By Sinhani Prem, Student at Jindal Global Law School, and Sukriti Bhagat, Associate at IndusLaw
With an objective of aligning and addressing the on-going issue of promoter/promoter group and requirements in an IPO, Securities and Exchange Board of India’s (SEBI) floated a new consultation paper dated 11 May 2021 and proposed four main changes— (1) Reduction in IPO lock-in periods, (2) Definition of the term ‘promoter group’, (3) Streamlining disclosure requirements of ‘group companies’ under the SEBI Issue of Capital and Disclosure Requirements (ICDR) Regulations, 2018, (4) replacing the term ‘promoter’ with ‘person in control’. While the replacement of the term ‘promoter’ with ‘persons in control’ seems to receive extensive scrutiny on account of the fundamental implications it may have on boilerplate corporate law principles in the one-tier structure of corporate governance in India, we believe it is also important to delve into the three other proposals within this consultation paper.
SEBI-appointed Primary Markets Advisory Committee (PMAC) formed a sub-committee in May 2019 to investigate the changing scenario of the Indian capital markets. The PMAC was keen on examining the relevance of the concept of ‘promoter’ within the Indian Securities Markets and proposed altering the term to ‘controlling shareholder’ or its equivalent, sourcing inspiration from other regulatory authorities such as the U.S. Securities and Exchange Commission (SEC) and the UK’s Financial Conduct Authority (FCA).
Reduction in Lock-In Periods for Minimum Promoter’s Contribution (MPC)
SEBI’s consultation paper proposes changes that are primarily in accordance with existing corporate governance mechanisms seen in other leading markets with one-tier structures such as the United States. This rationale becomes especially evident to understand their proposed changes for the lock-in period post the initial public offering (IPO) process in India. Under existing provisions, Regulation 16 of the ICDR Regulations dictates that the minimum promoter’s contribution (MPC), equal to 20%, is locked-in for a period of three years; from the date of allotment of the IPO or the commencement of the commercial production, whichever is later. Furthermore, Regulation 17 of the ICDR Regulations states that the entire pre-issue capital that is held by persons other than promoters is locked in for one year from the date of allotment of the IPO.
SEBI proposes to do away with these rather draconian requirements, reducing the MPC lock-up period to one year as opposed to the current mandate of three years, similar to the 90-180 days lock-up period observed in the United States. Promoters’ holdings greater than the MPC are proposed to be locked-in for a shorter period of six months from the date of allotment of the IPO. Persons other than the promoters are proposed to have their entire pre-issue capital locked-in for six months from the date of allotment of the IPO, cutting the lock-in period by half.
SEBI’s rationale is commendable, and this proposal is indeed laudable. The consultation paper recognizes the dynamic situation in the Indian Securities Markets brought about by greater involvement of institutional investors— from the likes of private equity (PE) firms, venture capitals (VC) and hedge funds within the context of alternative investment funds (AIFs) — before listing, also rightly referencing the phrase ‘skin in the game’. Additionally, this proposal makes sense because there has been a steep decline in greenfield financing of IPOs in the Indian market and IPOs exceeding ₹100cr are under the scrutiny of a monitoring agency.
Definition of ‘Promoter Group’
Regulation 2(1)(pp)(iii)(c) of the ICDR Regulations currently define a promoter group as: “Any body corporate in which a group of individuals or companies or combinations thereof acting in concert, which hold twenty percent or more of the equity share capital in that body corporate and such group of individuals or companies or combinations thereof also holds twenty percent or more of the equity share capital of the issuer and are also acting in concert.”
This definition, therefore, states that a promoter group can be composed of individuals, companies or a combination of individuals and companies that hold a minimum of 20% of the equity share capital of a company and work together. However, such a definition is absent in the Companies Act, 2013; the term ‘promoter’ has been defined under Section 2(69) but ‘promoter group’ finds no definition other than the 2018 ICDR Regulations. SEBI proposes to delete this definition altogether and its rationale for this deletion stems from the fact that this definition might extend to common financial investors who do not have “real interest” within the company; to common stakeholders who are not extensively involved within the management of the company. They also reason that it is not relevant to reveal and identify common stakeholders post listing. The consultation paper seeks to delete the definition of the term ‘promoter group’ in furtherance of their proposal of changing the definition of ‘promoter’ to a term similar to ‘controlling shareholder’.
