LODR – Page 11 – Vinod Kothari Consultants

Independent Directors: The Global Perspective

July 17, 2021/0 Comments/in Corporate Laws, LODR, SEBI /by Staff

Ajay Kumar KV, Manager and Himanshu Dubey, Executive (corplaw@vinodkothari.com)

Introduction

The role or failure of independent directors in preventing corporate scandals became one of the central themes in corporate governance in India, and when SEBI issued a Consultation paper proposing a dual approval process for the appointment of independent directors, there was a substantial concern among leading companies in the country. Following discussions, the SEBI board has eventually decided to drop the proposal for dual approval, and instead, go for approval by a special majority. The decision of SEBI to not implement dual approval has not been appreciated by several commentators including Mr. Umakanth Varottil. Therefore, there is a sizzling controversy on the mode of appointment of independent directors.

In this article, we have made a comparison of the legislative framework for independent directors, especially the process of appointment, across various jurisdictions. While we note that some countries have moved to a dual approval process, the concept such as a database of IDs and a proficiency test remains an Indian aberration.

Independent Directors – Evolution in India

In India, the idea, or rather the need of having Independent Directors on the board of companies (especially those involving public interest) was acknowledged in the early 2000s through the SEBI Listing Agreement. Therefrom, the concept found a concrete legislative recognition in late 2013 as the Companies Act, 2013 took shape and character covering unlisted companies as well.

A snapshot of the concept’s evolution through guidelines and report to the Companies Act and SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 is given below –

As compared to India, the western world was way ahead in the race- the concept of Independent Directors traces its inception as long back as in the 1950s when the murmurs of representation of small shareholders surrounded the corporate world. However, like in India, it took a long time for countries in Europe and North America to bring the concept within the regulatory framework. In the USA, the concept of Independent Director received regulatory recognition under the Sarbanes-Oxley Act, 2002. Thereafter the regulations issued by various stock exchanges took the lead.

Who is an Independent Director – The Indian Viewpoint

With all the hullabaloo about Independent Director, the natural question was ‘who is an independent director’; while the terminology was largely suggestive of the answer – “someone who is capable of putting forth an independent view about the business of the company”, it was crucial to define the term.

The definition of Independent Director from Section 149 of the Companies Act, 2013 (‘Act’) and Regulation 16 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘LODR’). While unlisted companies are required to adhere to the requirement under section 149 of the Act; listed companies or those intending to be listed are required to abide by LODR too.

On the same lines as discussed above, LODR identifies an independent director as someone who is not related to the company, either as a promoter or director of the company, its group companies, who do not have a material pecuniary relationship with the company or its group, as well as someone who does not or has not been related to the company in any manner in the recent position, such that s/he could influence the decisions/ business of the company.

The aforesaid is provided in Regulation 16 of LODR^[1], which defines “Independent Director” as “a non-executive director, other than a nominee director of the listed entity, who:

who, in the opinion of the board of directors, is a person of integrity and possesses relevant expertise and experience;
who is or was not a promoter of the listed entity or its holding, subsidiary or associate company or member of the promoter group of the listed entity;
who is not related to promoters or directors in the listed entity, its holding, subsidiary, or associate company;
who, apart from receiving director’s remuneration, has or had no material pecuniary relationship with the listed entity, its holding, subsidiary or associate company, or their promoters, or directors, during the [three]* immediately preceding financial years or during the current financial year
none of whose relatives ;

[(A) is holding securities of or interest in the listed entity, its holding, subsidiary or associate company during the three immediately preceding financial years or during the current financial year of face value in excess of fifty lakh rupees or two percent of the paid-up capital of the listed entity, its holding, subsidiary or associate company, respectively, or such higher sum as may be specified;

(B) is indebted to the listed entity, its holding, subsidiary or associate company or their promoters or directors, in excess of such amount as may be specified during the three immediately preceding financial years or during the current financial year;

(C) has given a guarantee or provided any security in connection with the indebtedness of any third person to the listed entity, its holding, subsidiary or associate company or their promoters or directors, for such amount as may be specified during the three immediately preceding financial years or during the current financial year; or

(D) has any other pecuniary transaction or relationship with the listed entity, its holding, subsidiary or associate company amounting to two percent or more of its gross turnover or total income:

Provided that the pecuniary relationship or transaction with the listed entity, its holding, subsidiary or associate company or their promoters, or directors in relation to points (A) to (D) above shall not exceed two percent of its gross turnover or total income or fifty lakh rupees or such higher amount as may be specified from time to time, whichever is lower;]*

who, neither himself/herself nor whose relative(s) —
holds or has held the position of a key managerial personnel or is or has been an employee of the listed entity or its holding, subsidiary, or associate company [or any company belonging to the promoter group of the listed entity]* in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;

[Provided that in case of a relative, who is an employee other than key managerial personnel, the restriction under this clause shall not apply for his / her employment.]*

is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of —
- a firm of auditors or company secretaries in practice or cost auditors of the listed entity or its holding, subsidiary, or associate company; or
- any legal or a consulting firm that has or had any transaction with the listed entity, its holding, subsidiary, or associate company amounting to ten percent or more of the gross turnover of such firm;
- holds together with his relatives two percent or more of the total voting power of the listed entity; or
- is a chief executive or director, by whatever name called, of any non-profit organisation that receives twenty-five percent or more of its receipts or corpus from the listed entity, any of its promoters, directors or its holding, subsidiary or associate company or that holds two percent or more of the total voting power of the listed entity;
- is a material supplier, service provider or customer or a lessor or lessee of the listed entity;
who is not less than 21 years of age.
who is not a non-independent director of another company on the board of which any non-independent director of the listed entity is an independent director

Evidently, the definition in India is very comprehensive compared to other major jurisdictions. Below we discuss and compare some major provisions in the definition of IDs in India, the USA and the UK –

Basis	India	USA^[2]	UK^[3]
*Material relationship*	The director shall, apart from receiving director’s remuneration, has or had no material pecuniary relationship with the listed entity, its holding, subsidiary or associate company, or their promoters, or directors, during the three immediately preceding financial years or during the current financial year; None of the director’s relatives [(A)is holding securities of or interest in the listed entity, its holding, subsidiary or associate company during the three immediately preceding financial years or during the current financial year of face value in excess of fifty lakh rupees or two percent of the paid-up capital of the listed entity, its holding, subsidiary or associate company, respectively, or such higher sum as may be specified; (B) is indebted to the listed entity, its holding, subsidiary or associate company or their promoters or directors, in excess of such amount as may be specified during the three immediately preceding financial years or during the current financial year; (C) has given a guarantee or provided any security in connection with the indebtedness of any third person to the listed entity, its holding, subsidiary or associate company or their promoters or directors, for such amount as may be specified during the three immediately preceding financial years or during the current financial year; or (D) has any other pecuniary transaction or relationship with the listed entity, its holding, subsidiary or associate company amounting to two percent or more of its gross turnover or total income: Provided that the pecuniary relationship or transaction with the listed entity, its holding, subsidiary or associate company or their promoters, or directors in relation to points (A) to (D) above shall not exceed two percent of its gross turnover or total income or fifty lakh rupees or such higher amount as may be specified from time to time, whichever is lower;]*	The director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder, or officer of an organization that has a relationship with the company). The references to “listed company” would include any parent or subsidiary in a consolidated group with the listed company	The director has, or had within the last three years, no material business relationship with the company, either directly or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company; The director has not received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or a performance-related pay scheme, or is a member of the company’s pension scheme
*Employment*	The director neither himself/herself nor his relatives hold or has held the position of a key managerial personnel or is or has been an employee of the listed entity or its holding, subsidiary or associate company, [or any company belonging to the promoter group of the listed entity]* in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed. [Provided that in case of a relative, who is an employee other than key managerial personnel, the restriction under this clause shall not apply for his / her employment]*	The director is not independent if the director is, or has been within the last three years, an employee of the listed company or an immediate family member is, or has been within the last three years, an executive officer, of the listed company. The director has received or has an immediate family member who has received, during any twelve-month period within the last three years, more than $120,000 indirect compensation from the listed company, other than director and committee fees and pension or other forms of deferred compensation for prior service (provided such compensation is not contingent in any way on continued service).	The director neither is or has been an employee of the company or group within the last five years
*Promoter/director or related to them*	The director is or was not a promoter of the listed entity or its holding, subsidiary or associate company or member of the promoter group of the listed entity; Who is not related to promoters or directors in the listed entity, its holding, subsidiary, or associate company;	No director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company either directly or as a partner, shareholder, or officer of an organization that has a relationship with the company.	The director has close family ties with any of the company’s advisers, directors, or senior employees.
*Cross-directorship*	The director is not a non-independent director of another company on the board of which any non-independent director of the listed entity is an independent director	The director or an immediate family member is or has been with the last three years, employed as an executive officer of another company where any of the listed company’s present executive officers at the same time serves or served on that company’s compensation committee.	The director holds cross-directorships or has significant links with other directors through involvement in other companies or bodies

One may find many similarities in the definition of IDs in foreign jurisdictions with that in India but as already mentioned above, the definition in India is one of the most comprehensive and meticulous ones.

Appointment/reappointment process of IDs in different jurisdictions

In India, the extant provisions require ordinary resolution to be passed by the shareholders for the appointment of IDs and a special resolution in case of re-appointment, based on the recommendation of the Nomination and Remuneration Committee (NRC) and the approval of the Board.

Earlier, SEBI had released a consultation paper w.r.t. regulatory provisions for Independent Directors which warranted a ‘dual approval’ for such appointment/ re-appointment as follows:

An ordinary resolution by shareholders (Special Resolution in case of re-appointment) and
A resolution by “majority of minority”

(Note: The Paper defined minority shareholders to mean shareholders other than the promoter and promoter group.)

However, owing to the response received thereafter, SEBI, in its Board Meeting held on June 29, 2021^[4] (SEBI Board Meeting), disregarded the earlier proposal of a dual approval and instead decided that the approval of shareholders would be required by way of special resolution for both appointment and re-appointment

[SEBI, vide (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2021 ( ‘Amendments’) notified on August 4, 2021, have amended the Regulation 25 providing that the appointment, re-appointment or removal of an independent director of a listed entity, shall be subject to the approval of shareholders by way of a special resolution. Thus, listed entities henceforth shall have to obtain the approval of members via a special resolution for the appointment as well.]*

In the USA, the NASDAQ Listing Rules provide that, where shareholders’ approval is required, the minimum vote that will constitute shareholder approval shall be a majority of the total votes cast on the proposal.

Akin to the NRC in India, the UK Corporate Governance Code of 2018 requires that the Board should establish a Nomination Committee, composed of majority independent non-executive directors, to lead the process for the appointment of all directors. Any appointment must be approved by the Board and shareholders of the company by way of an ordinary resolution.

