[Guest post by Nikunj Agarwal, a fifth-year B.A., LL.B (Hons.) student at Dr. RML National Law University, Lucknow]
In recent years, India witnessed a steady increase in foreign investment in the Indian economy. The preceding year also saw many private equity funds and other institutional investors making an exit through the initial public offering (IPO) route. However, legal issue amounting to a deal-breaker of sorts has arisen in relation to disclosures relating to foreign promoters under the regulations governing public issue of securities in India.
SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the Regulations) constitute the principle disclosure regime for public issue of securities. In regulation 2(1)(za) the term ‘promoter’ is defined as an entity which is in ‘control’ of the issuer, or the person or persons who are instrumental in the formulation of the plan pursuant to which the offer to public is being made, or the entity named in the offer document as promoter, subject to the provided exceptions. In so defining, Indian law does not differentiate between domestic and foreign promoters.
Therefore, foreign investors can be classified as promoter under the Regulations, which classification would be applicable largely at the time of public issue of securities, even where the intention at the time of initial investment in the issuer was not to become an entity classified as a promoter. The duty to disclose contained under Indian law, which works well in relation to a domestic promoter, might result in complete paralysis of an IPO by an issuer having a promoter that is required to comply with laws other than Indian laws. These promoters can be either foreign promoters or, Indian entities having operation outside India.
Schedule VIII of the Regulations requires disclosure of all actions by statutory or regulatory authorities, outstanding litigation and material developments involving, inter alia, the promoters of the issuer. The term action has not been defined under the Regulations. Therefore, a situation might arise where any proceeding against a promoter initiated by a foreign authority is considered an action by the Securities and Exchange Board of India (SEBI), the Indian market regulator, thereby triggering a duty of disclosure in India even though such proceeding is not classified as a regulatory or statutory action in the foreign jurisdiction where the action was in fact initiated. Thus, we have a two-fold problem here: first, identification of what proceedings against a promoter in any jurisdiction outside India qualify as an action under Indian law, and, second, management of the disclosure obligation in respect of such actions.
In some jurisdictions, certain regulatory or statutory proceedings are classified as material non-public in nature and hence cannot be disclosed by the entity against which the action has been initiated. Disclosure of such action requires prior permission of the authority which initiated the action. In a situation where permission is refused, the entity cannot disclose this information to any third party. This implies that a promoter entity is also restrained from communicating this information to the issuer. Therefore, compliance with the disclosure obligation under the Regulations becomes difficult in such situations.
Further, disclosure of actions pending against the promoter, but which have not acquired a material threshold, can have disproportionate impact on the promoter in multiple jurisdictions. A premature disclosure could result in a promoter facing financial repercussions and, in some cases, also expose it to avoidable litigation. The promoter might also have entered into third party contracts which require prior consent or impose a restriction on disclosure of certain type of non-public information.
If the issuer is not aware of an action against the promoter and proceeds with the IPO without consequently disclosing the foreign action, it may expose itself to enforcement proceedings by the market regulator in India if a confidential foreign action against the promoter is publicly disclosed subsequently anywhere in the world. This is because ‘all’ statutory and regulatory actions against the promoter are required to be disclosed. The due diligence teams must inquire from the promoters of the issuer if it is possible that there might be a confidential regulatory or statutory action against the entity in any jurisdiction outside India. Based on the disclosure regime, diligence here should not be in form of a question objectively asking whether any confidential action ‘does exist’, but it can be about ‘a risk’ of whether such action ‘can exist’.
The issuer can, as abundant caution, state in the prospectus that there might be confidential actions against the promoter of the issuer and the issuer might neither have information nor means to inquire about any such actions against the promoter. As a corollary, it should also not state anywhere in the prospectus that all statutory and regulatory actions against the promoter have been disclosed in the prospectus, where the risk has been identified. However, the compliance risk would still subsist given the duty to disclose all actions irrespective of notice or knowledge. Whether the qualifications of ‘notice’ or ‘knowledge’ can be read into the disclosure requirement for actions requires regulatory clarification.
Alternatively, the promoter can make a confidential disclosure to the market regulator and thereafter the regulator can take a call on whether the information is required to be publicly disclosed through the issuer’s prospectus. But, whether the promoter can make such confidential disclosure is again contingent on the law applicable to foreign action and if prior permission is required for such disclosure.
The Regulations do empower the market regulator to relax their strict enforcement. However, it remains to be seen whether the regulator would be willing to exercise the power to exempt disclosures of foreign actions as raised at present. It is important to note that the market regulator has held that the disclosure requirements under the Regulations are mandatory in nature and the issuer, the bankers to the issue and other prescribed entities need to make a declaration along with the prospectus that they have complied with the disclosure requirements contained in the Regulation.
The decision that the market regulator and lawyers working on the issue have to take is whether disclosure of such an action is so important for the investor that it would alter the total mix of information available to the market in such a way that the investment decision could be influenced by the disclosure. The answer to this question would reveal how far the market regulator would be willing to provide an exemption from the strict and wide ambit of the disclosure requirement or whether a confidential disclosure to the regulator would be permissible and whether the suggested risk statement would be sufficient to overcome the lack of information with the issuer so that the issuer is not exposed to an action by the market regulator in future.
- Nikunj Agarwal