The markets regulator has begun a process to move away from the broad concept of promoter to controlling shareholders in order to better identify who’s in charge. Shivanand Pandit reports

Paving the way for a notable change in the way promoters and more than 5,000 publicly listed corporate entities operate, the Securities and Exchange Board of India (SEBI) in a consultation paper has suggested doing away with the age-old concept of promoters, and shifting to “person in control”.

The SEBI has proposed the change to put an end to the present definition of the promoter group, with a vision of streamlining the disclosure incumbrance. It also announced other proposals, including: (1) decreasing the minimum lock-in period (the tenure an investor can hold on to securities) after an IPO for the promoters’ portion of a minimum 20% from the current three years to one year; and decreasing the lock-in period for holding more than 20% from one year to six months; and (2) decreasing the lock-in period for pre-IPO shareholders (those who invest in the entity even before the public issue) from one year to six months.

The notion of the promoter is a heritage from the time when a corporate body or a group of companies would establish a business unit, for example, a power or steel or fertiliser plant, pledging some funds of its own and financing the remainder of the project cost by borrowing from banks or financial institutions, on top of raising capital from the capital market.
This business unit would remain linked with the establishment – virtually through the entire lifespan of the project – having a fundamental interest in safeguarding its constant profitability and progress, and consistently working to achieve that goal of what one may label as “once a promoter, always a promoter”.

Clarifying meaning of control

The SEBI, in its board meeting on 6 August 2021, gave an in-principle assent to move from the concept of the promoter to “controlling shareholders”, as was recommended in the consultation paper dated 11 May 2021, which dealt with the evaluation of structure relating to promoters and the promoter group.

Although the consultation paper mentioned many other viewpoints and aspects, restructuring the definition of the promoter group and rationalising the disclosure needs for group entities was one of the key changes proposed. This seems to be a branding modification in the configuration of company law.

The Companies Act, 2013, along with the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018, have defined the term promoter “as a person who has been named as such in a prospectus, or is identified by the company in the annual return in section 92; or a person who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director or otherwise; or a person who is an agreement with whose advice, directions or instructions the board of directors of the company is accustomed to act”. A person, or a group of people categorised as a “promoter group”, should have at least 20% equity share capital.

As per the SEBI consultation paper, a controlling shareholder is intended to be defined as: “A person who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director or otherwise.”

According to regulation 2 (1)(e) of the Takeover Regulations, 2011, the term “control” has been defined as the right to appoint the majority of directors, or 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 or management rights, or shareholders agreements or voting agreements, or in any other manner. The term “control” has also been defined identically under section 2(27) of the Companies Act, 2013.

Although the clarification of the term “control” given by the SEBI has been changing, in the case of Subhkam Ventures v SEBI (2010), it pronounced that defensive agreements – namely positive votes extended to the nominee director of the investor on issues such as amendment of the articles of association, alterations in share capital, consent of the annual business plan, reorganising of the investee entity, the nomination of significant officers of the entity, etc. – qualifies as gaining of control by the investor.

However, on appeal, the Securities Appellate Tribunal (SAT) opined that control is a power by which, on one hand, an investor can instruct an entity to do what it wants to do. The SAT also explained that the power by which an investor can prohibit an entity from doing what the latter wants cannot by itself qualify as “control”.

The SEBI appealed against the SAT order before the Supreme Court, however the Supreme Court could not pronounce its verdict because of the removal of the case due to the departure of the investor.

The interpretation of the term “control” came up before a whole-time member of the SEBI for judgment in the case of Kamat Hotels v SEBI (2017). Whole-time members are senior members second only to the SEBI chairman. There are four of them and they oversee several departments simultaneously during their five-year tenures.

The whole-time member in this instance had to resolve, inter alia, whether there had been the attainment of control by the noticees (persons to whom a show cause notice or an order was issued) just by virtue of entering into a contract under which they were allowed a number of privileges that would activate an open offer under the Takeover Code, 1997.

The whole-time member judged that the determination of control because of the existence of positive voting rights, in light of the realities of the case, was inappropriate. The whole-time member, with regard to the privileges accessible to the noticees as per the above-mentioned contract, made an obiter (in passing) pronouncement in its order: “It is apparent that the scope of the covenants, in general, is to enable the noticees to exercise certain checks and controls on the existing management for the purpose of protecting their interest as investors, rather than formulating policies to run the target company.”

However, since the contract was ended on 31 July 2014, the terms and clauses that allegedly bestowed control on the noticees under the contract were no longer compulsory on the promoters of Kamat Hotels, and therefore the whole-time member opted that the determination of “control” was no longer appropriate.

On the basis of previous precedents, it looks like that determination of control arises from several ideologies, which when applied to a given group of particulars and situations, offers scope for various interpretations. In the same background, the SEBI proposed a consultation paper in March 2016, in which the definition of control under the takeover regulations was considered to be amended as: “(a) the right or entitlement to exercise at least 25% of voting rights of a company irrespective of whether such holdings give de facto control; and/or (b) the right to appoint the majority of the non-independent directors of a company.” However, this has not yet been executed.

