Bimal Jalan Committee report- some interesting remarks

The recommendations in the report of the Bimal Jalan Committee (the “Committee”) (discussed in a previous post) has generated a lot of buzz. These recommendations have mostly been met with criticism, the most criticised being the stand taken by the Committee to disallow the listing of the stock exchange. A column in a newspaper (available here) reports the sharp exchanges between the stakeholders and the Committee members over the recommendation to disallow the listing of stock exchanges in a meeting organised by CII.

Further, in an open letter published in newspapers (see Economic Times and Financial Express- 21st December 2010) by a minority stakeholder in NSE to the NSE's managment, the view expressed is that- “Without listing, minority shareholders feel trapped". To the contrary, the MD of NSE seems to be supportive of the Committee’s recommendations, as is evident from this news report available here. He is reported as stating that “Some people have argued that this conflict is not serious or that a poorly governed exchange will collapse. If the conflict is not serious, how is it that every developed market has taken out the regulatory role from an exchange.” This is apparently demonstrating a rift between the minority shareholders and the management of NSE, reflecting the wider debate and lobbying over the Committee’s recommendations. This is portrayed in another news column available here.

The most interesting remark to the Committee’s recommendation has been that- “Jalan panel disrespects Parliament”, which is in a news column available here, wherein the author brings out the contradictions between the Committee’s recommendation and the previous report of committee headed by former Chief Justice of India M.H. Kania, pursuant to which major amendments were brought to the Securities Contract (Regulation) Act, 1956. The author therein remarks that “The Jalan Committee takes us back not just in time but to the soviet philosophy of 1970s” [emphasis mine].

SEBI amends the Listing Agreement

SEBI has made some significant changes to the equities listing agreement (the “Listing Agreement”) by a circular (available here) on 16th December, 2010. The changes introduced are as under:

1. Changes to clause 35
Clause 35 of the Listing Agreement mandates companies to file the details of their shareholding pattern with stock exchanges on a quarterly basis within 21 days of end of each quarter. SEBI has now added two more reporting requirements in clause 35 which are (i) companies should disclose their shareholding one day prior to the listing of its securities and the stock exchanges are required to disseminate these details before the first trade (this ensures wider public dissemination of shareholding pattern), and (ii) companies should report within 10 days any capital restructuring resulting in a change exceeding +/-2% of the total paid-up share capital.

Another change introduced in clause 35 is with respect to the details of ‘shares held by custodians and against which DRs(depositary receipts) have been issued', which are presently required to be disclosed in Table (I) (a) of Clause 35, should from now on be further segregated as those pertaining to the ‘promoter/promoter group’ and to the ‘public’.

This will ensure a holistic and true picture of the promoter/promoter group holding.

2. Changes to clause 5A
Clause 5A of the Listing Agreement contains the procedure to be followed by the companies with respect to the unclaimed shares pursuant to public or any other issue. Before the amendment, the clause only dealt with the shares issued in electronic and provided nothing for shares issued in the past in physical mode. Vide this amendment, SEBI has inserted specific provision for procedure to be followed in respect of unclaimed shares issued in physical form.

This will end the difficulties faced by the companies which have in the past issued shares in physical form.

3. Changes to clause 20
Clause 20 of the Listing Agreement mandates the companies to intimate the exchange of the outcome of the board meeting to consider payment of dividends or buyback. The existing clause does not require the companies to intimate the date of payment/dispatch of dividends to the exchange. Vide this amendment, SEBI has made it mandatory for the companies to also inform the exchange the date on which dividend would be paid.

This will enhance transparency and enable the investors to manage their cash/securities flows efficiently

4. Changes to clause 22
Clause 22 of the Listing Agreement mandates the companies to intimate the exchange within 15 minutes of the closure of the Board meeting the particulars of the decisions taken therein pertaining to increase of capital by issue of bonus shares, re-issue of forfeited shares/securities or any other alterations of capital. Vide this amendment, SEBI has made it mandatory for the companies to also inform the exchange the date on which the bonus shares would be credited/ dispatched.

