Operation of RPT Regulations in Adani Group’s Brazen Growth

[By Amartya Sahastranshu Singh and Atika Chaturvedi]

The authors are students of National University of Study and Research in Law, Ranchi.

 

Related party transaction [“RPT”] means “A transfer of resources, services or obligations between a reporting entity and a related party, regardless of whether a price is charged.” Simply put, RPTs are covenants between parties who share a ‘relationship’. What relationships make a party ‘related’ are already prescribed in law. Broadly, it means an ally, relative, holding company, subsidiary, an affiliated entity, etc. This concept of RPTs has quite a significance. It can create a conflict of interest between the management and the stakeholders. For instance, sometimes, dealings with related parties may occur at above or below market rates. In other words, they may not occur at an ‘arm’s length basis’. This deludes investors who rely upon the company’s financial statements. The non-disclosure of RPTs may misrepresent the company’s true financial results. Thus, disclosure is made necessary.

Provisions and regulations related to RPT are widely spread across the following:

  1. Companies Act, 2013 [“the Act”] (S. 2(76), S. 177, S. 188),
  2. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 [“LODR”] (Regulation 23),
  3. Companies (Meeting of Board and its Powers) Rules, 2014 (Rule 15),
  4. Companies (Specifications of Definition Details) Rules, 2014, (Rule 30) and
  5. Indian Accounting Standard 24.

The basic functions that these laws perform are defining the nature and scope of related parties, describing related party transactions, regulating its approval and audit aspects, and extending the concept of ‘arm’s length’. Arm’s length transactions involve two related parties acting as though they were unrelated. The rationale of these provisions is to avoid conflict of interest.

However, despite various regulations, the media has pointed out the growing frequency of non-disclosure and defaults in RPT approval from listed companies. Thus, SEBI, alarmed at this development, resorted to amending the law related to RPTs. The motive behind this was strengthening corporate governance, ensuring disclosure, and protecting public interest. The foundation of this Amendment was the recommendations of the SEBI Working Group. The Amendment was ushered in 2021 on the basis of their Report dated 27th January, 2020.

From a bird’s eye perspective, the amendment brought the following changes in the regulations:

  1. Earlier, a ‘promoter’ was not included in the definition of a related party. But post-amendment, promoters/promoter groups are encapsulated within the definition of ‘related party’.
  2. The definition of ‘related party’ has been amended to incorporate any party having equity shares worth 20 percent or more with effect from 1st April, 2022, and 10 percent or more with effect from 1st April, 2023, either on a direct or beneficial interest basis.
  3. SEBI expanded the term “RPT” under Regulation 2(1)(zc) of the LODR to include subsidiary transactions.
  4. A transaction between the listed entity or any of its subsidiaries and any other person or entity which benefits a related party will also constitute an “RPT” as of April 1, 2023. This provision was drawn from the UK Premium Listing Rules.
  5. The Amendment also classified transactions even between two subsidiaries (including overseas) as RPTs and subjected those to the approval of listed entity’s audit committee [“AC”].
  6. For the approval of the AC when the estimate of every transaction that surpasses 10% of the annual consolidated turnover, according to the last audited financial statements. The materiality threshold for attaining approval of shareholders has been modified to contain transactions that surpass Rs. 1000 Crore or 10% of the annual consolidated turnover, whichever stands lower.

Under this amendment, the scope of RPTs has widened. Companies and their subsidiaries now require several clearances for RPTs. This poses complications for listed several companies. It will also affect the businesses of many companies because of the general business structure of India. Most of the big corporate entities in India are managed by families or groups. As of March 2020, the average number of subsidiaries for Indian public companies has more than tripled in the last 15 years. A survey by SEBI and OECD revealed that the primary reasons for the group structure of Indian companies were ‘economies of scale’ and ‘efficient resource allocation’.