However, as per the UK Listing Rules, the appointment of IDs is dependent on the existence of a controlling shareholding^[5]. A snapshot of the manner of appointment is given below

Hence, approval is required from both the set of shareholders. If the company still proposes to appoint the same person as an independent director despite failing to receive the dual nod as discussed above, it can propose another resolution to elect the same person, but after 90 days from the date when the previous proposal was put to vote. This time the resolution will only require approval by the shareholders of the company^[6].

Databank of Independent Directors & the Online Proficiency Test

One of the prerequisites to become an Independent Director in India is the inclusion of their name in the Databank of Independent Directors (‘Databank’) and passing an Online Proficiency Test (‘Test’) within a period of two years from the date of inclusion of name in the databank as per Section 150 of the Act, read with Rule 6 of the Companies (Appointment and Qualification of Directors) Rules, 2014. However, certain categories of persons have been exempted^[7] from the requirement of passing the Test who possess requisite experience and expertise as prescribed;

The question, however, is whether such arduous and tedious criteria required for an appointment really ensure board independence and good governance practices. It is understood that the tenet behind such steps was quality control – it was to ensure that only persons with a certain minimum level of expertise & experience are appointed as Independent Directors.

Further, some previous instances of celebrity directorships were also to be discouraged since the role of IDs is to ensure good governance practices and upholding the interest of all the stakeholders as a whole including minority stakeholders. Therefore, it should not merely be used as a tool of publicity.

However, keeping in mind the seniority of the position of directors in companies as well as lack of precedent, the requirement of passing the test seems rather odd and brings anomalies in the IDs’ regulatory regime in India vis-à-vis the rest of the world.

Constituted Body for selection of candidates for the role of IDs

As per the extant laws in India, the NRC recommends the persons to be appointed as IDs on the board of the company. This committee oversees the functions of formulation and recommendation of remuneration of the directors and the senior management. It has been decided in the SEBI Board Meeting that the process to be followed by NRC while selecting candidates for appointment as IDs, shall be elaborated and be made more transparent including enhanced disclosures regarding the skills required for appointment as an ID and how the proposed candidate fits into that skillset.

[SEBI, via the Amendments, has added a new sub-clause after sub-clause (1) in Para A in Part D of Schedule II for implementing its decision on an elobaroted and transparent selection oricess of IDs.

The NRC of every listed entities shall, for every appointment of IDs,

evaluate the balance of skills, knowledge and experience on the Board and on the basis of such evaluation
prepare a description of the role and capabilities required of IDs.
ensure that the person recommended to the Board for appointment as an ID has the capabilities identified in such description.

For the purpose of identifying suitable candidates, the Committee may:

use the services of an external agencies, if required;
consider candidates from a wide range of backgrounds, having due regard to diversity; and
consider the time commitments of the candidates

Thus, the NRCs of every listed company henceforth has to first formulate the description of the role of an ID after considering the skill sets and knowledge and experience required for acting as an ID of the company. This has also widened the scope of NRC as well as the responsibility for finding the right candidate for the position of an ID. The extant practice was to give disclosures in Corporate Governance Report and the Board report that forms part of the Annual Report of the Company.]*

Just like the NRC in India, companies in the USA have to constitute Compensation Committee as per the NASDAQ Stock Market LLC Rules [5605. Board of Directors and Committees] “Each Company must have, and certify that it has and will continue to have, a compensation committee of at least two members. Each committee member must be an Independent Director as defined under Rule 5605(a) (2).”

As per the NASDAQ Rules, director nominees must either be selected, or recommended for the Board’s selection, either by:

Independent Directors constituting a majority of the Board’s Independent Directors in a vote in which only Independent Directors participate, or
a nominations committee composed solely of Independent Directors.

The New York Stock Exchange Listed Company Manual (‘NYSE Manual’) vests on the nominating/corporate governance committee, the sole authority to retain and/or terminate any search firm to be used to identify director candidates, including sole authority to approve the search firm’s fees and other retention terms.

The UK Corporate Governance Code, 2018 states that the board should establish a remuneration committee of independent non-executive directors, with a minimum membership of three, or in the case of smaller companies, two. In addition, the chair of the board can only be a member if they were independent on appointment and cannot chair the committee. Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.

Tenure and re-appointment of IDs

In India, one term of appointment of IDs is for a maximum of 5 years and can be re-appointed for another term. Such re-appointment has to be made by way of passing a special resolution. Further, the performance of Independent Directors is to be evaluated every year based on which the NRC recommends whether the said director shall be re-appointed or not. However, the question of such recommendation only comes when the tenure of the director comes to its end.

Furthermore, the UK Corporate Governance Code provides that all directors should be subject to annual re-election. The code also considers the presence of an ID for more than nine years on the Board of a company as a threat to his independence.

In Singapore, Rule 720(5) of the SGX Listing Rules (Mainboard) / Rule 720(4) of the SGX Listing Rules (Catalist)^[8] requires all directors to submit themselves for re-nomination and re-election at least once every three years.

The rule requires a re-nomination & re-election of all directors of the company at least once in 3 years and it helps to ensure that the assessment of independence happens once in every 3 years by members.

Cooling-off Period for appointment/reappointment of IDs

In India, a cooling-off period of 2 years is required in case of any material pecuniary transactions between a person or his/her relative and the listed entity or its holding, subsidiary, or associate company. The LODR has prescribed a cooling-off period of three years for Key Managerial Personnel (and their relatives) or employees of the promoter group companies, for appointment as an ID in the listed entity. However, relatives of employees of the company, its holding, subsidiary, or associate company have been permitted to become IDs, without the requirement of a cooling-off period, in line with the Companies Act, 2013.

[SEBI via Amendments has provided that an ID who resigns from a listed entity, shall not be appointed as an executive / whole time director on the board of the listed entity, its holding, subsidiary or associate company or on the board of a company belonging to its promoter group, unless one year has elapsed from the date of resignation.]*

The NASDAQ Stock Market LLC Rules^[9] (‘NASDAQ Rules’) have prescribed a cooling-off period of 3 years for the appointment of an independent director where such person has a relationship with the company as prescribed under the rule.

UK Corporate Governance Code, 2018^[10] (‘UK Code’) provides that a person who has or had within the last three years, a material business relationship with the company, either directly or as a partner, shareholder, director, or senior employee of a body that has such a relationship with the company shall not be appointed as an Independent Director.

The Singapore Code of Corporate Governance, 2018^[11] prescribes a cooling-off period of 3 years for the appointment of an independent director where such person has a relationship with the company.

Remuneration of Independent Directors

In India, offering stock options to Independent Directors is prohibited. On the contrary, as per the New York Stock Exchange Listed Company Manual (‘NYSE Manual’), Independent directors must not accept any consulting, advisory, or other compensatory fees from the Company other than for board service.

Further, the UK Corporate Governance Code 2018 provides that remuneration for all non-executive directors should not include share options or other performance-related elements. Independent directors shall not be a member of the company’s pension scheme.

The Singapore Code of Corporate Governance 2018 the Remuneration Committee should also consider implementing schemes to encourage non-executive directors (NEDs) to hold shares in the company so as to better align the interests of such NEDs with the interests of shareholders. However, NEDs should not be over-compensated to the extent that their independence may be compromised.

Fees payable to non-executive directors shall be by a fixed sum, and not by a commission on or a percentage of profits or turnover. (Appendix 2.2 Articles of Association)

Important determinants of Independence across jurisdictions

Determinants of Independence	India	USA	UK	Singapore
Present or past employment relationship	Yes	Yes	Yes	Yes
Relationship of close family members	Yes	Yes	Yes	Yes
Pecuniary relationship with company*	Yes	Yes	Yes	Yes
Cooling-off period	Yes	Yes	Yes	Yes
Restriction on Stock options	Yes	Yes	Yes	No
ID databank & Proficiency test	Yes	No	No	No

* Subject to specific monetary limits

Conclusion

The regulatory framework for Independent Directors in India has a lot of things in common with other jurisdictions around the world. However, the requirement of passing an online test for becoming eligible to be appointed as an Independent Director is something peculiar to India. The regulators across jurisdictions have been proactive in bringing changes to the Independent Director regime, to strengthen the corporate governance in listed companies. One may expect some of the above discussed benchmark practices in different foreign jurisdictions may soon be adopted in India as well.

[1] https://www.sebi.gov.in/legal/regulations/sep-2015/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirement-regulations-2015-last-amended-on-may-5-2021-_37269.html

[2] https://nyse.wolterskluwer.cloud/listed-company-manual

[3]https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.PDF

[4] https://www.sebi.gov.in/media/press-releases/jun-2021/sebi-board-meeting_50771.html

[5] A company is said to have controlling shareholder(s) if a shareholder/ an entity/ a group holds more than 30% voting power in the company

[6] https://www.mondaq.com/uk/acquisition-financelbosmbos/315598/new-dual-process-for-appointing-independent-directors-amendments-to-articles-of-association

[7] https://www.independentdirectorsdatabank.in/pdf/databank-rules/FifthAmdtRules_18122020.pdf

[8] https://rulebook.sgx.com/rulebook/board-matters-1

[9] https://listingcenter.nasdaq.com/rulebook/nasdaq/rules

[10] https://www.frc.org.uk/getattachment/88bd8c45-50ea-4841-95b0-d2f4f48069a2/2018-UK-Corporate-Governance-Code-FINAL.PD

[11] https://www.mas.gov.sg/-/media/MAS/Regulations-and-Financial-Stability/Regulatory-and-Supervisory-Framework/Corporate-Governance-of-Listed-Companies/Code-of-Corporate-Governance-6-Aug-2018.pdf

*[ The changes are applicable with effect from 1st January, 2022].

Step-by-step guide for disclosure for Analysts/Investors Meet

July 7, 2021/0 Comments/in LODR, SEBI /by Staff

Do’s and don’ts to be ensured by listed companies

CS Aisha Begum Ansari, Senior Manager corplaw@vinodkothari.com

Updated as on September 28, 2023 , pursuant to the SEBI LODR (Second Amendment) Regulations, 2023

Brief Background

In order to disseminate information regarding performance of the company, its future prospects etc. listed companies usually conduct gatherings of analysts/investors after dissemination of quarterly results or atleast once in a year. Such meets generally include conference calls or meeting with group of investors or one-to-one meet or calls with investors or analysts, including those in the nature of walk-in. The idea behind conducting such meets is to provide transparency for the company’s performance figures, to address the queries of the analysts/investors and to ensure that the company’s information is available to the stakeholders. However, the risk of information asymmetry in such meets or gatherings is very inherent.

While the regulatory framework of SEBI i.e. SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) provided for disclosure of adequate and timely information to enable investors to track the performance of a company including the information pertaining to occurrence of investors meet/conference call with analysts, however, several inconsistencies were observed in the disclosures made by the companies. For instance, some entities were not divulging the details of what transpired in such investors’ meetings and were merely disclosing the limited presentations w.r.t. the meetings. As such, minority shareholders, who did not attend these meetings, were not privy to the information shared with a select group of investors, thereby creating information asymmetry among different classes of shareholders.

