Sunday, November 29, 2015

SEBI Adjudication Order: Disclosure of Encumbrances Over Shares

The SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (the “SAST Regulations”) contains provisions in Reg. 31 that requires promoters of a company to disclose to the company and the stock exchanges the details of shares encumbered by them and also any invocation or release of encumbrance. 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.

Recently, SEBI had occasion in an adjudication proceeding to consider the nature of such disclosure obligations. The case involved United Breweries (Holding) Ltd. and Kingfisher Finvest India Ltd., being the promoters of United Spirits Limited (“USL”). The brief facts are that SEBI’s investigation led to its allegation that, during 2012, the promoters of USL did not disclose the creation, invocation or release of certain pledges in respect of USL shares in a timely manner.[1]

In this post, I confine myself to one legal issue pertaining to promoters’ disclosure obligations. It was argued on behalf of the promoters that in case of invocation of the pledge, it is possible for them to discharge their disclosure obligation only when they themselves are made aware of the invocation by the lenders. In other words, the time period for disclosure must ought to be triggered only when the promoters become aware of the invocation. However, the Adjudicating Officer did not accept the argument and applied a strict interpretation of the disclosure obligation under Reg. 31 of the SAST Regulations. The order states:

Here, I do not agree with the aforesaid plea / contention of “knowledge/intimation” of invocation of pledge transactions on the two following grounds. Firstly, as per the bare reading of regulation 31(3) of the SAST Regulations, the disclosures are required to be made “within seven working days from the creation or invocation or release of encumbrance”. The said regulation clearly stipulates the mandatory requirement of disclosures to be made from the date of creation / invocation / release of the pledge and does not leave any scope of “knowledge/intimation” as prior condition for the person who is required to make such disclosures. Had the “knowledge / intimation” been the intent of the statute then, it would have been very well incorporated in the SAST Regulations itself. Secondly, while making / creating pledge of shares by the borrower, certain terms / condition as well as the timeline of invocation of pledged shares in case of breach in making payment/loan are pre fixed between the borrower and the lender. Needless to say that if such time line towards the pledged shares are there, then, the borrower … is supposed to know the last day after which invocation of pledged share may take place by the lender upon breach of payment.

Following this, the Adjudicating Officer also dealt with the fact that under the SEBI (Depositories and Participants) Regulations, 1996, the depository participants had an obligations towards the pledgor / pledgee to immediately notify any invocation of a pledge. For these reasons, the Adjudicating Officer came to the conclusion that information or knowledge of the invocation of the pledge is not a precondition for disclosure obligations on the part of the promoters to arise.

While this approach is consistent with the text and intent of the SAST Regulations, it does impose significant obligations on the part of the promoters to notify in a timely manner the creation, invocation and release of pledges. The knowledge of the promoters as to the invocation or release of the pledge does not come in the way of the disclosure obligation. As before, SEBI treats the disclosure obligation as an inherent aspect of securities market efficiency. As the Adjudicating Officer’s order observes:

Before arriving to the quantum of penalty in the matter, it is necessary to refer [to] the importance of such disclosures. The main objective of the SAST Regulations is to achieve fair treatment by inter alia mandating disclosure of timely and adequate information to enable shareholders to make an informed decision and ensuring that there is a fair and informed market in the shares of companies affected by such change in control. Correct and timely disclosures are also an essential part of the proper functioning of the securities market and failure to do so results in preventing investors form taking well informed decision.

Hence, in respect of one of the promoters, viz. United Breweries (Holding) Limited, the Officer imposed a penalty of Rs. 15,00,000, after taking into account the circumstances of the case. In respect of the other promoter, viz. Kingfisher Finvest India Ltd., the Officer found that the delay in disclosure was minimal, and hence no penalties were imposed.

[1] Pages 3 and 4 of the Adjudicating Officer’s order has a table carrying the details of the delays

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