5. Changes to clause 40A
Clause 40A of the Listing Agreement contains the condition for minimum public float to be adhered to by a listed company. The Government in June 2010 through the Securities Contracts (Regulation) (Amendment) Rules, 2010 (a copy of which is available here), had mandated listed companies to achieve at a 25 percent public shareholding in the next three years. This amendment had also prescribed annual floors of 10%/ 5% by which the listed companies should reach the 25% public shareholding. However, there was a further amendment in August 2010 vide Securities Contracts (Regulation) (Second Amendment) Rules, 2010 (notification no. GSR662(E) dated 9th August 2010 available at MANU/EAF/0142/2010), whereby the 25% requirement was reduced to 10% for public sector enterprises and flexibility was provided to the listed companies to attain the 25%(10% for public sector enterprises) within three years without any annual floor.

Clause 40A has now been amended to bring it in alignment with this second amendment to the Securities Contract (Regulation) Rules, 2010 (the “Rules”). The amended clause 40A now specifically provides that a listed company has to comply with the requirements of the Rules and can reach the required level of public shareholding by issuance of shares to public through prospectus/offer of promoters’ shares to public through prospectus/sale of promoters’ shares through secondary market.

6. Insertion of new clause 53 and 54
The following new clauses have been inserted in the Listing Agreement by this amendment:
• “53. The issuer company agrees to notify the stock exchange and also disseminate through its own website, immediately upon entering into agreements with media companies and/or their associates, the following information:-
a. Disclosures regarding the shareholding (if any) of such media companies/associates in the issuer company.
b. Any other disclosures related to such agreements, viz., details of nominee of the media companies on the Board of the issuer company, any management control or potential conflict of interest arising out of such agreements, etc.
c. Disclosures regarding any other back to back treaties/contracts/agreements/MoUs or similar instruments entered into by the issuer company with media companies and/or their associates for the purpose of advertising, publicity, etc. “

• “54. The issuer company agrees to maintain a functional website containing basic information about the company e.g. details of its business, financial information, shareholding pattern, compliance with corporate governance, contact information of the designated officials of the company who are responsible for assisting and handling investor grievances, details of agreements entered into with the media companies and/or their associates, etc. The issuer company also agrees to ensure that the contents of the said website are updated at any given point of time.”

These added clauses seek to ensure public dissemination of details of agreements entered into by corporates with media companies. This change is basically a bye-product of an earlier SEBI press release available here, which has been discussed in a previous post.

The amendments to clauses 5A, 35, 40A and insertion of clause 53 comes with immediate effect, while the amendments to clauses 20, 21 and 22 would be applicable for all board/shareholders meetings held on or after 1st January, 2011. The insertion of clause 54 is to take effect from 1st April, 2011.

SEBI should be consistent in its approach: SAT

In a recent order, the Securities Appellate Tribunal ("SAT") made this striking remark- “It must be remembered that it is in public interest that a statutory regulator like the Board (read SEBI) should be consistent in its approach as that would send the right signals to the capital market and would also insulate the Board from the charge of discrimination.”

This remark was made in the concluding paragraph of its order in an appeal from a SEBI’s order (“Impugned Order”). Through the Impugned Order, SEBI refused to grant exemption to a promoter group from making a public offer to the existing shareholders to acquire further shares in the company under Regulations 10 and 11(1) of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 1997 (“Takeover Regulations”). The appellants in the appeal pointed out to the SAT a few earlier orders passed by SEBI wherein SEBI had granted exemption from Regulations 10 and 11 of the Takeover Regulations in a similar factual matrix of appellant’s case.