Realizing this, SEBI, on November 20, 2020, came up with the Consultation Paper and recommended enhanced disclosure requirements w.r.t. post earning calls and one-to-one meets. Our write-up analyzing the said consultation paper can be viewed here.

Later, vide notification dated May 05, 2021, SEBI enhanced the disclosure requirements w.r.t. Investors’/ Analysts’ meet. In this article, the author has made an attempt to discuss the changes made in the disclosure requirements w.r.t. analyst meet step by step.

Post amendment in Listing Regulations

On May 05, 2021, SEBI amended the Listing Regulations which inter alia, covered analyst meet. Pursuant to the said amendment, the companies are required to include enhanced disclosure requirements with respect to analyst/ investors meets so as to avoid selective disclosure and information asymmetry and to ensure market integrity and to safeguard the interest of investors. The said amendments were voluntary for FY 2021-22, and became mandatory from FY 2022-23. The synopsis of the amendment is provided below:

Figure 1: Disclosure requirement for analyst meet

Regulatory requirements in case of one-to-one meet

In respect of one-to-one meet, there are no explicit disclosure requirements as such. However, considering the intent of the Listing Regulations and SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’), the following things are explicitly clear:

One-to-one meets, even though unregulated, should be discouraged looking at the high possibility of leakage of UPSI; and
Even if the entity has one-to-one meet, it cannot share any UPSI.

Regulation 8 of PIT Regulations mandates every listed company to frame a code of practices and procedures for fair disclosure of UPSI in line with the principles set out in Schedule A to PIT Regulations. Para 6 of Schedule A requires the company to ensure that information shared with analysts and research personnel is not UPSI. Para 7 provides for developing best practices to make transcripts or records of proceedings of meetings with analysts and other investor relations conferences on the official website to ensure official confirmation and documentation of disclosures made.

The PIT Regulations do not distinguish between group meets and one-to-one meets. It requires the company to record such meets and develop best practices to disclose the same on its website. The practice of recording the meet also safeguards the company officials participating in the meeting from any possible allegation of having divulged UPSI.

Whether sharing of UPSI is allowed in a group meet or one-to-one meet?

The PIT Regulations prohibit sharing of UPSI in any manner to any person including analysts/ investors and require the companies to take all required steps to ensure the same. Considering the same, the fact whether it is a group meet/ call or otherwise or whether such meet/ call was organized by the company itself or not, becomes irrelevant and the prohibition shall apply in all cases.

Therefore, there is a remote chance of sharing such UPSI until and unless the same is as per the provisions of code of fair disclosure framed by the company. Accordingly, if any UPSI is shared, legitimately in terms of the said code or otherwise, the entity will have to disclose the audio/ video recordings or the transcripts of such meeting to the stock exchange promptly.

Guidance Note of Analyst/ Institutional investors’ meet

The amendment in the Listing Regulations came up with various interpretations and ambiguities w.r.t. disclosure requirements. We have discussed such anomalies in our previous article which can be viewed here.

In order to clear the ambiguities w.r.t the disclosure requirements, BSE, vide circular dated 29th June, 2021 and July 29, 2022, provided further clarifications and recommendations. In this article, we have tried to provide step-by-step guide for disclosure on analyst meets and post earning calls. Further, we have also provided the do’s and don’ts to be ensured by the companies.

Disclosure requirements w.r.t. Analyst meets

In order to comply with the provisions of Listing Regulations in letter and spirit, the companies are required to ensure that it makes timely disclosure to stock exchanges and on their own website. The compliance requirement as per the amended provisions w.r.t. analysts/ investors meet are jotted down below:

Sr. No.	Cases	Disclose what?	By When?	Other Points to be ensured
1.	Post earning calls/ Quarterly calls, by whatever name called (after disclosure of quarterly financial results)	Schedule of such meeting	Atleast 2 working days in advance (excluding the date of intimation and date of the meet).	Mandatory only for group meets.
		Presentation and the audio/ video recordings of such meeting	Before the next trading day or within 24 hours from the conclusion of the meet, whichever is earlier.	Mandatory for both group meets and one to one meets.To be disclosed whether conducted by a company or any other entity.To be hosted on the website of the company for minimum 5 years and thereafter as per the archival policy of the company. To be disclosed simultaneously to the stock exchange.
		Transcripts of such meeting	Within 5 working days of conclusion of the meet.	Mandatory for both group meets and one-to-one meets.To be disclosed whether conducted by a company or any other entity.To be hosted on the website of the company and preserved permanently.To be disclosed simultaneously to the stock exchange.
2.	Other Analysts/ Investors meets	Schedule of such meeting	Atleast 2 working days in advance (excluding the date of intimation and date of the meet)	Mandatory only for group meets.
	Other Analysts/ Investors meets	Presentation made in such meeting	Before the next trading day or within 24 hours from the conclusion of the meet, whichever is earlier..	Mandatory only for group meets.To be disclosed on the website of the company, whether conducted by company or any other entity.To be disclosed simultaneously to the stock exchange.
	In case any UPSI is shared	Audio/video recordings or transcripts of such meeting	Promptly	Applicable to both group as well as one-to-one meets.To be disclosed on the website of the company, whether conducted by a company or any other entity.To be disclosed simultaneously to the stock exchange.

Best practices that may be adopted by companies

Disclosure of schedule of meet/ call

While making disclosure of schedules, the company may also provide the details pertaining to the meet/ call, mode of attending, details pertaining to registrations, disclaimers/ note to complete/ ease registration/ attending the call, details regarding specific platform requirements, if any, inclusions/ exclusions of audience/ participants if any, etc.

Further, a disclaimer or a confirmation may be added in the intimation stating that ‘Company will be referring to publicly available documents for discussions’ or ‘No UPSI is proposed to be shared during the meeting / call’. This will create confidence amongst the investors and will maintain sanctity of the meet / call.

Disclosure of transcripts of the meet/ call

While disclosing the transcripts of the meet/ call, the companies may also consider providing the list of attendees and record the dialogues, Q&As and assents and dissents of the analysts/ investors. Further, a confirmation may be added in the disclosure that no unpublished price sensitive information was shared/ discussed in the meeting / call.

Do’s and Don’ts to be ensured by the companies

The companies will be required to observe some crucial points while scheduling or attending analysts’/ investors’ meet, conference calls, post earning calls etc. Briefly, the following are the do’s and don’ts:

Sr. No.	Do’s	Don’ts
1.	Always conduct scheduled meets.	Avoid unscheduled meets.
2.	Always schedule group meets.	Avoid scheduling one-to-one meet.
3.	Upload the schedule of group meets/ calls on the website atleast 2 working days in advance (excluding the date of intimation and date of the meet) and also simultaneously submit the same with the stock exchange.	Do not forget to upload and send the schedule on the website and to the stock exchanges, respectively beyond the prescribed time.
4.	Upload the presentation made to analysts/ investors in the scheduled group meet on the website promptly before the next trading day or within 24 hours from the conclusion of the meet, whichever is earlier and also simultaneously submit the same with the stock exchange.	Do not forget to upload and send the schedule on the website and to SE, respectively beyond the prescribed time.
5.	Ensure to make audio and video recording of the post earnings/ quarterly calls, whether conducted physically or through digital means, either conducted by company or any other entity including one- to-one meets.	Do not avoid making audio/video recording of such calls irrespective the same was conducted by the company itself or by any other entity.
6.	Ensure transcripts of the post earnings/quarterly calls, whether conducted physically or through digital means, either conducted by company or any other entity including one-to-one meets.	Do not avoid making transcripts of the proceedings of such calls irrespective the same was conducted by the company itself or by any other entity.
7.	Ensure that the information shared with the investors is already available in the public domain.	Do not share UPSI with the investors.
8.	Maintain a silence period, if any, as provided in the code of fair disclosure framed by the entity.	Discourage any sort of meets either group meet or one-to-one meets (including walk-in investors) during silence period.
9.	Upload all audio/video recordings and presentation of the post earning/ quarterly calls on the website of the company within 24 hours of conclusion of such calls or next trading day, whichever is earlier.	Avoid uploading audio/video recording beyond the prescribed time.
10.	Upload all transcripts of the post earning/ quarterly calls on the website of the Company within 5 working days of conclusion of such calls.	Avoid uploading transcripts of the post earning/ quarterly calls on the website of the company after 5 working days of conclusion of calls.
11.	Simultaneous to uploading audio/video recording and transcripts on the website of the company, submit the same to the recognized stock exchange.	Do not forget to send audio/video recording and transcripts of the meets to the recognized stock exchange
12.	Preserve the disclosures made on the website of the Company (a) Audio/video recording- for minimum 5 years and thereafter as per archival policy of the company; (b) Transcripts: permanently	Do not avoid preserving of audio/video recording and transcripts of the meets

Conclusion

The amendment in Listing Regulations and guidance note by the stock exchanges give us the clear view that the companies are required to make timely disclosure of audio/ video recordings, transcripts of post earning calls and only presentations of analyst meet to the stock exchange. Even though this seems to be the compliance burden on part of the listed companies which are already pressed with various disclosure requirements, this step is surely a welcome move as it will help the watchdog of capital markets to curb insider trading and information asymmetry.

Our other article on similar topics can be read here – http://vinodkothari.com/2020/11/sebi-proposes-enhanced-disclosures-for-meetings-with-analyst-investors-etc/

Our Podcast on the topic: https://open.spotify.com/episode/2oVRo2iEOV7cVVqYwcqb2c?si=b860b48d6f924ad6&nd=1

Our Resource Centre on LODR:

LODR Resource Centre

Presentation on LODR Amendments

June 18, 2021/0 Comments/in LODR, SEBI /by Staff

BRSR Reporting: Actions and disclosures required for business sustainability

June 8, 2021/0 Comments/in LODR, Sustainability /by Staff

Abhishek Saraf, Manager and Payal Agarwal, Executive (corplaw@vinodkothari.com)

Background

The Business Responsibility and Sustainability Reporting (“BRSR”), originating from the MCA report on Business Responsibility Reporting, has found its way into the regulatory provisions by way of an amendment to the Regulation 34(2)(f) of the Listing Regulations[1], notified on 5th May, 2021. Further, SEBI vide circular dated 10^th May, 2021 introduced the format of BRSR and the guidance note to enable the companies to interpret the scope of disclosures.

The BRSR will replace the existing BRR format w.e.f. FY 2022-23. For the FY 2021-22, the top 1000 listed entities may voluntarily submit the BRSR and from FY 2022-23 onwards, the same has to be submitted mandatorily. It is notable that the BRSR, though replacing BRR, is actually an extension of the existing BRR reporting While the BRSR has been made effective from FY 2022-23, it has to be understood that reporting is secondary, and needs to be backed by the company taking appropriate actions to ensure a positive report. Where the BRSR reporting of a company is negative, the same, though not a non-compliance of the regulatory provisions, will result in a negative impact on the minds of the stakeholders.

