By Mainak Mukherjee and Abhishek Bhatra
SEBI’s Minimum Public Shareholding (herein after ‘MPS’) norm mandates that all listed companies maintain a minimum 25% shareholding in the hands of the public, ie, non-promoters. The primary objective behind implementing this norm was to ensure transparency, public participation, and to mitigate susceptibility to market manipulation. However, the MPS regime has unfortunately fallen short of achieving its intended objectives, giving rise to a range of challenges and setbacks. This article explores the multitude of issues plaguing the current regime while presenting comprehensive solutions to address these challenges.
WHAT IS THE MINIMUM PUBLIC SHAREHOLDING NORM?
Rule 19A (1) of the Securities Contract Regulations Rules 1957 (hereinafter ‘SCRR’), coupled with Regulation 38 of the Listing Obligations and Disclosure Requirements (hereinafter ‘LODR’), mandates all listed companies to maintain a minimum public shareholding of 25% of the total issued share capital. Prior to 2010, listed companies were required to maintain a minimum of 10% of post-issue paid-up share capital in public hands. However, certain entities, including government companies/Public Sector Undertakings (hereinafter ‘PSUs’), infrastructure companies, and those under the purview of the Board for Industrial and Financial Reconstruction, were exempted from this norm. In 2010, SEBI amended the SCRR to make the MPS requirement consistent across all company types, raising the threshold to 25%.
In India, vital company decisions need a special resolution, requiring 75% of the votes cast at a shareholders’ meeting. These resolutions are crucial for issuing capital, changing the company’s name or registered address, amending constitutional documents, and more. The rationale behind the 25% MPS requirement is to ensure that critical resolutions receive support from stakeholders beyond the promoters and controlling shareholders.
Non-compliance with these requirements results in monetary penalties and other punishments, including freezing of promoter assets. However, as previously discussed, the current MPS regime suffers from drawbacks that impact the ease of doing business in India. Therefore, it is imperative to reassess and restructure the MPS norms to ensure compliance without hindering business operations.
POTENTIAL PITFALLS AND PROPOSED SOLUTIONS
Despite over a decade since the adoption of the MPS requirements by SEBI, disputes with this norm persist. While one could argue that such disputes are inevitable for SEBI as the regulator of the securities market, the nature of these conflicts indicates inherent flaws within the MPS regime, calling for specific reforms.
- Definition of ‘Promoter’ and ‘Promoter Group’: Section 2(69) of the Companies Act 2013 defines a ‘promoter’ as a person who controls the day-to-day business affairs of a company. Additionally, Regulation 2(1)(pp) of the SEBI ICDR Regulations 2018 defines a ‘promoter group’ as any person, entity, or corporate body related to the promoter and having control over the entity. However, the definitions of these terms are ambiguous, primarily due to the term ‘control’. The investor landscape in India is changing, and as a result, private equity firms and institutional investors are investing in companies and acquiring significant shares. In some cases, these investors obtain special rights like the nominations of directors. However, these investors are not considered ‘promoters’, even though they influence company decisions. This situation leads to classified ‘promoters’ and ‘promoter groups’ having no controlling rights and minority shareholding. Consequently, the classified ‘promoter’ may exert disproportionate influence over the listed entity, which may not align with the interests of all stakeholders.
The ambiguity has also led to promoters adopting the practice of categorizing funds under the label of ‘public shareholding’ despite the fact that these funds are, in reality, owned and controlled by the promoters themselves. For example, Gillette India and Gokaldas Exports tried re-classifying their promoter’s shareholding as public shareholding to comply with the MPS requirements. The lack of clarity in the definition allows promoters to bypass this obligation, and erode the market undermining transparency and fairness as it presents a distorted image of the actual shareholding of the company.
To address this, SEBI has the option to adopt a regulatory framework to ensure that of the Financial Conduct Authority (herein after ‘FCA’) in the United Kingdom, wherein the term ‘Controlling Shareholder’ is utilized in lieu of the designations of promoters or promoters groups. On May 11, 2021, SEBI published a Consultation Paper proposing the introduction of the ‘Controlling Shareholder’ concept to replace the existing framework of promoters and promoter groups. SEBI’s definition of a ‘Controlling Shareholder’ was stated as follows: “A person who exercises control over the affairs of the company, directly or indirectly, whether in the capacity of a shareholder, director, or through any other means.” Nevertheless, the proposed concept was never implemented. The adoption of the Controlling Shareholder concept by SEBI would serve to streamline the regulatory approach when imposing obligations. Moreover, this concept would eliminate the notion of ‘once a promoter, always a promoter’ enabling Controlling Shareholders to reclassify their holdings more easily should they wish to relinquish control.
