Stricter rules

Preferential allotments of shares have long been a contentious issue, because of the obvious possibilities of their misuse.

Preferential allotments have been justified on the grounds that they could be useful in situations where the foreign partners need to be given a stake in the company, where injection of fresh funds may be required for improving the health of a company, or where technical collaborators ask for a stake in a company.

At the same time, they could go against the interest of the majority of shareholders if preferential allottees offload their shares in the market.

The solution has therefore been to ensure that preferential allottees are not able to use the method to make a fast buck. This is done by having rules regarding the price at which shares can be issued and by locking them in for a few years.

The Securities and Exchange Board of India knows these issues, and has been slowly tightening the rules over the years.

The market regulator's recent proposals are further steps in that direction. Sebi's Primary Market Advisory Committee has received suggestions on the issue and it has now invited public comments on the proposals.

One of the loopholes it wants to plug is the clause stipulating that while promoters have a lock-in period of three years, not more than 20 per cent of the capital of a company can be locked in.

The new proposal is to drop the 20 per cent rule, so as to ensure that the promoters' lock-in period is not diluted. Another proposal is to make changes in the method of computing the minimum price at which preferential offers can be made.

Instead of the weekly high and low closing prices for calculating the offer price, the weighted average price is now proposed to be used.

Further, while the current rules for pricing require that the minimum price be fixed on the basis of either the average weekly prices for six months preceding the relevant date or the average prices for two weeks prior to that date, whichever is higher, Sebi suggests that the minimum price should not be lower than the average price of the share for a period of 130 trading days preceding the relevant date, or the average price of the share for the preceding 10 days, whichever is higher. This is not expected to make much of a difference to the pricing.

More important is the proposal to impose a maximum annual rate of return for calculating the price at which convertible instruments are to be converted into equity.

Sebi's intention is to ensure that preferential convertible issues are not sweetened by paying a premium on redemption or by higher than market rates on the convertible bond.

The market regulator has also proposed certain changes to clear the ground for the issue of preferential shares with differential voting rights.

Disclosure requirements are also proposed to be reinforced while the rules for the issue of warrants on a preferential basis are also being strengthened.

Since it is clear that preferential allotments essentially amount to favoured treatment for a class of investors, stringent rules against abuse are required. Sebi's suggestions are all aimed at ensuring that those requirements are met.