Financial transactions with promoter entities become part of CG disclosure

June 4, 2021/0 Comments/in LODR /by Staff

SEBI’s move to strengthen transparency

Pammy Jaiswal| Partner| Vinod Kothari and Company

corplaw@vinodkothari.com

Background

It has always been interesting to see how SEBI takes various steps to increase the level of transparency for augmenting the level of corporate governance in a listed company. Recently, SEBI notified the changes under the SEBI Listing Regulations on 6^th May, 2021, which contained several significant changes to enhance corporate governance (hereinafter referred to as CG), like specifying the scope of the risk management committee or intimation of recordings and transcripts for analyst meetings[1]. Following the said notification, SEBI, on 31^st May, 2021, came up with a circular[2] dealing with enhanced disclosures under CG report to be submitted to the stock exchange under Regulation 27 (2) of the SEBI Listing Regulations by adding Annexure IV to the existing formats.

The new requirement coming out from this circular is extremely significant since it aims at revealing almost all types of financial transactions (to say almost 24 types of permutations) which the company has entered into with its close connections and which may have the highest chances of involving any conflict of interest.

In this write up we have tried to critically discuss and examine the requirements emanating from the said circular.

Scope and time of applicability

Annexure IV which contains the new disclosures will have to be filed by the listed entities which have listed their specified securities.
The same is to be filed on a half yearly basis starting from the first half year 2021-2022, i.e., for the half year ended 30^th September, 2021.
While Regulation 27 (2) only talks about quarterly filings within 21 days from the end of the quarter, therefore, there is no explicit time period within which this new annexure will have to be filed with the exchange from the end of the half year.
The disclosure will not only cover the financial transactions undertaken during the half year ended 30^th September, 2021, but also cover all outstanding financial contracts which the entity has entered any time in the past.

Financial Permutations covered

Critical Aspects

While the format under the new annexure may seem to be simple in terms of presentation, however, it has various aspects related to it which needs to be discussed. Owing to the extent of disclosure required, listed companies will have to consider and understand every part under the format before feeding the details. Some points which need to be discussed include the actionable, the meaning of the entities controlled by the promoters, the meaning of direct and indirect accommodation, distinction between a LoC and a co-borrowing arrangement, and last but not the least the ‘affirmation’ on the economic interest of the company.

Actionable on the part of the listed entity

Identify the entities
- This identification process may reveal that companies have a large number of interested entities falling under these 4 types of entities.

Identify transactions
- After having prepared the list of entities that are included under the 4 categories, the next step will be to identify the financial transactions which include loan, guarantee or security in connection with the loan to the entities under the list.

Identify outstanding balances
- Once the entities and the transactions entered into with them have been identified, listed companies will have to identify the outstanding balance as on the date of the report.
- Since the transactions involve providing guarantee or security as well, there can be a situation that companies will have to look for both on and off-balance sheet items to come to the actual outstanding balance for the purpose of reporting.

Entities controlled by Promoters/ PG

While the meaning of the term promoter and PG is well defined under SEBI ICDR Regulations, the question that may arise is which entities will be considered to be controlled by the promoters or the PG. The meaning of control here has to be taken form SEBI Takeover Regulations, which defines it as a right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or PAC, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

As per the definition of PG, entities which have a substantial stake (20%) held by the promoters or by common group pf shareholders are covered under the said definition of PG. However, if one has to identify the entities which are controlled by PG, it may cover even larger number of companies.

Ambit for covering directors and controlled entities for the purpose of disclosure

The ambit for making disclosures is very wide under Annexure IV. Therefore, it becomes imperative to pinpoint the entities related to the directors of the listed entity that are covered for the purpose of disclosure under the said Annexure. The same is represented below:

SEBI Listing Regulations refer to the definition of ‘relatives’ provided under Section 2(77) of the Companies Act, 2013.

In a situation where the directors do not have any direct control over the entity to whom the listed entity has extended the financial accommodation, but the control is with the relatives of such directors alone, the same should be enough to make the financial transaction be covered for the purpose of the disclosure under Annexure IV.

Leaving such transactions outside the disclosure will frustrate the whole intent of the said requirement since, it is very unlikely that a financial accommodation will be offered to an entity controlled by the director’s relative without any nexus or benefit to the directors altogether. There exists a possibility of the directors or their relatives indirectly gaining benefit or influencing transactions undertaken. Therefore, such transactions will also be required to be disclosed, given the intent of the disclosures.

Nature of book debt covered

As per the format of annexure IV, any other form of debt advanced is also required to be included for the purpose of the said disclosure. Looking at the intent of the disclosure, any book debt that is present in the books like merely selling of goods on credit should not be made part of this disclosure. In our view, only the book debt which has the color of an advance and which is in the nature to serve as a financial accommodation (for example selling of goods on credit for an unreasonable period of time or under unreasonable terms of understanding) is required to be disclosed.

Meaning of direct and indirect financial accommodation

As per the requirement, one of the biggest challenges for the listed entities will be to identify the connecting links or conduits through which these interested entities have been benefitted. Such transactions are generally camouflaged and put through layers to create smokescreen. These entities which are used to route the benefits to the interested parties are merely acting as a stopover. Therefore, it is extremely important to identify such transactions where there is a clear and direct nexus between flow of money from the listed entity to the intermediary and ultimately to the interested party. For instance, if a company raises preference share capital with the reason that it needs it for its own business operations, however, uses the funds so raised to on lend to another entity.

Difference between LoC and co-borrowing arrangement

The new requirement includes an LoC to be disclosed in the half yearly report. One needs to understand that providing a guarantee or giving an LoC by the listed company is nothing but to agree and provide financial accommodation to the borrower. It is significant to note that companies cannot disguise the LoC into a co-borrowing arrangement and therefore, avoid the disclosures to be made under Annexure IV.

Under a co-borrowing arrangement, if the listed entity is the co-borrower, then it should be getting the benefit or be a beneficiary of the loan being taken together with the interested party. Acting merely as a signatory to the co-borrowing agreement will make it no different from being considered as a guarantee or providing an LoC.

Affirmation for being in economic interest of listed company

One of most crucial and difficult part of the disclosure is the part requiring affirmation that loan (or other form of debt), guarantee / comfort letter (by whatever name called) or security provided in connection with any loan or any other form of debt is in the economic interest of the Company.

Some pointed issues under this are:

Who will give this affirmation?

The report on CG as per the SEBI circular (annex I, annex II and annex III) are required to be signed either by the compliance officer or the company secretary or the MD or CEO or CFO. However, Annex IV (which is the new requirement) requires the affirmation to be signed either by the CEO or CFO.

Further, the practicing professionals who provide their report on compliance with CG requirements and which has to be annexed with the CG report cannot be expected to dive into this question and scrutinize the reasoning provided by the company.

What will be the basis of this affirmation?

Further, it is imperative to note that the entities covered under this disclosure are mainly upstream entities which are either promoters or PG or controlled entities by them. Therefore, it becomes all the more difficult to justify the act of financial accommodation to be in the economic interest of the company. If it were a case of downstream accommodation (like subsidiaries, associates, joint ventures, etc.), it would have been much easier to form a basis to affirm that the same is serving the economic interest of the company since any profits in them will reflect in the consolidated financial results of the listed entity, however, the same reason cannot be for an upstream entity.

Also, merely earning an interest on loan granted or a commission on a guarantee or security or even on lending cannot act as a justification here since the earning interest or commission cannot be said to serve the economic interest of a company which is not even in the business of lending. Having said that listed NBFCs may have an upper hand in terms of providing justifications in this case.

• Whether the same needs to be reviewed by the Audit Committee as well?

Regulation 18 of the Listing Regulations read with Part C of Schedule II as well as section 177 of the Companies Act requires that the audit committee needs to scrutinize the inter-corporate loans and investments. While the same is required and covers loans, there does not seem to be any reason to exclude provision of security or extending guarantee since it is given in connection with loan.
The management needs to show the audit committee how does the transactions covered for the purpose of the said disclosure are in the economic interest of the Company.

Comparison between section 185 of the Companies Act, 2013 and Annexure IV

Section 185 of the Companies Act, 2013 (Act, 2013) deals with the provisions to provide loan and related services to directors or the interested entities. While section 185 is more from an angle of regulated provisions, the extent of casting restrictions on providing loan to directors or its connected parties is divided into two parts. One is completely prohibited (to directors and to firms where the director or his relative is partner) and the other one is restrictive, which means, financial accommodation can be given subject to prior approval of the shareholders.

The new disclosure requirement has several similarities with section 185 which are given below:

Basis of comparison	Section 185	Annex IV of SEBI Circular dated 31^st May, 2021
Services covered	Provision of loan, provision of guarantee or Letter of Comfort and providing security in connection with the loan	Similar
Mode	Direct as well as indirect	Similar
Entities covered	· director of company, or its holding company or any partner or relative of any such director; · any firm in which any such director or relative is a partner; o The aforesaid two bullets are completely prohibited · any private company of which any such director is a director or member; · any body corporate at a general meeting of which not less than twenty-five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; · any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company	Refer to figure 1 above.

While the format requires the financial accommodation made, if any, to the directors or their relatives or entities controlled by them, it will surely not include or have any disclosure relating to financing of directors since it is completely prohibited under section 185 of the Act, 2013.

Exclusions

The aforementioned disclosure shall exclude the reporting of any loan (or other form of debt), guarantee / comfort letter (by whatever name called) or security provided in connection with any loan or any other form of debt:

by a government company to/for the Government or government company
by the listed entity to/for its subsidiary [and joint-venture company whose accounts are consolidated with the listed entity.
by a banking company or an insurance company; and
by the listed entity to its employees or directors as a part of the service conditions.

While one of the exclusions is for a banking company, it is imperative note the following:
 SEBI (LODR) Regulation does not define the term “banking company” but the term “banks”.
 Section 5(c) of the Banking Regulation Act, 1949 (‘BR Act’) defines banking company as: “banking company” means any company which transacts the business of banking in India;”
 Further, section 5(d) of the BR Act defines company as: “company” means any company as defined in section 3 of the Companies Act, 1956 (1 of 1956) and includes a foreign company within the meaning of section 591 of that Act;”
 Public sector banks like State Bank of India, being a body corporate, do not fall under the aforesaid definition of banking company. However, it is engaged in the business of banking and should therefore, be excluded.

Accordingly, clarity on the same is still awaited from SEBI.

Concluding remarks

As stated in the beginning, SEBI’s move to increase the standards for CG has been extremely interesting. Further, considering the fact that listed companies have a limited amount of time to arrange for huge amount of information, this circular needs the immediate attention of the listed entities.

