to promoters. Umakanth dealt with the element of potential prohibition of voting in areas of conflict of interest on August 1.

Here is a piece I wrote in the Business Standard today, with a slightly different perspective on the concept of preferential allotment and deals with the issue of a potential voting prohibition, a trend already started by SEBI:-


By Somasekhar Sundaresan

The Securities and Exchange Board of India’s (“SEBI”) passed an order last week, nicely articulating why preferential allotment (out of turn allotment other than an evenly-made allotment to all existing shareholders) of warrants to promoters is kosher.

The order was passed after the Bombay high court asked SEBI to deal with the grievances of an investor association that had questioned the policy on issuance of warrants to promoters. The order makes for interesting reading and certain aspects highlighted in the order call for reflection.

Warrants are instruments that entitle the holder to acquire shares at a future date a pre-determined price. Guidelines issued by SEBI regulate the issuance of warrants. The warrant holder has to pay 25% of the exercise price upfront, may exercise the warrant no later than 18 months from issue, forfeit the upfront amount paid if he lets the warrants lapse, and has to suffer a lock-in not only on the warrants but also on the shares arising out of the warrants. Besides, the minimum price at which the warrants may be exercised is regulated – a function of market price average related to the time at which the issuance is approved by shareholders. Four issues in the SEBI order call for analysis.

First, it the case of the eight companies complained of, the amount forfeited by promoters aggregated to Rs. 1515 crores. The amounts were tiny in some cases (Rs. 6.52 crores in the case of Nagarjuna Fertilizers Ltd.) and large in other cases (Rs. 783 crores for Reliance Infrastructure Ltd. and Rs. 377 crores in the case of Aditya Birla Nuvo Ltd.). In order words, a good amount of money went into the listed companies free of cost i.e. without any capital dilution. Therefore, SEBI’s policy on this count has indeed worked well.

Second, SEBI’s order is perfectly legitimate in asserting that when the rules for pricing are made clear, it is open for every company’s board to issue warrants in accordance with the rules. If a fresh issue of warrants is made when the market price is lower, so long as the issuance is compliant, there can be no quarrel on the ground that warrants issued in the past had lapsed. The SEBI order also notes that of the 1108 preferential allotments made between April 2007 and June 2009 from among 4,934 listed companies, 360 cases involved allotment of warrants. Of these, in 100 cases, promoters allowed the warrants to lapse and forfeited the funds paid upfront. Only 13 companies re-issued warrants following non-exercise of earlier warrants.

Third, the investors had alleged that funds ought to be raised only if the company were to be in need of funds, not to shore up promoter holding – an unexceptionable argument. When funds are raised through an initial public offering or a follow-on public offering, a lot of explanation is required to be given by way of an offering circular. In a preferential allotment, the explanatory statement to shareholders has to provide disclosures of the objects of the proposed allotment. However, the rigour and standard of disclosure is not the same. Preferential allotment is indeed widely perceived to have lesser justification in the company’s need for funds and greater justification in the need to keep promoter stake intact or bolstered.

If the board of a listed company thought it fit to raise funds through warrants, it stands to reason that the board comes up with good explanations on how it intends to bridge the gap caused by a lapse of warrants. This aspect has to be gone into in greater detail. One would be surprised if there is any spectacular documentation in the boards’ minutes, of why the board felt funds were needed, how they were chose a course of fund raising, and how they gap in funding is being bridged due to lapse of warrants.

Finally, while rightly holding that banning warrants would be a retrograde step, SEBI has indicated that it would seek views on whether promoters should be debarred from voting on resolutions entailing preferential allotment to promoters. The issue should in fact be addressed by SEBI on a broader footing – whether any interested party or a beneficiary of a shareholder resolution should be permitted to exercise voting rights as a shareholder on the resolution. If the answer is in the negative, there should be no justification to single out promoters for disenfranchisement for preferential allotment. Jurisdictions such as neighbouring Singapore have such rules in their company law.

SEBI has already set a very adverse precedent in the case of delisting – ignoring the promoter’s vote, the votes cast in favour of the delisting proposal by public shareholders (non-promoter shareholders) ought to be at least twice the votes cast by public shareholders against the proposal. Having made a beginning, it is highly likely that SEBI will go down the path of regulating voting rights in various other situations – that will be subject matter of another column altogether

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