Right time to drop ‘promoter’?

Many will give a quick answer to the above question as “yes”, since the concept of promoter has become stagnant. The concept embraces all types of informal people, including blood relatives, who have been filing cases in court, also as promoters. In short, persons who have no control whatsoever of the organisation are treated as promoters. This gives an incorrect feeling to the investors of the organisation.

The SEBI should make the concept smarter, more fluid and accurate, rather than completely abolishing the responsibility of the leading shareholder. This can be done by employing global yardsticks. Expressions like a person acting in concert, or person in control, are understood throughout the world, and this will surely speak to who is overseeing the entity.

The minority shareholder will be better off if this modification is implemented. It is clear that the concept of promoter has not gone away, and the only change is in the terminology, which has been transited from “promoter” to “person in control”. This is a step forward because once a promoter, he/she need not always be a promoter.

During the previous decade, the investor structure in India experienced a radical variation where a new class of shareholders arose as leading investors, namely private equity funds, alternate investment funds, mutual funds, etc. Due to this, the shareholding of the promoter has been decreased to marginal, and total promoters’ holdings in prominent 500-listed entities by market value is on a downhill track since 2009, when it topped at 58%.

The new class of shareholders invests in new-age and tech business units (although unlisted) by means of what is termed “control deals” even prior to these going for an IPO. They continue to retain shares post-listing, many times being the biggest public shareholders, holding special privileges such as the right to appoint directors.

Although the actual ownership and controlling rights of a company have transferred to private equity funds or alternate investment funds, the establishment that introduced the business firm continues to possess power (notwithstanding its shareholding having been lessened to minority status) as the current regulation sorts it as a promoter.

The market watchdog desires to fix this glitch by changing emphasis from promoters to controlling shareholders, or the so-called person in control. Nonetheless, it also needs to ask whether the new class is indeed enthusiastic to take control.

Chasing a changing scenario

These organisations signify a collection of tens of thousands of investors, and in the case of mutual funds, they run into hundreds of thousands of investors. They gather money from individual investors, and many of them are high net-worth individuals and invest in companies with the prime aim of producing handsome returns.

In a basic sense, they are financial investors who would stay invested in an entity as long as the target is achieved, or otherwise depart. While the role of a person in control necessitates that they stay invested over the long term, the question now is: Does the SEBI really expect promoters to play the role of the person in control?

From its suggestions on the minimum lock-in period, it does not seem to be so. Post any IPO, the SEBI proposes to allow the promoter to discard his or her portion of a minimum of 20% within one year, against the existing three years, while holding more than 20% can be discarded in six months instead of one year.

The regulator is even contemplating entirely getting rid of the condition of minimum shareholding for a person to qualify as a promoter. If a unit, for instance, a private equity fund, can dispose of its shareholding obtained before the IPO (even though it’s big enough to give it the position of a promoter) within one year of the public issue, or the condition of minimum shareholding itself is relinquished, how can it be possible to do fairness to the role of a person in control?

Irrationally, the watchdog does not even want the public to recognise the individuality of investors behind the issuer. As per the relaxed disclosure obligations, the issuer need not furnish financial statements of group entities associated with the one being listed. It also need not name financial investors as promoters in IPOs, and it need not specify precise corporate entities that are part and parcel of the promoter group. As such, how can an entity whose basis of funding is masked in privacy infuse confidence?

Today, many listed companies are professionally administered, and much of the activity is positioned around the board of directors, including several independent directors. It also includes the CEO supported by numerous teams including the audit committee, remuneration committee, etc., for crystal clear operation. Could the person in a control role be delegated to the CEO or the board of directors? The answer is no.

The members of the board, including the CEO, are professionals. They are nominated and obtain their power from the shareholders, either by majority vote or any other method approved to by the shareholders. If the majority shareholders vacate, then it is doubtful that the current CEO or board of directors would continue.

Furthermore, if the majority shareholders leave within a short period, which is highly possible as per new regulations suggested by the market regulator, then the case for a CEO or board performing as a person is put in greater doubt. When the person who established the entity is dropped to a minority, and the new group of shareholders who have majority share are reluctant to sneak into the former’s shoes, it is tantamount to impelling the listed entity into the position of a ship without a captain.

The market watchdog should take another look at its suggestions, keeping two essential principles in mind. They are: (1) the voting or controlling power of an investor must be proportional to its investment, or the shares held by them; and (2) solidity of the management.

In the present situation, where the majority of shareholding is entrusted in a private equity fund or alternate investment funds, they should be made accountable to accept the role of a person in control, and remain invested in the entity over a reasonably long period.

The market regulator must not decrease the lock-in period. It should also not abandon the prerequisite of minimum shareholding for an entity to remain in control of the unit, and demand complete clarity on funding bases. Amazingly enough, transitioning from promoters to controlling shareholders will be pointless unless the SEBI effectively tackles the elephant in the room – the definition of control.

Shivanand Pandit is an independent finance and tax adviser with 25 years of experience in the fields of finance, accounting, taxation laws, wealth management, audit, corporate and banking laws. He can be reached at: panditgoa@gmail.com