Friday, May 30, 2014

Proposal to Overhaul Delisting Regime

Delisting of companies from the stock exchange (also known as privatization) has become a common phenomenon around the world, as it has in India. The rationale for delisting a company is detailed below:

A number of reasons are proffered as motivations for delisting. Where there is a perception that the market price of the company is not reflective of the true value of its businesses, share price may cease to be an accurate indicator of the company’s worth. By privatising the company, the target and its management obtain greater flexibility in managing the business of the company without being dictated by market expectations, which can often be short-term in nature. In other words, the management is free from market pressures. This flexibility would help in responding to a more challenging business environment. Moreover, the skyrocketing costs as well as management attention required to ensure compliance with increasingly onerous securities laws and regulations as well as listing standards compel managements and controlling shareholders to delist the company so as to enable greater focus on the company’s business.[1]

For these and other reasons, the Indian markets have witnessed delistings by controlling shareholders who are either domestic promoters or multinational companies (MNCs). The spate of MNC delistings have been occasioned also by the relaxation of sectoral caps under the foreign direct investment norms whereby the MNC promoters are able to shore up their holdings beyond restrictions that were previously placed that enable a delisting of the Indian listed subsidiary.

At the same time, delisting can also result in significant risk to minority shareholders. As observed in the work referred to above: “A combination of factors conspires to provide undue advantage to the target and its controlling shareholders. These include the fact that the target and controlling shareholders can determine the time of delisting, that they benefit from information asymmetry that operates in their favour and that they are entirely in control of the process.” For example, the controlling shareholder may be in a position to initiate a delisting when the share price of the company is low. The company may also significant important projects or developments until the delisting is completed so that the prospects from those are not factored into the share price taken into account for the delisting.

The effort of regulations pertaining to delisting must strike a delicate balance. On the one hand, it must permit value-enhancing delistings that are beneficial to both the promoters as well as the company, but on the other hand it must not result in deprivation of value that the minority shareholders are otherwise entitled to when they decide to exit from the company. The complexities involved in formulating a regulatory regime for delisting is clearly evident from the evolution of such a regime in India. Although specific regulation of delistings in India is only over a decade old, it has been unsuccessful in achieving it objective, due to which it is under a constant state of revision (with the accompanying flux and lack of clarity or certainty). The first set of SEBI (Delisting of Securities) Guidelines, 2003 was substituted by the SEBI (Delisting of Equity Shares) Regulations, 2009. Even the relatively new guidelines have not achieved the desired success, and hence the need has been felt for a further review of the regime.

It is in this context that SEBI earlier this month issued a Discussion Paper on Review of Delisting Regulations. The Discussion Paper seeks to review the current state of affairs, identify the deficiencies in the delisting regime and propose some suggestions for overhaul. It observes:

The overall delisting activity has gone down considerably after the introduction of the [2009] Regulations. A total of 38 offers have been made during the period between the introduction of the said Regulations and March' 2014. …

Out of the above 38 offers, 29 offers were successful. Amongst 9 unsuccessful offers, in case of 7 offers, the number of shares tendered were less than the number required under the said Regulations. In the remaining 2 offers, acquirer rejected the discovered price.

Out of 38 companies, discovered / exit price in case of 7 companies was equal to the floor price. However, in case of 11 companies, premium in the discovered price was more than 100%. Premium is the price differential of discovered/exit price over and above the floor price.

Several difficulties have been identified with the current regime, but here I discuss only two of the crucial ones. The first is the use of the reverse bookbuilding mechanism (RBB) for price discovery for the delisting, and the second is the considerably elongated timeline that includes the need for shareholder approval through special resolution.

Reverse Bookbuilding

Under the RBB process, the company must fix a floor price, which is based on several financial and trading parameters. Public shareholders are able to place their bids for sale of shares in the delisting through an electronically linked transparent facility on the stock exchange at or above the floor. The final bid price is determined as one at which the maximum number of equity shares are tendered by the public shareholders. However, the promoter/acquirer has the ability to either accept the offer at that price or reject the same.

In the Discussion Paper, SEBI identified several problems with the RBB process. Public shareholders holding a significant stake can dictate terms as to the determination of the delisting price and thereby hold the other shareholders to ransom. Since bids are placed at a significant premium to the floor price giving rise to the likelihood of their rejection by the promoters, the minority shareholders are denied a fair exit. Moreover, the RBB process was found to be complex thereby resulting in incomprehensibility on the part of the minority shareholders, especially of the retail variety.