Briefly stated, the facts of this case were that a listed company (the "Company/Target Company") required finance for expanding its business for which it approached the banks. The banks agreed to sanction the required loan with a pre-disbursement condition that the company raises an upfront equity of Rs. 50 crores (to comply with the debt-equity ratio norms). To raise this amount the company decided to do a preferential issue to its promoters and another entity (whose holding post the issue was to be 13.82% of the shares of the Target Company) who agreed to subscribe to the requisite number of shares. The Company got the necessary shareholders approval through a postal ballot, wherein the resolution for this purpose was passed by 99.1% (7586 postal ballots received out of 71589 shareholders). In the explanatory statement sent to the shareholders, all the necessary details of this issue were brought to the notice of the shareholders including inter-alia the fact that there will be no change in the management or control of the company; and that a rights issue is not being resorted to by the Company as it would delay the process. Since this preferential issue was to increase the holding of the promoters/promoters acting in concert group from 25.32% to 45.91%, the proposed acquirers made an application for exemption from Regulations 10, 11(1) and 12 of the Takeover Regulations. This application was rejected by SEBI against which an appeal was filed in SAT, which reversing the order of SEBI, granted the exemption to the appellants.

SEBI was of the view that the method of preferential allotment denied to the shareholders an equal opportunity in the fund raising exercise, and being denied this equal opportunity, they should be given an exit option through an open offer by declining an exemption.

SAT termed this order of SEBI as ‘wrong in approach and perception of the shareholders’ interest’ and observed that “….. it is not for the Board (read SEBI) to advise or insist on any company as to how and in what manner it should raise its further equity capital when the law gives the aforesaid three options [i.e. a Further Public Offer/ Rights Issue/Preferential Allotment] to a company. Of course, it must ensure that whichever method a company may adopt for raising equity capital, the procedure prescribed by law for that method has been followed in letter and spirit.”

It was argued by SEBI that only 10 per cent of the shareholders had participated in the postal ballot and that this percentage does not represent the majority of the shareholders. This argument was rejected by the SAT on the premise that the majority had been provided with an opportunity to caste their vote and those who did not caste their votes were in silent agreement with the proposed resolution for the preferential allotment. In this regard, the SAT opined that- “Their silence cannot be taken otherwise in the absence of any statutory provision to the contrary. The matter would have been different if the majority had not been provided with an opportunity to cast their votes.”

The most important observation made by the SAT in the matter was this- “we cannot forget that the primary object of the acquisition was to provide additional financial assistance to the target company for its new project.” This order of SAT has some interesting aspects. In a way it can be seen as laying down the proposition that if the funds are required to meet the expansion activities and the objective of acquisition of shares is to provide financial assistance then the exemption under Regulation 3(l) of the Takeover Regulations should be granted. Of course this will be with the rider of ‘no change in control’.

To raise an upfront equity, a company has three options- it can go to public and ask for funds or it could approach the existing shareholders with a rights issue or it can do a preferential allotment to a select group of persons. A company can opt for any of these options as per its requirements. SAT agreed with the appellant's submission that preferential allotment was not only the quickest but also the surest way of raising equity. SAT appears to be highlighting the benefits of a preferential allotment in this order!

Dr. Bimal Jalan committee report on ownership and governance of the Market Infrastructure Institutions

SEBI, in January 2010, had appointed a committee under Dr. Bimal Jalan (former Governor of the Reserve Bank of India) to study and recommend changes on the ownership and governance of the Market Infrastructure Institutions ("MIIs") like stock exchanges, depositaries and clearing corporations. The committee, on November 22, 2010, has submitted its report ("Report") to SEBI and is available here for public comments. The report makes some particularly strong recommendations including not allowing such entities to get listed on stock exchanges.

The Report examines the nature of these institutions and the reasons for such institutions being referred to as MIIs in the light of doctrines like 'Essential Facilities', 'Natural Monopolies', 'Economies of Scale' and emphasizes on the systematic importance of these MIIs for the economy. The report views these MIIs as producers of public good and says that '….. the three MIIs in the securities holding-trading-clearing-settlement chain are engaged in the business of producing a valuable public good for society, which are essentially the price signals produced by a transparent and efficient market mechanism'.

The Report says that it is not possible to sever the regulatory role of the MIIs from their more obvious role of serving as providers of infrastructure of the market and goes on to describe the characteristics and functions of these MIIs emphasizing the following characteristics of such institutions:-

1. In general, MIIs are in the nature of public utilities.
   
2. All of them are vested with regulatory responsibilities, in varying degrees.
   
3. They have systemic importance to the economy.
   

In the above background, the Report highlights the conflict in the 'regulatory role' of these MIIs with their 'economic interests'.