[1] Our write up on the same can be viewed here

[2] To view the circular, click here

Our other articles on relevant topic can be read here – http://vinodkothari.com/2019/07/sebi-amends-format-of-compliance-report-on-corporate-governance/

‘Material Subsidiary’ under LODR Regulations: Understanding the metrics of materiality

May 20, 2021/1 Comment/in Corporate Laws, LODR, SEBI /by Staff

Barsha Dikshit | corplaw@vinodkothari.com

Himanshu Dubey | corplaw@vinodkothari.com

The term ‘subsidiary’ or ‘subsidiary company’ as defined under the Companies Act, 2013^[1] (‘Act’) refer to a company in which a holding company controls the composition of the Board of directors or may exercise at least 51% of the total voting power either on its own or together with one or more of its subsidiaries. A company may have a number of subsidiaries; however, all of them may or may not have a material impact on the holding company or on the group at a consolidated level. Therefore, regulations sometimes require identification of such subsidiaries which may have a material impact on the overall performance of the holding company/group.

Though SEBI (Listing Obligations and Disclosure Requirement) Regulations, 2015 (‘SEBI LODR’), define the term ‘Material Subsidiary’ as a subsidiary, whose income or net worth exceeds ten percent (10%) of the consolidated income or net worth, respectively, of the listed entity and its subsidiaries in the immediately preceding accounting year, however, there remains confusion w.r.t. the criteria provided for determining the materiality of a subsidiary. For instance, whether a subsidiary having negative net worth exceeding 10% of the consolidated net worth of the listed company will be qualified as a material subsidiary? Or say if the net worth at the group level is negative, however the net worth of the subsidiary is positive, will that subsidiary be treated as a material subsidiary, etc.

Through this article the author has made an attempt to decode some of these puzzling issues relating to determination of materiality of a subsidiary.

The Concept of ‘Material Subsidiary’

In present day corporate world, operating through a network of subsidiaries and associates is quite common. Sometimes, it is a matter of corporate structuring discretion, and sometimes, it is purely a product of regulation – for example, overseas direct investment can be made only through subsidiaries or joint venture entities. While the listed subsidiaries are always under the observation of SEBI, an appropriate level of review and oversight is required by the board of the listed entity over its unlisted subsidiaries for protection of interests of public shareholders. The board of directors of a holding company cannot take a tunnel view and limit their perspective only to the company on whose board they are sitting. After all, subsidiaries operate with the resources of the parent, and therefore, what happens at subsidiaries and associates is of immediate relevance to the holding company. Accordingly, the obligation of the board of a listed entity with respect to its subsidiaries has been increased vide SEBI LODR Amendment Regulations, 2018 dated 9^th May, 2018[2], thereby reducing the threshold for determining materiality of a subsidiary to 10% (as opposed to the previous limit of 20%) of the consolidated income or net worth respectively, of the listed entity and its subsidiaries, in the immediately preceding accounting year.

Since the material subsidiaries have a considerable role in the overall performance of the holding company or the group as a whole, it is important to arrive at the correct interpretation of the term in line with the intent and purpose of the definition as well as the compliance requirements following it.

In terms of the definition provided under Regulation 16(1)(c) of SEBI LODR the triggers for determining materiality of a subsidiary are- Net Worth ^[3]and Turnover. That is to say, the pre-requisites for determining materiality of a subsidiary are:

It has to be a subsidiary, in terms of the definition provided under Act, 2013; and
Its income/net worth in the immediately preceding financial year exceeds 10% of the consolidated net worth of the listed company.

It is pertinent to note that the definition of material subsidiary currently provides for 10% or more impact on the consolidated turnover or net worth of the listed company/group, however, it does not specify whether the said impact has to be in positive or negative. It just says that the impact has to be 10% of the overall income/net worth. Since the turnover of a company cannot be negative, the focus has to be made on the later.

A parent company is required to prepare consolidated financial statement taking into account the performance of its subsidiaries. While a subsidiary, with a good performance and positive net worth/income can add on the overall growth of the group, the same can affect the overall performance of the group with its negative net worth, and if the said impact exceeds 10% of the income/net worth of the consolidated performance of the group, the said subsidiary will become material and shall require special attention of the parent company. Therefore, for the purpose of determining the ‘materiality’, one has to drop the minus sign of the net worth of the subsidiary or group and has to see the absolute term and the overall impact it has on the group. In other words, if a subsidiary is big enough to shake the performance of its holding company, it shall be qualified as a ‘material subsidiary’.

Let us take some illustrations to understand the definition provided under Reg. 16 (1) (c) of SEBI LODR:

Illustration 1:

XYZ Limited is a subsidiary of ABC Limited. In the FY 2019-20, the net worth of XYZ Limited was Rs. 50 Crs. and the consolidated net worth of ABC Limited company was Rs. 400 Crs., Whether XYZ Limited be considered as a material subsidiary of ABC Limited?

Yes. The contribution of XYZ Limited towards the consolidated net worth of ABC Limited is more than 10%, therefore XYZ Limited shall be consolidated as a ‘material subsidiary’ of ABC Limited.

Illustration 2:

Net worth of XYZ Limited in FY 2019-20 was Rs. (50) Crs., however, the consolidated net worth of ABC Limited was Rs. 400 Crs, will XYZ Ltd. be considered as a material subsidiary of ABC Ltd?

Yes. Irrespective of having a negative net worth, since XYZ Limited contributes more than 10% of the consolidated net worth of ABC Limited, XYZ Limited shall be considered as a ‘material subsidiary’ of ABC limited.

Illustration 3:

Net worth of XYZ Limited in FY 2019-20 was Rs. (50) crores, and the consolidated net worth of ABC Limited was Rs. (400) Crs., will XYZ Limited be considered as a material subsidiary of ABC Limited?

Yes. Even if the net worth at the subsidiary level and the consolidated level are negative, however, one has to see as to how much contribution the subsidiary has in the consolidated net worth of the holding company. Therefore, irrespective of having negative net worth, XYZ Limited shall be considered as a ‘material subsidiary’ of ABC limited.

Illustration 4:

Net worth of XYZ Limited in FY 2019-20 was Rs. 50 crores and the consolidated net worth of ABC Limited was Rs. (400) Crs., will that subsidiary be considered as a material subsidiary of ABC Limited?

Yes. In the given case, because of the positive net worth of the subsidiary the net worth of the holding company has contributed to reduce the negative net worth of the holding company by more than 10%. Therefore, the subsidiary, viz. XYZ Limited shall be considered as a material subsidiary of ABC Limited.

Illustration 5:

Net worth of XYZ Limited in FY 2019-20 was Rs. 30 Crs. and the consolidated net worth of ABC Limited was Rs. (400) Crs., will that subsidiary be considered as a material subsidiary of ABC Limited?

No. Even though the positive net worth of the subsidiary is contributing to reduce the negative consolidated net worth of the holding company, however, that contribution is less than 10%, therefore in this case, XYZ Limited shall not be considered as a ‘material subsidiary’ of ABC Limited.

Thus, for determining ‘materiality’ of a subsidiary, the emphasis should not be on whether net worth is positive or negative, rather the impact of its net worth or income on the overall consolidated performance of the listed entity is to be seen.

Special Situation in case of Regulation 24 (1)

In the SEBI LODR, the term ‘Material Subsidiary’ has been defined twice, i.e under regulation 16 (1)(c) and under regulation 24 (1). While the threshold for determining ‘materiality’ provided under regulation 16 (1) (c) is 10%, the one provided under reg. 24 (1) is 20%. The reason behind the said increase in the threshold is the higher level of impact the said subsidiary can make on the performance of the listed company/group. That is to say, when a subsidiary is ‘material’ it requires attention of the parent company, however when it becomes significantly material, such that it can give shock to the parent company with its performance, it requires higher attention. Therefore regulation 24 (1) requires those significantly material subsidiaries to have on independent director of the parent company in its board.

The need for an independent director can be established by the fact that they are expected to be ‘independent’ from the management and act as the fiduciary of shareholders. This implies that they are obligated to be fully aware of the conduct which is going on in the organizations and also to take a stand as and when necessary, on relevant issues.

The requirement of appointing independent director is applicable only in case of significantly material subsidiary (unlisted), whether incorporated in India or not, and not in case of material subsidiary.

Obligation of the Listed Entity with respect to its Material Subsidiary(ies)

Other than the obligations provided under Reg. 24 of SEBI LODR for the listed companies w.r.t. their subsidiaries, the following additional obligations are applicable in case of material subsidiaries:

Formulating Policy– The listed entity is required to formulate a policy for determining materiality of its subsidiaries, and shall disseminate the same on its website.
Appointment of Independent Director– Pursuant to Regulation 24(1) of the LODR, at least one (1) independent director of the listed entity is required to be a director on the board of an unlisted material subsidiary (with respect to this provision, material subsidiary has been defined with a threshold of 20% of the consolidated income or net worth).
Disposing of shares in Material Subsidiary – A listed company shall not dispose of shares in its material subsidiary resulting in reduction of its overall shareholding to less than 50% or cease to exercise control over subsidiary without passing special resolution in general meeting except in case where such divestment is made under a scheme of arrangement (duly approved by the Tribunal/ Court) or in case of resolution plan duly approved in terms of section 31 of IBC, 2016.
Selling, disposing and leasing of assets – Pursuant to Regulation 24(6) of the LODR, the sale or disposal or leasing of assets amounting to more than 20% of the assets of a material subsidiary (on an aggregate basis during a financial year), subject to certain exceptions, requires prior approval of the shareholders of the listed holding company by way of a special resolution.
Secretarial Audit: Pursuant to Regulation 24A of the LODR, all listed entities and their Indian unlisted material subsidiaries are required to undertake a secretarial audit and annex such reports to the annual report of the listed entity.

The discussion above can be summarised in the presentation below:

Role of Policy on determining Materiality of Subsidiary

The definition of ‘material subsidiary’ under regulation 16(1)(c) defines a subsidiary that is material to the listed entity and the explanation to the aforesaid provision allows the listed entity to formulate a policy for the same, i.e., a listed entity can develop criteria that is stricter than what has been provided in the Regulations. However, nothing has been provided regarding the contents of the Policy in the SEBI LODR. Therefore, the Policy is nothing but a replica of what has already been provided in the law, as in order to ensure compliance of the law, listed entities frames policy for determining materiality of subsidiaries based on the contents of the regulations. Thus, the requirement of the policy is limited to ensure compliance of the law.

Can a section 8 company be treated as ‘Material Subsidiary’?

Section 8 Company, as defines in the Act, 2013 are companies that are formed with an object of promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment or any such other object. These companies are required to apply their profit, if any or other income in promoting their objects and are prohibited from payment of any dividend to its members. Whereas, the benchmark for satisfying the definition of ‘material subsidiary’ is contribution towards consolidated income or net worth of the holding company.

When we consolidate the holding company with a Section 8 company, it will however depict a wrong picture of the wealth of the holding company, as the holding company can never claim any right over the profits of a Section 8 Company. Therefore, the question of consolidation of section 8 with that the holding company does not arise.

