Sebi should phase out 'promoter' concept

WITHOUT CONTEMPT

Some concepts in the Indian securities market are indeed unique. They defy precedents and benchmarks in other parts of the world and over time take proportions of even defying logic. The concept of "promoter", which has now become an institution, is a classic example.

There is a plethora of provisions written around the concept of "promoter" across corporate and securities laws. The term is undefined in the Companies Act, 1956, although its very existence is linked to companies. The Sebi (Disclosure & Investor Protection) Guidelines, 2000 ("DIP Guidelines"), which regulate disclosures by issuer companies and by other persons in the context of public issuances of securities, defines the term.

The essence of Sebi's approach is to ensure that in the Indian context, where specific sets of shareholders control the functioning of even public listed companies, the involvement and the role of such shareholders in the management of the companies is material information for investors to take an informed investment decision. This is sound logic. Investors indeed ought to know more about the persons who are in control over the company seeking public money. The track record and reputation of such persons would indeed have a bearing on the future performance of the issuer company. However, it is when this concept is expanded over a range of other obligations and implications, that the substance begins to blur and technical form starts taking charge.

For instance, a promoter is required to contribute a minimum amount to the company which is making a securities offering. At first blush, it may appear logical and fair for regulation to insist that a person controlling a company ought to put his own money where his mouth his i.e, unless the promoter is himself asked to fund the company, he ought not to be allowed to approach the public for funding. Besides, if the promoter would not hold at least 20 per cent of the post-public offering capital, the company would be ineligible to approach public markets. Any requirement that statutorily forces a promoter to bring in specific investment amounts or maintain specific shareholding would necessarily perpetrate the unfortunate reality of keeping our listed companies in the hands of promoters.

In fact, the term "promoter" is defined to include "any person instrumental in the formulation of a plan" for offering of securities to the public. Therefore, although the DIP Guidelines notionally recognise in one provision that there could be companies without any "identifiable promoter or promoter group", the reality is that no Sebi-registered merchant banker will let you file a document taking a position that there is no identifiable promoter without warning you about severe potential delays and disputes with Sebi.

The requirement to "lock in" shares held by promoters is another example of form having taken charge of substance. The customary and conventional international practice of requesting a "lock-up" on shares held by substantial shareholders has been adapted to a statutory lock-in on shares in India. When securities are offered to the public and underwriters agree to take up shares, they would have a legitimate expectation that the market is not faced with a further supply of the same stock for a reasonable period of time.

Therefore, in international offerings (as indeed with ADR/GDR/FCCB offerings), substantial shareholders are requested by underwriters to agree not to sell their shares or structured products derived from their shares for 90-180 days. It is not abnormal to even provide for a carve-out from such a lock-up to the extent of some "head-room" percentage so that the substantial shareholder is free to sell some shares. In any case, such restriction on sale is contractual, and is capable of being waived by the underwriters.

However, in the domestic market, with some torture to language, the "promoter" is statutorily bound not to sell his holdings to the extent of at least 20 per cent of the issuer company's capital for a period of three years, with the rest too being locked for one year. Even non-promoters are obliged not to sell their shares held at the time of the initial public offering for a period of one year. These provisions indeed create a severe lack of supply of stock for newly listed companies, and contribute to the initial high premiums over the issue price at which newly listed shares tend to get traded. The law would do well to refrain from making prescriptions on what is essentially a commercial matter.

The promoter concept has been carried into other regulations too. For instance, the takeover regulations contain two variations of the definition of "promoter". A thorough review of approach to "promoters" is warranted. If Sebi truly desires the Indian market to have board-driven-professionally-managed companies, it should begin by considering a roadmap to do away with the "promoter" concept over time.

The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.

somasekhar@jsalaw.com