The key recommendations in the Report are the following:

1. Changes to Securities Contracts (Manner of Increasing and Maintaining Public Shareholding in Recognised Stock Exchanges) Regulations, 2006: The Committee has proposed the replacement of these regulations by a comprehensive set of regulations on the ownership and governance of stock exchange. By way of a transit, the committee recommends changes for the existing provisions of these regulations which inter-alia contains a recommendation that- ' All anchor institutional investors put together shall not hold more than 49% of the total equity capital of an exchange'. Currently depositories, clearing corporations, banks, insurers and public financial institutions are allowed to hold, individually, up to 15% in a stock exchange.

2. Ownership and Control of a MII in another classes of MII: As regards the ownership and control of MII, the committee has proposed the following:

• Clearing Corporations and Depositories may not be allowed to invest in other class of MIIs .
  
• at least 51% of the paid-up equity capital of the Clearing Corporation should be held by one or more recognised Stock Exchanges.
  
• the holding of stock exchanges in depositories may be restricted to a maximum of 24%.
  
• In case of all MIIs, FIIs should be allowed to acquire the shares through off market transactions including through initial allotment, as allowed for any other shareholders, subject to the limits specified by the Government from time to time.
  

3. Governance of MIIs: As regards the governance of MIIs, the committee has proposed the following:

Stock Exchanges:

• no trading /clearing member (irrespective of exchange where he operates) shall be allowed on the board of any of the stock exchange
  
• the number of public interest directors ("PIDs") on the board of a stock exchange shall at least be equal to the number of shareholder directors without trading/ clearing interest.
  

  Clearing Corporations:
  

• the number of PIDs on the board of a clearing corporation shall at least be equal to the number of shareholder directors without trading/clearing interest.
  

  Depositories:
  

• same as prescribed for listed companies under clause 49 of the listing agreement.
  

4. Disclosures by board members of MIIs: All transactions in securities of the board members of the MII and their family have to be disclosed to the board of the MII.

5. Disclosure and corporate governance requirements: The committee recommends that the disclosures and corporate governance requirements of the listing agreement applicable to listed companies shall be made applicable to MIIs too. The information required to be disclosed under the listing agreement should be posted on the website of the MII.

6. Mandatory appointment of Compliance Officers: SEBI has mandated various registered intermediaries and also depositaries to appoint a compliance officer to ensure that the intermediary complies with the rules, regulations, circulars and directives of SEBI. The committee recommends that such appointment should be made mandatory also for the stock exchanges and clearing corporation.

7. No listing of these MIIs: The committee is not in favour of listing of MIIs and observes that- '... MII should not become a vehicle for attracting speculative investments. Further, MIIs being public institutions, any downward movement in its share prices may lead to a loss of credibility and this may be detrimental to the market as a whole'.

8. Networth Requirements: The committee recommends that Stock Exchanges should have a net worth of INR 100 crores at all times. As regards depositories, the SEBI prescribed net worth of INR 100 crores is suggested to be retained with a rider that '…all other investments in related, unrelated/other business shall be excluded while computing the net worth'. For clearing corporation, the committee recommends an ongoing net-worth requirement of INR 300 crores in the form of liquid assets.

Apart from above, a recommendation in the report which may cause significant outcry is putting of a cap on the maximum return that can be earned by MII on its net worth and can be distributed / allocated to its shareholders. The committee observes '…MII being a public utility should endeavor to earn only reasonable profits at par with average earnings of the corporate sector in India'.

It would be interesting to see how much of these recommendations are implemented by the regulator. These recommendations are seen as a disappointment and have been met with criticism (here, here, here and here) on the lines that it would protect the monopolistic market structure and perverse anti-competitive practices by some and prevent new entrants on the stock exchange space. Also, the buzz in media is that the government is unsure of implementing these recommendations.

[The above post has been contributed by Vaibhav Kumar, who is an Associate at the law firm, Desai & Diwanji, Mumbai.]