Given that the income of a section 8 company cannot be consolidated with that of the listed company or can say that since the performance of a section 8 company has no role to play on the overall performance of the listed company, a section 8 company cannot be treated as a ‘material subsidiary’.

Concluding Remarks

The term “material subsidiary” has been prioritized over the years because of the impact it may have over the consolidated performance of the listed entity. The principle behind emphasizing absolute numbers of the net worth is the impact of the same on the consolidated figures. Any changes in the income/net worth of these material subsidiaries will be reflected proportionally on the listed entity since the net worth derived from the said material subsidiaries constitutes an integral part of the consolidated net worth of the listed entity. Accordingly, the listed entities should determine the materiality of its subsidiaries wisely and comply with the requirements of SEBI LODR as are applicable on the material subsidiaries.

Our other videos and write-ups may be accessed below:

YouTube:

https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Other write-up relating to corporate laws:

http://vinodkothari.com/category/corporate-laws/

Our article on similar topics –

^[1] Section 2 (87) of the Act

[2] https://www.sebi.gov.in/legal/regulations/may-2018/sebi-listing-obligations-and-disclosure-requirement-amendment-regulations-2018_38898.html

^[3] Section 2 (57) of the Act defines net worth as:

“Net worth” means aggregate value of the paid up share capital and all reserves created out of the profits and securities premium account, after deducting the aggregate value of the accumulated losses, deferred expenditure and miscellaneous expenditure not written off, as per the audited balance sheet, but does not include reserves created out of revaluation of assets, write-back of depreciation and amalgamation

SEBI eliminates one-to-one analyst meets from the purview of LODR

May 9, 2021/0 Comments/in Corporate Laws, LODR, SEBI /by Staff

-Recommendations of sub-group dropped under the LODR Amendment

By CS Aisha Begum Ansari, Assistant Manager, Vinod Kothari & Company

corplaw@vinodkothari.com

Background

Information symmetry is extremely important in a listed company since it helps in effective price discovery and builds the faith of the investors. Analyst and investor meets are one of the many ways used by the companies to disseminate information. The companies usually conduct analyst or investor meets after the disclosure of financial results to answer the questions relating to financial performance, future prospects, etc. based on generally available information without disclosing any unpublished price sensitive information (‘UPSI’). Such meets generally include conference calls or meeting with group of investors or group of analysts as per the prefixed schedule. Further, the same also includes one-to-one meet or calls with investors or analysts, which may either be prefixed or in the nature of walk-in.

While, SEBI mandates provisions under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) and SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’) to curb as well as regulate such leak of UPSI; one of the recent changes under the Listing Regulations vide SEBI Listing Regulations (Second Amendment) Regulations, 2021[1] (‘LODR Amendment’) issued on 7^th May, 2021 seems to have completely excluded one-to-one meet from the regulatory ambit prescribing disclosure requirements.

This article discusses the regulatory requirement in relation to investor meet, phases of amendment, present requirement and international practice.

Compliance requirements under SEBI Regulations

Erstwhile Listing Agreement

Clause 49 of the Listing Agreement[2] which specified the reporting requirements, obligated the companies to disclose on its website or intimate the stock exchange the presentations made by it to the analysts. Also, the companies were required to disclose in its Report on Corporate Governance, presentations made to institutional investors or the analysts as a means of communication to shareholders.

Listing Regulations (prior to amendment)

The Listing Regulations mandated listed entities to disclose the schedule of analyst or investor meets and presentations to such analysts or investors –

On the website of the listed entity [Regulation 46(2)(o) of Listing Regulations]
On the website of the stock exchange where its securities are listed (Clause 15 of Para A, Part A of Schedule III of Listing Regulations).
Means of communication in the form of presentations made to institutional investors or analyst in the annual corporate governance report. (Para C(8)(e) of Schedule V to Listing Regulations).

Erstwhile PIT Regulations (1992)

The 1992 regulations prescribed elaborate requirement in relation to analyst meets. Listed companies were required to follow the following guidelines while dealing with analysts and institutional investors:—

Only Public information to be provided – Listed companies were required to provide only public information to the analyst/research persons/large investors like institutions. Alternatively, the information given to the analyst were required to be simultaneously made public at the earliest.
Recording of discussion – In order to avoid misquoting or misrepresentation, it was suggested that at least two company representative to be present at meetings with analysts, brokers or institutional investors and discussion should preferably be recorded.

Handling of unanticipated questions – A listed company were required to be careful when dealing with analysts’ questions that raise issues outside the intended scope of discussion. It was suggested that unanticipated questions could be taken on notice and a considered response could be given later. If the answer included price sensitive information, a public announcement was required to be made before responding.
Simultaneous release of Information – When a company organized meetings with analysts, the company was required to make a press release or post relevant information on its website after every such meet. The company could also consider live webcasting of analyst meets.

PIT Regulations

PIT Regulations, presently, mandate listed entities to develop best practices to make transcripts or records of proceedings of meetings with analysts and other investor relations conferences on the official website to ensure official confirmation and documentation of disclosures made. Further, the listed entity needs to ensure that information shared with analysts and research personnel is not UPSI.

Discussion in working group/ committee reports

Report submitted by the Committee on Corporate Governance[3]

The Committee was of the view that the disclosure of schedules of analyst/ institutional investor meetings does not serve any practical purpose, and there have been instances of its misuse. Hence, the Committee recommended that the disclosure of schedules of analyst/institutional investor meetings may not be required. However, the information to be shared at such meetings has to be strictly in compliance with the SEBI PIT Regulations.

Report on disclosures pertaining to analyst/ investors meets[4]

The issue of information asymmetry between various classes of investors arising out of limited disclosures in respect of analyst meets/ institutional investors meet/ conference calls was discussed by Primary Markets Advisory Committee (PMAC) in the meeting in July, 2020. SEBI, based on the recommendation of PMAC, had formed sub-group which issued the ‘Report on disclosures pertaining to analyst meets, investor meets and conference calls’ (‘Report’) on November 20, 2020.

The Committee deliberated on best practice followed by listed entities in India, regulatory regime in developed countries and acknowledged the fact that existing regulations are not followed in letter and spirit by majority of listed companies thereby causing information asymmetry.

The Report explicitly distinguished between group analysts or investors meet and one-to-one in terms of the regulatory compliance. The Report recommended disclosure of transcripts and recordings of proceedings of group investors meet on the website of the company and to the stock exchange within a prescribed time frame whereas for one-to-one meetings, it recommended disclosing the number of such meetings in the quarterly compliance report on corporate governance along with a confirmation that no UPSI was shared with them.

The committee provided the rationale that the fundamental reason for analysts to seek meetings with the listed entity was to check their hypothesis that they have developed, based on controls and processes that have been built to comply with the public disclosures and complying with regulations relating to handling of private information and that premature public disclosure of these questions may lead to a regime of ‘’mandatory dissemination of proprietary information’’.

It is also important to note that the sub-group in its Report discussed that the content of the discussions for one-to-one meets, should not be intimated to the stock exchange due to following demerits:

Invasion of privacy of the institutional investors;
Allow third parties not a part of the meet to take speculative positions for trading decisions; and
Lead to overload of information to retain investors

Based on the sub-group’s discussion, the following recommendations were made:

Provide number of one-to-one meet as part of corporate governance report on a quarterly basis while submitting to the stock exchange;
The same needs to carry an affirmation that no UPSI was shared by any official of the company in such meetings; and
Company to maintain a record of all one-to-one meetings covering the name/names of the investor who were met, the name of the fund that he/ she represents, name of the brokerage firm which fixed the meeting (if any), the location, date and time of the meeting and a reference to the presentation made and preserve the same for a period of at least eight years.

Discussion in SEBI Board meeting of March 25, 2021[5]

The agenda provides details of recommendation made in relation to group analyst meet, however, does not provide any rationale/ discussion with respect to one-to-one meeting or reason for excluding the requirement from Listing Regulations altogether.

Anomaly in the LODR Amendment

Regulation 46(2)(o) and Clause 15(a) of Para A, Part A of Schedule III of Listing Regulations defines the term ‘meet’ as ‘group meetings or group conference calls’ for the purpose of disclosure of schedule of analyst/ investor meet and presentations made by the company to them.

Further, regulation 46(2)(oa) and Clause 15(b) of Para A, Part A of Schedule III provides for manner of disclosure of audio/ video recordings and transcripts of post earning calls or quarterly calls on the website of the company and to the stock exchange respectively. The said sub-clause has no reference of the term ‘meet’. The said provisions are reproduced below:

Regulation 46(2)(oa):

“(oa) Audio or video recordings and transcripts of post earnings/quarterly calls, by whatever name called, conducted physically or through digital means, simultaneously with submission to the recognized stock exchange(s), in the following manner:

the presentation and the audio/video recordings shall be promptly made available on the website and in any case, before the next trading day or within twenty-four hours from the conclusion of such calls, whichever is earlier;
the transcripts of such calls shall be made available on the website within five working days of the conclusion of such calls:

Provided that—

The information under sub-clause (i) shall be hosted on the website of the listed entity for a minimum period of five years and thereafter as per the archival policy of the listed entity, as disclosed on its website.
The information under sub-clause (ii) shall be hosted on the website of the listed entity and preserved in accordance with clause (a) of regulation 9.

The requirement for disclosure(s) of audio/video recordings and transcript shall be voluntary with effect from April 01, 2021 and mandatory with effect from April 01, 2022.”

Clause 15(b) of Para A, Part A of Schedule III

“(b) Audio or video recordings and transcripts of post earnings/quarterly calls, by whatever name called, conducted physically or through digital means, simultaneously with submission to the recognized stock exchange(s), in the following manner:

the presentation and the audio/video recordings shall be promptly made available on the website and in any case, before the next trading day or within twenty-four hours from the conclusion of such calls, whichever is earlier;
the transcripts of such calls shall be made available on the website within five working days of the conclusion of such calls:

The requirement for disclosure(s) of audio/video recordings and transcript shall be voluntary with effect from April 01, 2021 and mandatory with effect from April 01, 2022.”

Since, the term ‘meet’ is not mentioned in the above provisions, it leads to an interpretation that in case of post earning calls or quarterly calls, irrespective of the fact whether such meeting is with the group of investors or one-to-one meeting, audio/ video recordings and transcripts will be required to be submitted to the stock exchange.

Regulatory regime in other countries

1. United States of America

Regulation Fair Disclosure[6] (referred as ‘Regulation FD’) prohibits companies from selectively disclosing material non-public information (referred as ‘MNPI’) to analysts, institutional investors, and others without concurrently making widespread public disclosure.

Response to question 101.11 of the FAQs on Regulation FD[7] allows directors of the company to speak privately with a shareholder or group of shareholders by implementing policies and procedures to help avoid insider trading. Also, where a shareholder expressly agrees, through confidentiality agreement, to maintain confidentiality of MNPI, a private communication between the director and a shareholder does not violate Regulation FD norms.