This cohesive structure of Indian Companies makes RPTs a commonplace. A classic example of that is the Adani Group. Companies such as Adani Transmission and Adani Enterprises have witnessed a meteoric soar of over 1000% in their share prices. However, this phenomenal growth of the Adani Group is under question, causing a political stir. Inter alia, the group is alleged to be involved in unethical RPTs.

At this juncture, it is important to deal with the concept of ‘float’. Angle One, one of India’s leading full-service retail brokers defines ‘free float’ as, “shares you can trade publicly in the secondary market or the stock exchange.” Currently, the minimum float is set at 25% of total outstanding shares as per SCRR. This ensures liquidity in the secondary markets. However, the Adani Group allegedly violated these norms.

Hindenberg Research which specialises in ‘forensic financial research’ recently released a report on Adani Group. Among other irregularities, it pointed out several undisclosed RPTs. The report highlighted that the close relatives and associates of Gautam Adani, the chairman and founder of the Adani Group, were running several shell entities offshore. These entities are allegedly the largest public  (‘non-promoter’) shareholders of the Adani Group. Moreover, the research explicitly pointed out that “4 of Adani’s listed companies are on the brink of the delisting threshold due to high promoter ownership.

According to the data from the research, the following is the percentage holdings of the promoter group:

Sr. Listed Entity Percentage Holding by Promoter Group
1 Adani Power 74.97%
2 Adani Total Gas 74.80%
3 Adani Transmission 74.19%
4 Adani Enterprise 72.63%

As evident, about 75% of the shares are held by the promoter group. Only 25% of the total outstanding shares have been left floating. Here, those offshore shell companies come into the picture. They hold the lion’s share of the float. The public is left with very low liquidity. Moreover, the research alleges that irregular accounting was used to manipulate financial records. Since higher profit attracts investors, the demand for the shares ballooned. The supply, due to the reduced float was low. Ultimately, the prices went high. Since the majority of the shareholders were the promoter group itself, its wealth increased and skyrocketed. However, in its 413 pages reply to the report, the Adani Group has denied all such allegations.

What regulated the Adani Group? According to the current laws, the Adani Group did not violate any norms. However, post April 2023, the definition of ‘related party’ will become wider. With the ‘catch all’ policy borrowed from the UK Premium Listing Rules, which will come into effect from April 2023, several of such companies will be under scrutiny. As far as the audit aspect of the company is concerned, that certainly is in the grey. The Hindenberg Report shows unwarranted activities by the AC of the company. Moreover, the independent auditors of the Company are also alleged to be a deficient organisation. Against this report a PIL has been filed by an advocate, demanding an investigation for causing investor loss.

Although the amendment makes the regulation of AC stringent, the issues still remain. The amendment may result in ‘conflict of laws’. For instance, two subsidiaries of Adani Group in different countries may get under the scrutiny of the AC of the onshore company. This is not a desirable effect.

A farce of such kind shakes the confidence of the entire country, and not just the company or its investors. The public starts distrusting the share market. The money influx into the free market falls. Fixed income assets grow. Low market liquidity hinders the economic growth of the country. It affects employment, interest rates, bank rates, and healthy inflation. The impact is far and wide.

Certainly, this amendment seems to have the potential to increase public confidence. With the increase in the ambit of a related party, the strengthening of laws related to auditing, requirement of a higher degree of approval and stronger RPTs disclosure policy will increase public confidence in the system and the financial markets.

With better float comes better liquidity and stable rise (or fall) of free shares. Better disclosure ensures stronger and more informed fundamental analysis by institutions and pubic. Strict auditing ensures that scams (such ones in the case of Satyam Computers and Enron) are avoided. Both shareholders and stakeholders will feel the impact of this amendment. The confidence of retail investors and financial institutions (both domestic and foreign) will increase in the capital market, derivatives market, currency market, and debt market.

In conclusion, the authors would like to state that this is a policy that protects the public interest. Although the companies would have to pay a cost, i.e. higher auditing costs, added burden of shareholder’s approvals, and several other compliance costs, this policy will be a boon for the financial investors and the public.

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