A different kind of quiet quitting

Policy loopholes are encouraging many promoters to exit their companies stealthily, raising the question: Should promoters be in control after pledging their shares?

The shareholding pattern filed in June by 1,440 NSE-listed companies on the exchange’s portal, reveals that promoters of 24 companies have pledged 100 per cent of their equity holdings. Further, there are 78 companies whose promoter pledge is between 76 and 99 per cent and 57 companies, where the percentage is between 51 and 76. Together, in 159 out of the 1,440 companies, promoters have pledged more than 51 per cent of their holding. There are 82 companies with 26 per cent or more pledging. Most of the rest, except public sector units, also have some percentage of pledge, going up to 26 per cent. 

According to the Oxford English dictionary, pledge means: (1) A solemn promise or agreement. (2) Something valuable promised as a guarantee that a debt will be paid or a promise kept etc. It is a common practice for the debtors to pledge their properties to creditors as collateral while borrowing. Unlike land, buildings and machinery, which need to be credibly valued, shares of listed entities are in a uniquely privileged position — their prices are easily available in the public domain on a real-time basis. While the ease with which the pledged shares could be liquidated may make them the creditors’ preferred collateral, the creditors have to be extra vigilant in tracking the prices of encumbered shares. Moreover, as explained later, invocation of a large number of pledged shares may have implications for the other shareholders in the company.   

A promoter pledging his/her shareholding in a company was not considered a possible governance issue requiring regulatory intervention in India till the  Satyam Computer Services episode of 2009. It was revealed that the then promoters of the company had only about 7 per cent of shareholding at the time of the unfolding of the crisis, and that too was fully pledged. This prompted the Securities and Exchange Board of India (Sebi) to mandate companies to disclose pledging and other encumbrances by promoters and promoter group entities.

Regulation 31(4) of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR) made it mandatory for all entities falling under the promoter and promoter group to separately disclose their shareholding pattern on the website of stock exchanges. The format and the timeline for disclosures got periodically revised. More details, including the purpose of pledging, were prescribed. The original window of 14 days available to the companies to make the disclosure was reduced to two working days, if and when promoters and persons acting in concert (PAC) increased their pledge to more than 50 per cent of their holdings or more than 20 per cent of the total share capital of the company. All this has been done with a view to keeping investors aware of the happenings in the company and indebtedness of the promoter.

In a strict legal-centric way, it is the promoters’ choice whether they wish to pledge their shares or not — it is their property. However, such shares held in a joint stock company is a different cup of tea where the action of promoters or those who are in control of the company could seriously impact the interests of other stakeholders.

There have been cases in the last few years wherein the promoters holding substantive stake of the total equity shares encumbered their shareholding, mainly by pledging, ran down their companies, and the companies eventually landed up in insolvency proceedings. During the last three years, there have been at least four such instances. In these companies, the promoters held 38 to 53 per cent of the total shares as of March 31, 2019; which declined to 1.5 to 14 per cent by March 31, 2022. During the same period, their cumulative pledge went up from nearly 50 per cent to almost 100 per cent. There was no pledgee for the remaining small portion since the news of these companies going bust was out in the open. The speed with which these companies went down in parallel with the sharp increases in pledging percentage gives credence to the view that the promoters were knowingly leaving the company in a rather pre-planned manner. And in the process leaving the minority shareholders and the lenders in the lurch.

There have been instances where the PACs — unlisted holding companies— encumbered themselves along with their assets, which included substantive stakes of promoter holdings in listed companies. All such actions may or may not necessarily result in market mishaps or corporate tragedies. However, the question is: Can the regulators leave such potential corporate black holes to chance at a heavy price to the economy? Can a few promoters, who are captains of the ship, do a sort of “quite quitting” by encumbering their stake and still continuing to be in control of the company?

Corporate insolvency resolutions of companies through the Insolvency and Bankruptcy Code (IBC) have also brought forth a large number of mala fide activities of promoters/entities in control of several companies. Till June this year, 786 applications have been filed before the resolution authorities to claw back Rs 2,21,104 crore allegedly lost through such transactions, which are collectively called avoidance transactions (preferential, undervalued, fraudulent and extortionate). The needle of suspicion points towards people in control taking their companies deliberately to the insolvency route after massive asset striping.

So the question is, how to address a situation where the promoters of the companies encumber their holdings heavily and continue to be in control of those companies? Tightening the disclosure norms does not seem to be enough. While the subject needs deliberations and public consultations, one possible way could be to consider reduction in the number of promoter directors on the board and board committees in proportion to their pledging once it goes above 51 or 26 per cent. Further, in case the promoter holding goes down to nominal levels, their entire control should go. Time to address the situation of captains leaving their ships stealthily, putting their passengers at the mercy of rough seas.

Nair is director, NISM, and Tyagi is a former IAS officer and former Sebi chairman