Surfing The Waves Of Change: Has The Concept Of Promotors Come Of Age In India?

 [By Aashirwa Baburaj] 

The author is a student at NMIMS Kirit P. Mehta School of Law, Mumbai. 

With the rise of unicorns, such as PayTM, in the fintech industry and the emergence of a new shareholding pattern comprising of private equity (“PE”) and institutional investors; the controlling powers that were long vested in the hands of promoters in India, have begun to steadily slip through the fading Indian concentrated ownership structure.

In light of this shift, and at a time when many new-age companies from the startup world are making their way to the Indian IPO market, the Securities and Exchange Board of India (“SEBI”) has issued a consultation paper proposing a transition from the concept of a “promoter” to that of a “person in control”.

The aforementioned proposal merits a thorough examination on account of multiple reasons. To begin with; if this proposal were to come to life, it would result in a substantial reform of the Indian corporate regime as the idea and notion of promoters runs very deep in the Indian regulatory framework. Consequently, this move may have severe repercussions on laws administered by other regulators such as the Ministry of Corporate Affairs, the Competition Commission of India, and the Reserve Bank of India. Furthermore, while the proposal also contemplates reducing and minimizing the lock-in obligations for promoters and shareholders investing in an IPO and SEBI is clearly in favour of these reforms, it is important to assess whether the Indian corporate market is ready to adopt them.

Preface: Current Legal Framework & Proposed Changes

At the outset, it is pertinent to note that the changes proposed by SEBI presently are restricted to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR”).  Thus, while SEBI has highlighted that some of these recommendations may affect other legislations, it has not explicitly evaluated the implications of the same.

As per the current legal framework, promoters play a key role in the listing process since the ICDR regulations impose significant obligations on promoters to ensure their involvement in the company. The consultation paper proposes 4 major changes:

1. Shifting from the concept of ‘promoter’ to the concept of ‘person in control’.

• A ‘promoter,’ according to Regulation 2(1)(za) of the ICDR, is a person named in the offer document who is instrumental in the formulation of the plan on the basis of which securities are offered,      or promotes or sponsors mutual funds in the case of financial institutions, scheduled banks, and foreign institutional investors.
• The proposed change from ‘promoters’ to ‘persons in control’ by eliminating references to promoters and promoter groups, whilst adding the terminology of the person in control or controlling shareholders in numerous SEBI Regulations, is the centrepiece of SEBI’s proposal.

2. Reduction in lock-in periods

• Presently, as per Regulation 16 of the ICDR, a minimum shareholding of 20% in the company’s post-issue share capital is required, as is a three-year lock-in period on such shareholding. Additionally, a lock-in requirement of one year from the IPO has been listed for persons other than promoters under Regulation 17 of the ICDR.
• If SEBI’s proposal is adopted, then the lock-in period for persons other than promoters will be reduced to six months from the date of allotment in IPO; the current three-year threshold for promoters will be whittled down to one year. Further,  the Promoters’ holding in excess of minimum promoters’ contribution will only be locked in for a period of six months as opposed to the current requirement for one year.

3. Streamlining the disclosures of group companies

• Currently, a ‘group company’ intending to list its shares must disclose comprehensive details of the previous three years for its five largest listed group companies or five largest unlisted group companies based on the turnover where no listed group companies are involved. This includes information such as date of incorporation,  nature of activities,  equity capital,  reserves,  sales,  profit after tax, earnings per share and diluted earnings per share,  net asset value,  pending litigation involving the group company which has a material impact on the issuer etc.
• SEBI has proposed that the detailed disclosure requirement be eliminated and the IPO Offer Document merely includes the names and registered office addresses of all Group Companies. However, these disclosures — slated to be eliminated — may continue to be made available on the websites of the listed companies.

4. Rationalization of the definition of ‘Promoter Group’.

• Regulation 2(1)(pp)(iii)(c) of the ICDR stipulates  ‘promoter group’ to include “[a]ny   body corporate  in  which  a  group  of  individuals  or  companies  or  combinations  thereof acting in concert, which hold twenty per cent or more of the equity share capital in that body corporate and such group of individuals or companies or combinations thereof also holds twenty per cent or more of the equity share capital of the issuer and are also acting in concert.”
• In order to rationalize the disclosure burdens upon companies, SEBI has suggested eliminating the norm of mentioning the aforementioned corporate bodies as part of the promoter group vide the deletion of the aforementioned regulation, thereby diluting this concept.

Addressing This Wave Of Reform

1. Is The Promoter Landscape Changing in India?

As stated earlier, this proposed transition from ‘promoters’ to ‘persons-in-control’ lies at the heart of SEBI’s proposal. It is worth noting that the existence of a promoter-driven regulatory mechanism across the Indian legal framework is largely attributable to the prevalence of ‘family’ held companies in the Indian market, formerly. Due to this, promoters or founders ended up retaining a majority of the shares in a company.

However, with a large number of institutional investors (both foreign and Indian) penetrating the Indian market, numerous enterprises, particularly new age and tech companies, are now embracing a rather diversified shareholding pattern. These institutional investors are made up of thousands and thousands of investors who amass money from individual investors and invest it in companies with the sole purpose of maximizing returns. As a result, there has been a      paradigm shift in the ownership structure as these companies are not family-owned and/or lack a distinctly identifiable promoter/ promoter group.

This suggested change can thus be viewed as SEBI’s regulatory shift to adapt to India’s changing business realities driven by these institutional investors.

