The concept of demutualization of stock exchanges has given rise to some questions regarding the governance of demutualized exchanges. That concept requires exchanges to separate ownership and governance from that of its trading members. Some issues pertaining to demutualization have come up before SEBI in its investigation into the affairs of the United Stock Exchange of India Limited (USE). SEBI issued a recent order warning USE “to be more cautious and perceptive in the discharge of its function and the regulatory duties”. It also required USE to amend its articles of association (which is the subject matter of discussion in this post).
SEBI found concentration of volumes in trading on the USE through two trading members, with one of them Jaypee Capital Services Limited being a promoter of USE. An analysis of SEBI’s order on the issue of trading concentration can be found in Mobis Philipose’s column in The Mint; but this post focuses on the observation of SEBI regarding the board rights of the key shareholders of USE. Specifically, it relates to an insertion in the articles of association of a clause that provides for specific quorum, whereby no board meeting shall be constituted unless at least one director representing Jaypee Capital, BSE and Federal Bank (being the key shareholders) are present. SEBI found such a quorum requirement to impinge upon the governance of the stock exchange. The SEBI member observes:
I note that such kind of special arrangements as did by USE is not in the interests of independent functioning of the stock exchange. The Special Articles i.e., Part II of AoA has overriding effect over its General AoA and these rights to certain shareholders appear to be detrimental to the interest of other stakeholders. These are inconsistent, imprudent and contrary to the best corporate governance practices. In my opinion, such special arrangements surely constrain the independent functioning of the Stock Exchange. … I note that these defaults on the part of USE not only reflect bias on the part of the Exchange towards certain shareholders, but also reveals that such provisions in AoA are against the spirit of demutualization of stock exchanges.
This suggests that even a customary provision for quorum in shareholders agreements (that may be incorporated in the articles of association) can be found to go against the independent governance of a stock exchange. In that sense, the impact of SEBI’s order is to impose high standards of governance in an exchange, which may obviate special clauses in favour of particular shareholders that are common in other types of companies.
Moreover, this may be contrasted with cases involving other companies, where such protective provisions in shareholders’ agreements and articles of association in favour of particular shareholders are treated more liberally. For instance, in the controversy involving the definition of “control”, the Securities Appellate Tribunal (SAT) had held that not only such quorum provisions but even affirmative voting rights (or veto) rights would not confer “control” on the shareholder so as to trigger mandatory takeover offer requirements (although that ruling has been somewhat disturbed by a consent order on appeal before the Supreme Court).The key take away from this order of SEBI is that shareholders’ agreements and articles of association of stock exchanges may be subject to closer scrutiny by regulators who appear averse to special rights in favour of any particular shareholder.