- Prescribed Methods for achieving MPS: SEBI, until now, continues to introduce various methods for companies to fulfill the MPS requirements. However, the strict regime of restricting companies to only one of SEBI’s prescribed methods or obtaining prior approval poses a significant obstacle to compliance. For example, in the matter of Kesar Petro Products Limited (hereinafter ‘KPPL’), the company issued share warrants and subsequently converted them to adhere to the MPS requirement. In its order, SEBI determined that KPPL had contravened the prescribed norm by adopting a method not sanctioned by SEBI and failing to seek prior approval from the regulatory authority. This case underscores the inhibitory impact of SEBI’s rigorous methodology and approval regime on companies’ ability to comply with the MPS requirements. To circumvent this obstacle, SEBI should consider allowing listed entities to fulfill the norm without the need for relying solely on SEBI’s methods or seeking prior approval. Implementing such a flexible framework can improve the system and facilitate business operations for numerous entities. However, it is advisable for SEBI to contemplate the introduction of more market-friendly approaches, including but not limited to: increasing the limit on the sale of shares by promoters in the open market, recognizing employee welfare trusts as part of the ‘public’ category, and establishing distinct timelines. While facilitating market-friendly compliance should be a priority, it is crucial to augment the severity of consequences for contraventions in order to maintain a delicate balance.
- Uniform approach for all companies: The current MPS regime suffers from another drawback wherein all listed companies, regardless of their nature and size, are obligated to comply with the requirements. This blanket approach poses significant challenges in the market, particularly for companies that have already attained their desired share capital. Forcing these companies to increase their share of capital to meet the MPS norm can result in several negative consequences. One consequence is the potential increase in taxes and other financial obligations for the company, which would impact the company’s finances and profitability adversely, acting as a deterrent to its growth and development.
Furthermore, treating companies that are fully promoter-owned before going public on par with other companies and imposing the same compliance deadline fails to acknowledge the variations in their initial ownership structure and can impose unnecessary burdens on those that have already taken steps to ensure public participation . Moreover, small-scale companies, which do not have a reputation in the market, find it difficult to comply with the norms as the public at large may not invest due to lack of goodwill.
To rectify this issue, SEBI should consider revising its uniform approach and embrace a more flexible stance by implementing distinct timelines for companies. This would allow them to devise customized measures and strategies in accordance with their unique circumstances, encompassing factors such as share capital, ownership structure, industry-specific challenges, growth trajectory, financial distress, and the prevailing market disruptions. By doing so, a more practical and achievable path towards meeting the MPS threshold can be established. A pertinent example can be found in the matter of Sayaji Hotels Limited, where SEBI disregarded the company’s unfavorable profit history and the recessionary state of the industry as justifications for non-compliance with the MPS requirement. Such orders set an unfavorable precedent in the market, reflecting SEBI’s inflexible stance. The regulator must address this issue and adopt a differentiated timeline approach, wherein companies are granted varying deadlines based on considerations such as market conditions and historical profitability. However, to prevent misuse, SEBI should exercise meticulous scrutiny in granting such timelines.
- Lack of enforcement mechanisms: The MPS norm has had a checked history due to its frequent and repeated changes. It went from being a regime of having to maintain a high public shareholding, to a regime where different companies had different standards, to a regime where all companies by and large comply with a common standard. SEBI has entrusted the BSE and the NSE with the responsibility to detect any non-compliance with the MPS norm and thereunder with the power to issue notices and impose fines and other penalties. However, as is inherent in the recent Hindenburg-Adani controversy, there are significant flaws in the system. To rectify this, it is critical for SEBI to review the mechanisms employed by said exchanges and accordingly prescribe measures to ensure an effective enforcement system – similar to the steps taken by SEBI for tackling the governance lapses at the NSE in 2017.
Further, the Income Tax Authority’s effective employment of robust mechanisms and processes to ensure tax compliance among individuals and entities, should be used as a benchmark by SEBI for this purpose. Herein, any instances of non-compliance are swiftly detected and addressed, fostering a culture of heightened compliance. Taxpayers are aware of the potential consequences of deviating from the regulations, which creates a sense of fear and encourages concentrated compliance.
While the MPS requirement is crucial for ensuring transparency and public participation in any securities market, it should not unduly burden promoters and promoter groups. As previously discussed, the SEBI MPS norm has adopted several amendments over time to accommodate compliance-friendly measures. However, it is essential for SEBI to acknowledge that in the rapidly evolving securities market, previous mechanisms may quickly become outdated, thereby creating opportunities for contradictions and non-compliance. This article acknowledges the shortcomings of the current regime and highlights the need for SEBI to overhaul the entire framework, incorporating changes that benefit both the regulator and market players.
Cite as: Mainak Mukherjee & Abhishek Bhatra‘Beyond The Status Quo: Rethinking SEBI’S MPS Norm Vis-a-Vis Fostering Ease Of Doing Business In India’ (The RMLNLU Law Review Blog4 July 2023)