2. Are The Proposed Changes Necessary?

• The Transition from Promoters to Persons in Control

With a shift in their ownership patterns, companies are gradually veering away from their stance of “once a promoter, always a promoter” — this has also provided them with new channels of control. Since institutional investors are ultimately a conglomeration of several stakeholders who invest capital in order to maximize their advantages and acquire high returns, these companies have begun to decouple control from ownership and are professionally managed to achieve this goal. PayTM is a great illustration of this — the business entity, with its diversified board of directors and shareholders, has categorized itself as a professionally managed company.

Notably, the aggregate market value of the stake held by institutional investors has grown 21% of overall market capitalizations in 2001 to 34% in 2018.

This indicates a gradual shift toward a “purer” notion of shareholders and management, that is aligned with this new reality in which some of the largest shareholders are to be PE investors and other institutional investors who may not fall under the ‘promoter/promoter group’ category, but are in a position to influence the company’s management and the decision-making process.

While SEBI regulations like the Listing Obligations and Disclosure Requirements, 2015 (“LODR”) contain various restrictions to protect the interests of stakeholders, however, it is essential to note that these restrictions only extend to the company’s promoters/promoter groups. In companies with diverse ownership patterns, the person in control would evidently be beyond the definition of ‘promoter/promoter group,’ but would exert considerable influence over the company. Consequently, this would aid those who are culpable in evading accountability.  As a result, this proposed transition is essential in order to have more control over such companies and hold them accountable under the specific segments (so applicable) of the SEBI Regulations.

However, adequate regard must be given to the fact that, while Indian markets are moving toward the establishment of professionally managed companies, it remains a fusion of promoter centric and professionally managed enterprises as of today.

Thus, SEBI would need to frame and adapt its regulatory framework such that it envelops both these enterprises. However, one of the most pressing issues that would arise with this change is determining who might be designated as a person-in-control.

Given that this transition is analogous to a shift from an Indian promoter-centric approach to a western approach, due consideration should be given to the parameters for determining control in countries such as Canada or France, where an entity is deemed to be in control of a company if:

1. it has the right or exercises control, directly or indirectly, over the majority of voting rights at the general meeting; or
2. has the ability to control the composition of a majority of the board members of the company.

This is somewhat similar to the Indian paradigm under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”), where the following factors are taken into account:

1. the right to appoint a majority of the directors; or
2. the right to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding, management rights, shareholders or voting agreements, or in any other manner.

Further, SEBI could even choose to review the discussion paper on the Brightline Tests for Acquisition of  ‘Control’ under the SEBI Takeover Regulations (which the regulatory body stepped back from)      released in 2016 to decide if a numerical threshold or a principle-based test should be used to assess whether a person has control of a listed entity. This way, while SEBI’s proposal would most definitely alter the present regulatory framework, it could be consistent with what was meant to be modified under the Takeover Regulations.

• Revamping Lock-in Requirements

The lock-in clauses were enacted to ensure that promoters continue to have “skin in the game” after receiving public funding, as well as to ensure and maintain the confidence of these investors (i.e., the public shareholding).

Given the locomotion of corporate structures toward a more diversified ownership pattern, such reform should undoubtedly be endorsed. This transition, led by institutional investors, would increase their involvement in the market since they generally partake and invest in IPOs in order to optimize their returns and, as a result, are opposed to prolonged lock-in periods. This move also shows SEBI’s attempt to adapt to commercial realities by shifting from regulatory lock-in requirements to market-driven lock-in requirements.

• Disclosure Requirements

SEBI’s regulations cast obligations on the issuing company to disclose details such as the name of the group companies, details of registered address, business description and financial details among others. SEBI’s proposal to publish only the names and addresses in the IPO offer document, excluding financial data of group businesses, is a step in the right direction. These financial details are usually readily accessible on the websites of these companies and thereby, the proposed move removes the need for making repeated detailed disclosures without interfering with the delivery of material information to investors. However, it would be imperative to mandate these companies to make such information readily accessible as a safeguard.

Furthermore, this consultation paper proposes to simplify disclosures by diluting the definition of ‘promoter group’. According to SEBI, the present definition of promoter group imposes regulatory obligations on investee individuals/companies who may no longer control the entity.  Now, it is pertinent to note that this definition merely classifies majority owners as promoters regardless of the amount of control or influence they hold. Furthermore, institutional investors clearly do not fit into this categorization.  As a result, a concise definition will lower the disclosure requirements for non-material entities while ensuring investors obtain material information.

Concluding Remarks

The adoption or even the consideration of SEBI’s current proposal is the stepping stone to an incredibly long and tedious journey. Despite the increased involvement of institutional investors in the securities market, India’s regulatory architecture continues to be promoter-specific; and can lead to such a person being held accountable for an act done by someone else in vague control.  This suggested change from promoters to persons-in-control would most likely envelope these entities with actual control under the umbrella of accountability and thereby, potentially lead to a clear separation of ownership and management.

This transition, however, raises two indispensable questions that SEBI must look into:

• Who shall be regarded as a person in control?; and
• Would the existing framework specified in the takeover code be relied upon?;

The consideration of this proposal also offers an opportunity for SEBI to revisit its 2016, “Brightline Test” discussion paper, in which the securities regulator evaluated the adoption of a qualitative or principle-based test of control.

Furthermore, given that the Indian market in its current form is a hybrid of family-owned and institutionally driven enterprises, the proposal would undoubtedly have to be implemented in stages to avoid any disorientation. Additionally, incremental measures would need to be made since this proposed paradigm shift has the potential to reboot the entire regulatory system, necessitating waves of reform across multiple legislations. It is not simply the SEBI regulations (such as the ICDR, LODR, Takeover Regulations etc.     ) that will have to be tailored; the implementation of this proposal would also have profound effects on Company law and the Insolvency & Bankruptcy Code — enforcement strategies would require reorientation, delisting regulations would need to be revisited, and lending practices would need to be revamped.