Recently, the Securities Appellate Tribunal (SAT) had to deal with two separate situations pertaining to the disclosure of pledge or other encumbrance over shares. In an order discussed earlier today, the SAT found that the acquisition of shares by a public financial institution through the invocation of a pledge was required to be disclosed in accordance with SEBI’s Takeover Regulations. Separately, in another order involving Golden Tobacco Limited, the SAT ruled against any disclosure requirement on the company to disclose any “encumbrances” on its shares imposed on promoters through the restraint order of an arbitrator. Both these orders involved the interpretation of disclosure obligations on pledge or encumbrance of shares, albeit under different legal requirements.
In the Golden Tobacco case, SEBI alleged that the company failed under clause 35 of the listing agreement to disclose to the stock exchange that by an arbitration order dated July 23, 2009, nine promoter entities of the company were restrained from selling transferring or creating third party interest in any manner in the shares of the company held by such promoters. Clause 35 requires the company to disclose to the stock exchange the details of “shares pledged or otherwise encumbered”. On account of such failure, SEBI’s adjudicating officer imposed penalties under section 23E of the Securities Contracts (Regulation) Act, 1956 and section 15HA of the Securities and Exchange Board of India Act, 1992. It is against this order that the company preferred an appeal to SAT.
Disclosure of Encumbrances
A peculiar situation arose in this case. Normally, disclosures regarding shareholding (as well as pledge or encumbrance) have to be made by the relevant shareholders to the company, which in turn has to notify that information to the stock exchanges. This is the scheme of regulation, including under SEBI’s Takeovers Regulations as well as Insider Trading Regulations. The channel for the flow of information emanates from the shareholder and passes through the company ultimately to the stock exchange for public consumption. The peculiarity arose here because clause 35 requires the company to provide information to the stock exchanges regarding the encumbrance without a concomitant obligation on the shareholder to notify the company of the same in the first place. In other words, it imposes a unilateral obligation on the company to initiate disclosures without being aided by information from the shareholders. Using this logic, SAT came to the conclusion that it would not be possible to impose such an obligation on the company given that it creates an incongruous position under the listing agreement. On this aspect, SAT observed as follows:
14. … It is surprising that the format attached to clause 35 of the Listing Agreement casts an obligation on the listed Companies to disclose to the Stock Exchanges details of the shares that are otherwise encumbered by the promoter/promoter group, without making corresponding obligation on the promoter/promoter group to make such disclosures to the listed Company. … If promoter/promoter group are not obliged to give to the listed Company details of shares that are otherwise encumbered under any provision framed by SEBI, then, making it mandatory for listed Companies to disclose to the Stock Exchanges details of shares that are ‘other [sic] encumbered’ by the promoter/promoter group would be wholly unjustified and contrary to the policy decision taken by SEBI which was made public by press release dated January 21, 2009. … Thus, the format annexed to clause 35 of the Listing Agreement goes beyond the scope of clause 35 of the Listing Agreement and contrary to the policy decision of SEBI …
15. … SEBI has created an anomalous situation, because, promoter/promoter group who have details of shares that are ‘otherwise encumbered’ are not obliged to disclose the same to the listed Company, whereas, listed Companies to whom such details are not furnished by the promoter/promoter group are made to disclose such details to the Stock Exchange. …
This conclusion is entirely reasonable. On matters of shareholding, it would be unduly onerous to impose disclosure obligations on the company without similar obligations on shareholders. The primary disclosure ought to come from the shareholders who are best placed to make these disclosures. Moreover, the expression “or otherwise encumbered” must be read in the context of a pledge (which concept precedes the words in quotes). In other words, the encumbrance must be in the nature of a security interst or something similar over the shares. Viewed in that light, a restraint order of arbitrator (or judicial authority) cannot operate as an encumbrance. Similarly, a negative covenent (sometimes referred to as a negative pledge) or a non-disposal undertaking or a contractual lock-in on the shares would not operate as an encumbrances. In any event, it would be wholly unnecessary to require a disclosure of such matters to the stock exchanges.
The genesis of the requirement to disclose pledge and other encumbrances arose after the Satyam scandal where promoter shares were pledged to financial institutional unbeknownst to the remaining shareholders. The drastic fall of the promoter shares upon invocation of the pledge adversely affected the shareholders. Hence, if a pledge or other encumbrance is likely to result upon invocation in a divestment of promoter share, then that is information worthy of disclosure to the other shareholders. But, in a restraint order or negative covenant, that objective does not even exist. To the contrary, the promoter is unable to sell the shares and exit from the company, which ought to be of additional comfort to shareholders rather than something that shakes the foundations of their trust in the company and its promoters. Although the SAT did not adopt the approach of analyzing these issues and objectives, they are consistent with the ultimate conclusion it arrived at.
While the above constitutes the principal substantive issue that required SAT’s consideration, a few other incidental issues are noteworty, as discussed below.
Amendments to Listing Agreement
While SAT did not have to conclusively rule on the issue, the case raised some issues regarding the legal veracity of the listing agreement as a regulatory instrument, and more particularly the manner in which it can be amended. In amending clause 35 to introduce its current language, it was argued that while SEBI’s circular merely advised the stock exchanges to amend the clause, there was no actual evidence of amendment by the exchanges. However, based on statements provided by the stock excahnges that they have amended the listing agreement, SAT “proceeded on the basis that the amendments have been carried out in accordance with law”.
Although the issue did not emerge to the forefront in this case, the manner of regulating corporate governance and disclosure norms through the listing agreement is bound to raise some consternation. While the listing agreement is essentially contractual in nature between the issuer company and the stock exchange, it derives its legal validity from the Securities Contracts (Regulation) Act. Despite its contractual foundations, it can be amended at SEBI’s instance so as to bind the listed companies without their concurrence. In that sense, it begets unilateral alteration to which issuers are implicitly bound. Matters of procedure regarding the announcement and effectuation of amendments ought to be streamlined further between SEBI and the stock exchanges to obviate such issues.
Consistency in Adjudication
SAT also called for uniformity in the approach of SEBI’s adjudicating officers in similar cases, and also reaffirmed their duty to passed reasoned orders after considering relevant circumstances. The allegation was that the adjudicating officer in this case disregarded a contrary view of another officer in a different case without assigning reasons. SAT observed:
However, the Adjudicating Officer, in the present case, has neither found fault with the order passed in case of Dewan Housing Finance Corporation Ltd. (Supra) nor assigned any reason for taking a view contrary to the view taken therein. Such an attitude on part of the Adjudicating Officer of SEBI deserves to be condemned. View taken by one Adjudicating Officer of SEBI cannot be disregarded by another Adjudication order without assigning any reasons. It is high time that SEBI takes remedial measures and ensure that its Adjudicating Officers respect orders passed by each other. We make it clear, respecting each others order does not mean that even an erroneously order, passed by the Adjudicating Officer must be followed blindly. In such a case, contrary view could be taken by recording reasons for taking such contrary view.
This step would introduce greater consistency in SEBI’s approach in similar cases.