[ Arushi Gupta & Durga Prasad Mohapatra ]
The authors are 3rd year students of NLU Odisha.
Introduction
The concept of PIPE(Private Investment in Public Equity), developed in the US with separate provisions regulating the same. However, Indian law has no such specific regulations which guide the PIPE deals .The PIPE deals in India are regulated by the preferential allotment rules elucidated by SEBI. Considering the fact that the PIPE deals in India are not really developed, the article attempts to draw a distinction between the take of the US and Indian laws by analyzing the relevant provisions.
SEBI (Issue of Capital and Disclosure Requirements), 2009
The SEBI (Issue of Capital and Disclosure Requirements), 2009 (“ICDR”)deals with various modes of issuance of securities wherein Chapter VII of the ICDR Regulations lay down the provisions regarding preferential issue of securities. The main area of emphasis with regard to PIPE transactions will be upon Section 72(1)(a) and Section 78(2) of the ICDR Regulations. Section 72(1)(a)[i]lays down the conditions for preferential issue whereby a special resolution passed by the shareholders is a prerequisite in cases of preferential allotment. However, in the US, the shareholder approval[ii]is not mandatory and is guarded by threshold limits. With regards to the NASDAQ, the shareholder approval is not required in case of bonafide private financing. A bonafide private financing[iii]is a sale whereby the issuer sells the securities to multiple investors, provided, that no individual investor would have more than 5% of the shares of the common stock. This is an effective way to avoid dilution of control and may act as a safeguard for the shareholders in the cases where their approval is not taken. The NYSE rules, on the other hand, impose a threshold limit of 20%, whereby shareholder approval is required in cases where the issue would amount to more than 20% of the outstanding common stock. This rule is also shareholder centric as it aims at prevention of dilution of control unless otherwise approved by the shareholders. It can be inferred from the practices in the 2 jurisdictions that ‘control’ as a factor is relevant in case of PIPE transactions and an attempt is made to prevent the dilution of control in both the cases but by the usage of different mechanisms and techniques.
Section 78(2)[iv]provides for a lock-in period of 1 year in case of preferential allotment of specified securities being made to persons other than the promoter. A lock in period[v]is basically a time frame within which an investor is forbidden from selling or redeeming shares.Under Section 144, Securities Act 1933,[vi]such securities are restricted in nature but can be resold on the trading market once a registration statement has been declared effective[vii]by the SEC. In case of US, the transaction provides a higher level of liquidity as the statement is declared effective within 45-90 days[viii]of closing of the deal. Liquidity is one of the key factors which make a PIPE deal suitable for investors. PIPE transactions are preferred over other alternatives due to the increased liquidity they offer to purchasers of registered security with the certainty and speed of a private placement.[ix]The problem of liquidity which the Indian law poses in this matter can be cited as one of the reasons for PIPE deals still being at a nascent stage.
SEBI (Prohibition of Insider Trading) Regulations, 2015
An area of prime concern with regards to PIPE transactions is that it leaves room for insider trading. A due diligence test[x]i.e. a process by which the investor gathers all the necessary information in order to evaluate the potential risks involved is conducted by the investor in order to better understand the potential pitfalls associated with the deal . Due diligence is not a concern in law, provided that the process does not lead to dissemination of Unpublished Price Sensitive Information (“UPSI”). UPSI[xi]refers to all such information which is directly or indirectly related to the company and has the potential of affecting the prices of securities of the company. Regulation 6 of Schedule II[xii]deals with disclosure of Price Sensitive Information to institutional investors whereby only public information can be provided to investors by the listed companies.
With the recent amendment to the Insider Trading Regulations, any person who while conducting due diligence comes across UPSI would be referred to as an insider[xiii]. Furthermore, such a person is not allowed to deal with the securities of the company even if a confidentiality /non-disclosure agreement has been signed[xiv]between the parties. On the other hand, in US, the disclosures are governed by the Regulation Fair Disclosure[xv]wherein the acquirer of UPSI is allowed to trade in the securities of the company, provided that a confidentiality agreement has been signed between the parties. The disclosure regulations in India are stringent and hence may pose a threat to the investors as they would always apprehend the possibility of a liability being imposed upon them while conducting due diligence and consequently refrain from investing in PIPE deals.
Conclusion
The aspect of control whereby under the ICDR Regulations, the PE firms willing to invest in public companies have to deal with a lock in period of one year and hence cannot exit the companies even when they face heavy losses. With regards to the questions of insider trading, SEBI has put forth certain conditions such as appropriate confidentiality and nondisclosure agreements which have to be signed before any due diligence process begins as provided under Regulation 3(4) of the SEBI (Prohibition of Insider Trading) Regulations. Further, promoters often do not expect to cede any sort of control to private investors as they do not consider them to be an added source of expertise, they only expect them to be passive investors instead of a genuine source for newer perspective who can provide business guidance.
Even though PIPE investments are a quick fix to gain financing especially by smaller companies who want immediate capital for working, the market environment in the country has still to be made conducive to such financing methods as a number of problems still plague the market such as a lack of clarity about rules and regulations as seen by multiple regulations and no harmonization of such guidelines across government agencies
[i]Section 72(1)(a) of the SEBI(ICDR) Regulations,2009.
[ii]https://www.sullcrom.com/files/upload/Blaut_Veeraraghavan_LPA_PIPEs_May2018.PDF.
[iii]Stuart H. Gelfond, The NYSE’s Complex Shareholder Approval Rules: Issuing new securities? Do you need shareholder approval? Available at: https://www.lexisnexis.com/lexis-practice-advisor/the-journal/b/lpa/archive/2016/09/13/the-nyse-s-complex-shareholder-approval-rules-issuing-new-securities-do-you-need-shareholder-approval.aspx.
[iv]Section 78(2) of the SEBI(ICDR) Regulations, 2009.
[v]https://www.investopedia.com/terms/l/lockup-period.asp
[vi]Section 144 of the Securities Act, 1933.
[vii]https://www.paulhastings.com/docs/default-sources/PDFs/715.pdf
[viii]https://media2.mofo.com/documents/faqspipes.pdf
[ix]Leib Lerner, Disclosing Toxic Pipes: Why the SEC Can and Should Expand the Reporting Requirements.
Available at: https://www.jstor.org/stable/40688136?seq=1#page_scan_tab_contents
[x]http://www.businessdictionary.com/definition/due-diligence.html
[xi]Section 2(n) of the SEBI (Prohibition of Insider Trading) Regulations, 2015.
[xii]Regulation 6, Schedule II of the SEBI (Prohibition of Insider Trading) Regulations, 2015.
[xiii]Regulation 2(g) of the SEBI (Prohibition of Insider Trading) Regulations, 2015.
[xiv]https://www.thehindubusinessline.com/opinion/a-major-omission-in-insider-trading-rules/article7916275.ece.
[xv]Sambhav Ranka & Vyapak Desai, SEBI must set rules to avoid insider play in PIPE deals. Available at: http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Sebi_must_set_rules_to_avoid_insider_play_in_PIPE_deals.pdf.