However, the flip side to this rationale is the fact that these stakeholders, irrespective of their limited direct involvement with management, often serve as the ‘first customers’ of the company and can widely help by constructively critiquing new projects of the company. Hence, however indirect, their involvement as a pair of ‘fresh eyes’ can ultimately help the company in its profitability goals.
Disclosures regarding Group Companies
Regulation 2(t) of the ICDR Regulations defines the term ‘Group Company’ to include within its scope companies, other than promoters and subsidiaries, which the issuer has conducted related party transactions with during such period for which financial documents are disclosed in the offer document. Disclosures that are mandated in the current regulatory framework include registered address, equity capital, type of activities, description of business, the financial documents of top five listed and unlisted group companies, the nature and degree of direct/indirect interest of such group companies in the issuer et al. The proposed amendment stipulates that such disclosures be jettisoned in favour of the relaxed requirement of only demanding the names and registered addresses of each group company in the offer document. The rationale for this change is that the present framework requires disclosures from such group companies which may not be material, disclosures pertaining to related party transactions already exist autonomously for both pre- and post-listing process and restructuring of the pre- and post-listing requirements since groups companies don’t exist after listing and are not reflected in any other SEBI regulations. While this amendment holds potential for substantially reducing the disclosure burden at the IPO stage, the proposal for including such information on the company’s website will still require the process of requisition of information from group companies and will carry further implications. SEBI’s cognizance of the notion of group companies growing obsolete is a welcome change, however, its reticence for complete abandonment of such disclosures is highlighted from the inclusion of the provision for proving such information on the website.
Shifting the Focus from “Promoters” to “Persons In Control”
The concept of “promoter” is unique to the Indian corporate framework. Conventionally, Indian companies have witnessed a concentration of family-owned and managed businesses. Consequently, a wide definition of the term ‘promoter’ was introduced for the smooth identification and governance of promoters. This concept continues to be relevant for the regulatory framework ad infinitum rather than through the nascent stages of the company. ‘Promoter’ is defined within Regulation 2 (oo) of the ICDR regulations as (a) a person who has been identified as the same in the (draft) offer document or by the issuer in its annual returns; (b) exercises direct or indirect control over the issuer in its capacity as a director, shareholder or otherwise; (c) whose advice, instructions or directions the board of directors of the issuers act in accordance with/ follow.
SEBI has proposed to recalibrate the framework to shift the focus towards ‘person in control’. The grounds for these are multifarious:
- The paradigm shift in the Indian investor landscape indicates a steady growth of shareholdings of institutional investors and private equity in both listed and unlisted companies as compared to the traditional scenario of promoter/ promoter group. Additionally, the concept of “once a promoter, always a promoter” is being shed with identifiable promoters engaging in various M&A activities. Such private equity and institutional investments will be stimulated if cumbersome post-exit liabilities are done away with.
- Companies are now focusing on improving corporate governance practices and remodelling themselves into professionally run businesses with a shift of powers and responsibilities to the board and management leaving no discernible promoter. Furthermore, publicly listed companies are mandated to appoint a prescribed number of independent directors on the board for increased accountability and transparency. Thus, the concept of promoters is becoming passé.
- Since the concept of promoter groups is losing relevance, there might be situations where persons who aren’t promoters may be identified as such. The disclosures pertaining to such persons would be an unnecessary burden on them and redundant to the investors of the issuer.
The shift from ‘promoter’ to ‘persons in control’ and the other proposals not only seek to address the above-mentioned problems but also realign the Indian Markets with other matured markets such as the U.K., U.S.A., and Singapore markets. However, amending the entire regulatory framework to streamline it with this proposal can pose crucial challenges since the concept of ‘promoter’ is manifested deep within this framework. Furthermore, the concept and definition of control itself is cryptic and stratified. SEBI had previously introduced the suggestion of giving bright line tests statutory recognition for determining control but refrained from enforcing it. Therefore, it is pertinent that an objective definition of control is developed to define a controlling shareholder. As a consequence of this proposal, SEBI’s enforcement mechanisms also need to evolve from a general Mareva injunction for ‘promoters’. This tectonic shift will impose implications on the frameworks regulated by other bodies such as the RBI, MCA and IRDAI; and a lack of cohesive approach of these regulatory bodies will give rise to disparity and ambiguity which will adversely affect the market.