Sebi proposes curbs on wilful defaulters

Mulls ban on public issues, restrictions on open offer; will allow counter-bid to foil hostile takeover

After the central government and the Reserve Bank of India (RBI), it is the turn of the capital markets regulator, Securities and Exchange Board of India (Sebi), to tighten the screws on wilful defaulters. In a discussion paper issued on Monday, it proposed a ban on public issue of equity securities, debt securities and non-convertible redeemable preference shares by entities so listed by the central bank. Also, restrictions on making open offers of shares.

Reactions have been invited till January 23. An entity is tagged a wilful defaulter if it stops repaying despite having the ability to do so or uses the loan for a purpose other than what was specified. The rise in strictness is because non-performing assets in the banking system have been increasing.

WHO IS A ‘WILFUL DEFAULTER’?

• Deliberate non-payment of dues despite adequate cash flow and good net worth
• Siphoning of funds to the detriment of the defaulting unit
• Assets financed either not having been purchased or having been sold and proceeds misutilised
• Misrepresentation/falsification of records
• Disposal/removal of securities without bank’s knowledge
• Fraudulent transactions by the borrower

Shriram Subramanian, managing director, InGovern Research, said denying access to the capital markets is in line with what RBI also does when it comes to debt. Under the current regulatory framework, a wilful defaulter is allowed to issue any instrument other than convertible debt by way of public issue.

“Any company which wants to raise money from the public is required to make all disclosures. To that effect, even a company or promoter declared a wilful defaulter can access the market, with disclosures. However, many common investors don’t look at disclosures. From that point of view, it is important that there is a check from the regulator to restrict such entities,” said R S Loona of Alliance Corp Lawyers.

The markets regulator has also proposed to restrict such defaulters from making open offers in other listed entities with the intention of taking control. However, it says, they would be allowed to launch ‘counter bids’ to fend off hostile takeovers. More important, a company declared a wilful defaulter will be given access to equity capital by way of a rights offering or a Qualified Institutional Placement, albeit “with full disclosures in the offer document”, says the discussion paper.

This is to ensure such entities are not choked of funding.

“Restriction of access to the capital market by way of a rights issue may negatively impact operations of the listed company, thereby negatively impacting its share price. Such a measure may not be in the interest of the shareholders. Theoretically, the shareholders should infuse funds if the company is in trouble. Shutting down finance even from own shareholders appears unreasonable,” says the paper.

It has said identifying such wilful defaulters could pose a challenge. The list in this regard is issued by a subsidiary of RBI, not the central bank itself. Sebi has asked if it is appropriate for it to “take cognizance of such action initiated by an intermediary of RBI and then act upon it by restricting access to the capital market by way of a public issue or rights issue”. Subramanian said implementation would depend on who does the follow-up. “A regulator has to (be the one declaring someone a wilful defaulter ). The nomenclature has been challenged in court,” he said.

“This is a welcome step and (there should be) greater co-operation between the regulators...Of course, (the system) should have sufficient checks and balances. It should not be that someone is declared a wilful defaulter due to some misintepretation of data and all sources of funding are cut off,” said Amit Tandon, managing director of proxy advisory firm Institutional Investor Advisory Services.