Due to this, SEBI has come out with various suggestions, some of which relate to amending the RBB process to make it more workable, with others that relate to doing away with that process altogether by migrating to an alternative price discovery mechanism.

Suggestions: In my view, there is merit in migrating from the RBB process (or a variant thereof) to another more flexible price discovery mechanism. While the RBB provides considerable power to the public shareholders, that power is capable of being usurped by the more significant among such shareholders who hold a large number of shares. Although it would be possible to make some adjustments to this mechanism to avoid these distortions, they cannot be eliminated altogether. The RBB process is rigid and inflexible, and any benefit of certainty and clarity it provides is overshadowed by the restrictions it imposes in a successful completion of the delisting offer.

Hence, the recommended option would be for the promoters/acquirers to propose a bid price, which the public shareholders may either accept or reject (by either tendering their shares in the delisting offer or refraining from doing so). At first blush, this might seem to provide too much leeway to the acquirers. But, that can be counteracted through other protective measures, which are discussed below.

(i)        First, if the price is too low, the public shareholders will not tender their shares so as to not provide the minimum required acceptances to make the delisting offer successful.

(ii)       Second, the board of the target company must be foisted with the duty to advise the shareholders as to whether the terms of the delisting offer are fair and reasonable. In doing so, there must be a committee of independent directors that provides the advice/recommendations. This is consistent with developments such as the Companies Act, 2013 and the revised Clause 49, which impose greater roles and responsibilities on independent directors, especially when the board or promoters are afflicted with conflicts of interests such as in the case of delisting.

(iii)      Third, the committee of independent directors must obtain advice from an independent financial adviser or valuer who provides an opinion as to the fairness and reasonableness of the terms of the delisting offer. This would ensure the review of the terms by an outside gatekeeper.

This approach of price discovery is desirable as it is both flexible and protective. It is also consistent with the approach followed for delistings in several developed jurisdictions. From a comparative standpoint, the RBB process in India appears to be a rarity, and SEBI must not continue to embrace it unless there are compelling reasons to do so. If past experience is anything to go by, such a rationale for continuance does not appear compelling.

Shareholder Approval

Under the current regime, delisting can be allowed only if approved by way of a special resolution by the shareholders through postal ballot. Further, the special resolution stands supported only if the votes cast by public shareholders in favour of the proposal is at least twice the number of votes cast against it. In other words, apart from a standard special resolution, the proposal must enjoy the support of the public shareholders. However, the Discussion Paper highlights a practical concern whereby this requirement adds considerably to the timeline for delisting that takes away from its effectiveness. Delistings are said to take anywhere between 4 and 6 months. One proposal is to do away with the shareholder approval requirement with others suggestions making variations as to timing.

Suggestion: Despite the concern on timing, the shareholder approval requirement is an important protection to public/minority shareholders and ought not to be done away with. As indicated earlier in this post, the public shareholders are vulnerable in a delisting, as the process is orchestrated by the promoters/acquirers who are conferred a natural advantage. Unlike a standard takeover offer (which does not require shareholder approval), the delisting will result in illiquidity of the shares of the target company. Before public shareholders have been deprived of such liquidity on their shares (which does not occur in a standard takeover offer), their consent must be obtained. The additional approval through a requisite majority of public shareholders is also an important one that must be retained because the promoters/acquirers are interested in a delisting due to which their vote must be discounted. What is required is an approval through a “majority of the minority” vote, which is now a recognised concept under the Companies Act, 2013 (e.g. for material related party transactions).

Conclusion

The Discussion Paper also makes a number of other suggestions that relate to the process of delisting, disclosure requirements, eligibility, etc., which are not capable of being discussed within the confines of a blog post. However, one issue that is conspicuous by its absence in the Discussion Paper relates to the interplay between the SEBI Delisting Regulations and the SEBI Takeover Regulations. Currently, there appear to be difficulties in undertaking a takeover offer that would be followed by a delisting in case of requisite acceptances that reduce the public shareholding below the minimum. Although SEBI had been providing indications that the asymmetry between the two sets of regulations will be ironed out in due course, no concrete proposal has been forthcoming in that regard.

In all, the effort to overhaul the delisting regulations is an important and timely one. Given the spate of delistings that have been attempted in India (and more that may perhaps ensue in the near future), it is necessary to provide for a regime that efficient, timely and carries the necessary clarity and certainty for the promoters/acquirers, but also one that sufficiently protects the interests of the public shareholders.


[1] Wan Wai Yee & Umakanth Varottil, Mergers and Acquisitions in Singapore: Law and Practice (Singapore: LexisNexis, 2013).

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