2. Canada

Part V of the National Policy on Disclosure Standards[8] provides guidelines with respect to private briefings with analysts/ institutional investors. The Policy does not prohibit one-to-one discussions with analysts but identifies that the potential of selective disclosure of material non-public information is fraught with difficulties. It emphasizes on timely public disclosure of material information and entering into confidentiality agreements with the analysts.

3. United Kingdom

Market Abuse Regulation (“MAR”)[9] prevents selective disclosure of MNPI. MAR requires that the companies must not disclose MNPI selectively at the investor meetings. If they do, an immediate announcement would be required but it would still be a breach of the regulations.

4. Singapore

Rule 703(4) of the Singapore Exchange Listing Rules[10] requires the issuer to observe the Corporate Disclosure Policy as provided under Appendix 7.1. of Rule[11]. Para 23 under PART VIII of the Policy recommends the issuer to observe an “open door” policy in dealing with analysts, journalists, stockholders and others.

Issuer is required to abstain from disseminating material information which has not been disclosed to the public before. However, if such material information is inadvertently disclosed at meetings with analysts or others, it must be publicly disseminated as promptly as possible by the means described in Part VIII.

Conclusion

One-to-one meets carry a significant amount of risk with it for being a source / device for leak of UPSI especially where the same are not explicitly regulated. The intent behind recording and disclosing the same is to safeguard the company officials from any potential charge of breach of PIT Regulations. One will have to wait and watch if the relaxation results in any adverse implications. Further, SEBI will have to clarify on the ambiguity relating to disclosure requirements of one-to-one analysts meet w.e.f. post earning calls or quarterly calls if the intent is to restrict only to ‘meet’ as defined in the respective clauses.

[1] https://egazette.nic.in/WriteReadData/2021/226859.pdf

[2]https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/1293168356651.pdf#page=7&zoom=page-width,-16,792

[3] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/oct-2017/1509102194616.pdf#page=1&zoom=page-width,638,870

[4] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/nov-2020/1605853267317.pdf#page=1&zoom=page-width,-16,792

[5] https://www.sebi.gov.in/sebi_data/meetingfiles/apr-2021/1619067296590_1.pdf

[6] https://www.sec.gov/rules/final/33-7881.htm

[7] https://www.sec.gov/divisions/corpfin/guidance/regfd-interp.htm

[8] https://www.osc.ca/sites/default/files/pdfs/irps/pol_20020712_51-201.pdf

[9] https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R0596&from=EN

[10] http://rulebook.sgx.com/rulebook/703-0

[11] http://rulebook.sgx.com/rulebook/appendix-71-corporate-disclosure-policy

Our article titled SEBI proposes enhanced disclosures for meetings with analyst, investors, etc. can be accessed through following link:

SEBI proposes enhanced disclosures for meetings with analyst, investors, etc.

SEBI notifies substantial amendments in Listing Regulations

May 7, 2021/3 Comments/in LODR, SEBI /by Staff

Proposals approved in SEBI BM of March, 2021 made effective

Payal Agarwal | Executive ( corplaw@vinodkothari.com ) May 07, 2021

Introduction

SEBI, the capital market regulator of India, vide a gazette notification dated 06^th May, 2021 notified Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations, 2021 [“the Amendment Regulations”] that were approved in SEBI’s Board Meeting held on March 25, 2021. Most of the amendments were already rolled out earlier as consultation papers in 2020. The amendments become effective from May 06, 2021.

This article discusses the major amendments carried out and the likely impact and actionable for the listed entities.

Brief of the amendments are as follows –

A gist of all the amendments under the Amendment Regulations have been captured in a snippet.

1. Applicability of the Listing Regulations

In terms of Regulation 3 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2013 (‘Listing Regulations’) the provisions of Listing Regulations are applicable to entities that list the designated securities on the stock exchange.

The Amendment Regulations clarify that the applicability of certain provisions of Listing Regulations based on market capitalisation will continue to apply even where the entities fall below the prescribed threshold.

While the market capitalisation may be derived for any day, the recognised stock exchanges viz. BSE Limited and National Stock Exchange of India Limited releases a list of listed entities based on market capitalisation periodically. However, the provisions under Listing Regulations become applicable based on market capitalisation as at the end of the immediate previous financial year.

The present amendment on the continuation of applicability of provisions even after the listed entity ceasing to be among the top 500, 1000, 2000 listed entities, as the case may be, seems inappropriate. The applicability of these provisions were originally introduced in view of the size of the listed entities that held major market cap. Indefinite applicability of the said provisions despite fall in the market capitalisation of the listed entity is more of a compliance burden. The provision should be amended by SEBI in line with the timeframe provided under Reg. 15 i.e. where a listed entity does not fall under the list of top 100, 500, 1000, 2000 for three consecutive financial years, the compliance requirement should cease to apply.

Therefore, a conjoint reading of both the provisions should be allowed to take a liberal interpretation in respect of the newly-inserted Regulation 3(2) as well, thereby relaxation of compliance requirements on completion of a look-back period of 3 consecutive financial years.

2. Risk Management Committee

Regulation 21 of Listing Regulations requires the listed entities to constitute a Risk Management Committee (RMC). A comparative study of the erstwhile and the amended provisions w.r.t RMC is given below –

Topic	Erstwhile provisions	Amended provisions
Applicability of RMC	· On top 500 listed entities (Based on market capitalisation)	· On top 1000 listed entities based on market capitalisation
Composition	· Members of Board of Directors · Senior executives of listed entity · 2/3rds IDs in case of SR Equity Shares	· Minimum 3 members · Majority being members of board of directors · Atleast 1 Independent Director (ID) · 2/3rds IDs in case of SR Equity Shares
Minimum no. of meetings	One	Two
Quorum	Not specified	· 2 or 1/3rds of total members of RMC, whichever is higher · Including atleast 1 member of Board
Maximum gap between two meetings	Not specified	Not more than 180 days gap between two consecutive meetings
Roles and responsibilities	The board of directors were to define the role and responsibility and delegate monitoring and reviewing of the risk management plan and such other functions, including cyber security.	As provided under Part D of Schedule II, that inter alia includes: · Formulating of risk management policy; · Oversee implementation of the same; · Monitor and evaluate risks basis appropriate methodology, processes and systems. · Appointment, removal and terms of remuneration of CRO.
Power to seek Information	No such power. The same was only available with Audit Committee under Reg. 18 (2) (c).	RMC has powers to seek information from any employee, obtain outside legal or other professional advice and secure attendance of outsiders with relevant expertise, if it considers necessary.

The roles and responsibilities of the RMC has now been specified in the Regulations itself, which were once left at the discretion of Board. The formulation of Risk Management Policy has also been delegated to the RMC, with particular contents of the policy being specified under the Schedule.

An important role of the RMC, among others, include review of the appointment, removal and terms of remuneration of Chief Risk Officer (CRO). The appointment of CRO is not a mandatory requirement under Listing Regulations. CRO is required to be appointed for all banking companies, and non-banking financial companies (NBFCs) having asset size of Rs. 50 billions or more, being registered as an Investment and Credit company, Infrastructure Finance Companies, Micro Finance Institutions, Factors, or Infrastructure Debt Funds. Further, the Insurance Regulatory and Development Authority of India (IRDAI) Corporate Governance Guidelines requires the insurance companies to appoint CRO.

The role of RMC further provides for co-ordination with other committees where the roles overlap. It is seen that the risk management function is also laid upon the Audit Committee. Therefore, the roles of both the committees might be overlapping. In view of the same, some companies choose to constitute one joint committee combining the roles of both Audit Committee and RMC. From the provisions providing for co-ordination of activities, it may also be taken as a clear indication that the committees cannot be merged into one, but co-ordinate where the activities require so.

Actionables –

Changes in the constitution of RMC / Constitution of RMC in case of first-time applicability;
Modification of the Risk Management Policy as per the Amendment Regulations;
Amending the existing charter of the Committee to align with the amendments.

While the Amendment Regulations are effective immediately, the changes cannot take place overnight. Therefore, it is advisable that the listed entities shall take the matter of constitution/ re-constitution of RMC in the ensuing Board Meeting. The modification of Risk Management Policy will be then taken up by the RMC and can be done within a reasonable period of time.

What should be this period? A probable answer to this should lie in the proviso to clause (a) of Reg. 15 that permits a timeline of six months from the applicability to comply with corporate governance requirements as stipulated under regulations 17 to 27, clauses (b) to (i) and (t) of sub-regulation (2) of regulation 46 and para C, D and E of Schedule V. However, that is applicable only in case of companies covered in Reg. 15 (2) (a). Therefore, the time available is till June 30, 2021 as thereafter, the companies will be required to confirm on RMC composition in the quarterly filings done under Reg. 27.

3. Overriding powers of LODR Regulations

Earlier, proviso to Regulation 15(2)(b) provided a clear stipulation of overriding effect of specific statute in case of conflicting provisions. The Amendment Regulations provides for deletion of the said proviso effective from September 1, 2021. No rationale seems to have been provided in the agenda[1] put up before SEBI at the board meeting for this major amendment.

Regulators viz. RBI, IRDA, PFRDA at times have specific corporate governance related compliances that are stricter and at times conflicting with the requirements of Listing Regulations. For eg. With respect to composition of Audit Committee for a public sector bank, RBI Circular of September, 1995 provides for following composition in case of public sector banks: (a) Executive Director of the Bank (Wholetime director in case of SBI) (b) two official directors (i.e. nominees of Government and RBI) and (c) Two non-official, non-executive directors (at least one of them should be a Chartered Accountant). Directors from staff will not be included in ACB. This is certainly conflicting with the composition provided in Reg. 18 of Listing Regulations.

Subsequent to September 1, 2021 these entities will be regarded as non-compliant of the provisions of Listing Regulations and may be subject to penalty in terms of SEBI Circular dated January, 2020.

4. Reclassification of promoters into public – related exemptions and procedural changes

Regulation 31A of the LODR Regulations specifies the conditions and approvals post which the promoters can be re-classified into public shareholders. SEBI had proposed changes to the same in a consultation paper dated 23^rd November, 2020. The consultation paper was critically analysed in our article. Amendments have been made on similar lines in Regulation 31A.

5. Alignment with the provisions of the Companies Act, 2013

Certain amendments have been made to remove the gap between the provisions of LODR Regulations, with that of the Companies Act, 2013 as given below –

Separate meeting of independent directors – The requirement of conducting a separate meeting of the independent directors without the presence of any other member of the Board of the company is required under both the Companies Act, 2013 as well as the LODR Regulations. However, whereas the Companies Act requires one meeting in a financial year, the LODR Regulations required one meeting in a year (calendar year). Therefore, the same has been substituted with a “financial year” so as to align the requirements of both the governing laws.
Display of Annual Return on website – Section 92 read with allied rules requires the companies, having a website, to display its Annual Return on the website. New clause has been inserted under Regulation 46 of LODR Regulations that requires placing the Annual Return on the website of the company.
Changes in requirements pertaining to placing of financial statements on website – The audited financial statements of each of the subsidiaries was required to be placed on the website prior to the Amendment Regulations. New provisos has been inserted under the same so as to avoid preparation of separate financial statements of the subsidiary company, where the requirements under the Companies Act, 2013 are met if the consolidated financial statements are placed instead of separate ones.

6. Mandatory website disclosures

Regulation 46 of the LODR Regulations provides the mandatory contents to be placed on the website of a listed entity. Most of the disclosures were already existing under respective regulations viz. Reg 30, 43A etc. However, the same has been consolidated under regulation 46. This will now enable stock exchanges to levy penalty in terms of SEBI circular dated 22^nd January, 2020.

7. Analyst meet

The listed entity is required to disclose the schedule of analyst or institutional investor meet and the presentations made to them on its website under regulation 46 and on the website of the stock exchange under Schedule III. The Amendment Regulations have explained the term ‘meet’ to mean the group meetings and calls, whether digitally or by physical means. The Amendment Regulations will require the listed entity to upload the audio/ video recordings and the transcripts within the prescribed timeframe. The same is in line with SEBI’s Report on disclosures pertaining to analyst meets, investor meets and conference calls. However, the amendment does not cover disclosure of one-to-one investor/ analyst meet conducted with select investors recommended in the said Report.

8. Consolidation of various SEBI circulars

Certain circulars of SEBI lay down various requirements to be complied with in relation to the LODR Regulations. The Amendment Regulations have consolidated the requirements under the principal LODR Regulations.

Requirement of Secretarial Compliance Report – While the requirement of Annual Secretarial Compliance report were applicable on the listed entities and its material subsidiaries since a few years back, the same has now been specifically provided under newly inserted sub-regulation (2) of Regulation 24A. Earlier, the practice came pursuant to a SEBI circular.
Timeline for report of monitoring agency regarding deviation in use of proceeds – Pursuant to the requirements of Regulation 32 of the LODR Regulations, the monitoring agency is required to give a report on the utilisation of proceeds of issue on a quarterly basis. While timelines were not specified in the LODR Regulations, the report was required to be given within 45 days from the end of the quarter. This timeline was pursuant to the SEBI circular dated 24^th December, 2019 . Now, with the Amendment regulations, the same is specified under regulation 32(6) of the LODR Regulations.
Requirement of Business responsibility and sustainability report (BRSR)- SEBI had proposed a new format to replace the existing Business Responsibility Report. The proposal was finalised and the BRSR format has been made mandatorily applicable from FY 2022-23 onwards, vide SEBI circular dated April, 2021 . The same has also been consolidated under Regulation 34 of the LODR Regulations. A detailed discussion on BRSR is covered in our article.

Conclusion

The Amendment Regulations are very crucial and significant in nature. While on one hand, certain provisions are aligned with the Companies Act, 2013, whereas on the other hand, overriding powers have been given to LODR Regulations which will require the listed entities formed under special statute to comply with the LODR Regulations in entirety. Uniformity in timelines and relaxation in certain disclosure requirements will encourage ease of doing business, and the coverage of certain provisions extended to listed entities based on market capitalisation will have a remarkable impact on the corporate governance of listed entities.

[1] https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/meetingfiles/apr-2021/1619067328922_1.pdf#page=18&zoom=page-width,-17,763

Our other materials on the relevant topic can be read here –

SEBI (LODR) (Second Amendment) Regulations, 2021

May 7, 2021/0 Comments/in Corporate Laws, LODR, SEBI /by Staff

Revised Regulatory Framework for IDs of listed entities in India

March 3, 2021/0 Comments/in Corporate Laws, LODR, SEBI /by Vinod Kothari Consultants

-Independence becomes stricter!

Payal Agarwal, Executive ( payal@vinodkothari.com )

Updated on 6th August, 2021

Introduction

The concept of independent directors was first introduced in the Desirable Corporate Governance Code issued by the Confederation of Indian Industry[1] followed by the recommendation in the Corporate Governance Committee constituted by SEBI and headed by Mr. Kumar Mangalam Birla[2] (Kumar Mangalam Birla Committee). Later in the year 2000, SEBI incorporated the recommendations of the Kumar Mangalam Birla Committee under Clause 49 of the Listing Agreement[3]. Independent directors have always been regarded as the means to strengthen the corporate governance framework in a public or a listed company.

Keeping in mind the intent of the lawmakers to introduce the requirement for having Independent Directors (IDs) on the board of certain companies, it is understood that SEBI cannot accept a situation where the IDs themselves turnout to either be ineffective for strengthening the corporate governance or act against the interest of the public shareholders. Therefore, with the intent to further strengthen the role and responsibility of IDs, SEBI had introduced a Consultation Paper[4] (Paper) on review of regulatory provisions related to IDs on 2^nd of March, 2021. Through this Paper, SEBI had proposed to make stringent regulatory changes in the provisions of the Listing Obligation and Disclosure Requirements Regulations (LODR/ Listing Regulations) relating to

eligibility criteria of IDs,
role of Nomination and Remuneration Committee (NRC),
composition of Audit Committee (AC) and Nomination and Remuneration Committee (NRC)
appointment and removal procedure of IDs

Further, SEBI, in its Board Meeting held in July, 2021 discussed to review the regulatory framework applicable on IDs and incorporate amendments in the Listing Regulations based on public comments and discussions w.e.f. 1^st January, 2022. However, the changes in the regulatory framework as notified on 3^rd August, 2021 vide SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2021 [the Amendment Regulations],was initially notified to be applicable with immediate effect whose applicability has now been deferred to the date as originally decided in the Board Meeting of SEBI, i.e., 1^st January, 2021 .

A brief snippet on the changes can be accessed here.

This write up critically covers the changes in the regulatory framework for IDs pursuant to the Amendment Regulations and discusses the potential impact of the same on the working of a company including the corporate governance aspects. The amendments are discussed below under the relevant heads.

1.Widening the criteria for independence

Regulation 16(1) of the Listing Regulations provides the definition of “independent director”. SEBI seeks to broaden the criteria of “independence” by expanding the outreach of the restrictions given under the said Regulation and at the same time standardising the cooling off period provided therein.

Amendments in line with the Paper

The Paper proposed two amendments in the independence criteria of IDs in addition to the extant definition which have been made applicable with the notification of the Amendment Regulations:

KMPs and employees of companies falling under the promoter group of the listed entity & relatives of such KMPs should not be eligible to act as an ID until a cooling off period of 3 years has passed.

This is in addition to the existing fetter on the KMP and employee of the listed entity, its holding, subsidiary or associate company.

Another amendment is with regard to increasing of the cooling-off period in Regulation 16(1)(iv) and Reg 16(1)(v) of the Listing Regulations.

Currently, the Regulations specify a cooling-off period of 2 years in case of material pecuniary transaction between a person or his relative and the listed entity or its holding, subsidiary or associate company. This has been increased to 3 years to make it similar to the other provisions of Regulation 16 where a cooling-off period of 3 years is required to be satisfied.

Amendments not proposed in the Paper

Certain amendments not proposed in the Paper but brought by means of the Amendment Regulations are given below:

The criteria under Regulation 16(b)(v) earlier provided only for the pecuniary relationship of the relatives of proposed ID with the company. This has been amended in line with Section 149(6)(d) of the Companies Act, 2013.
Further, a proviso has been inserted after Regulation 16(b)(vi)(A) providing a relief to the proposed ID appointment when the relative of such proposed appointee is a mere employee and not KMP.

Rationale behind the Amendment Regulations:

This amendment aims to make the independence criteria more broader and stricter so that there is no way by which the candidates influenced by promoter group entities can take undue benefit due to any loopholes in the language of law.

On the other hand, the amendment increasing the cooling off period is for making the same uniform all through the independence criteria.

Further, it has to be noted that the amendments are in harmonisation with the provisions of the Companies Act, 2013, as also contemplated in the Board meeting of SEBI and does not bring in any drastic changes in the existing requirements apart from looping in promoter related entities as well.

Actionable arising pursuant to the Amendments

Revised declaration to be obtained so as to ensure compliance with meeting the revised independence criteria as soon as possible.

2.Process for appointment/ re-appointment and removal of independent directors

The Paper proposed to bring a major change in the procedure of appointment/ re-appointment as well as removal of IDs by means of “dual approval”. However, the said proposal has not been brought under the current Amendment Regulations. The changes have been brought to have the following impact:

Matter	Requirements under extant provisions	Proposal under Paper	Provisions as per Amendment Regulations
Appointment/ Removal of IDs	Ordinary Resolution	§ Dual approval (Special Resolution in case the proposal fails) § Prior approval of Shareholders	§ Special Resolution § Shareholder’s approval required within earlier of – § Next general meeting § 3 months from appointment of a person on board
Re-appointment of IDs	Special Resolution	Dual approval (Special Resolution in case the proposal fails)	Special Resolution (no change from the existing provisions)
Filling of vacancy of IDs	Later of the following – § Next board meeting § 3 months from vacancy	Within 3 months from vacancy	Within 3 months from vacancy

Further, in case of appointment of any other director in board, whether executive, non-executive, additional director, director appointed due to casual vacancy etc , every such appointment has to be regularised by the shareholders within a maximum period of 3 months from such an appointment.

Rationale for such Amendments

Requirement of passing a special resolution

While SEBI had, in its Paper, proposed the “dual approval” model in line with the legislative requirements of Israel and UK, especially in interest of the minority shareholders, the Board disclosed that majority of comments were against such proposal due to practical difficulties in implementation of the same, citing causes such as delay in appointment due to an unintended deadlock, voting skews in case of minority public shareholders having significant shareholding etc. Due to such practical difficulties, a balanced approach has been chosen to require a special resolution for all cases related to appointment, re-appointment as well as removal.

Time gap available to regularise the appointment by the shareholders

Similarly, as regards the proposed prior approval before appointment, the majority of comments dissented against the proposal citing reasons of additional compliance burden on companies, giving a midway suggesting that while the prior approval should not be mandated, a timeline should be provided within which the appointment should be approved by the shareholders.

Actionable pursuant to the Amendments

After the Amendment Regulations come into force, it would be necessary to regularise the appointment of all directors appointed in additional capacity within 3 months of the board meeting in which they were appointed by way of shareholders’ approval. Considering the fact that the amendments have been notified well in advance, the companies will not be able to excuse themselves for some further time after the amendments come into effect.

The amendments can be explained with the help of following examples –

1.A director has been appointed in additional capacity on 10^th December, 2021. His appointment will have to be approved by shareholders within 3 months, i.e., 10^th March, 2022.

2. A director has been appointed as additional director on 20^th August, 2021 in the board of a company. The period of 3 months ends on 20^th November, 2021. However, since the amendments are effective from 1^st January, 2022, he may continue as an additional director in the board of the company till 31^st December, 2021. However, if his appointment is not been approved by the shareholders within such period of time, he’ll have to resign from his position. The proposal of his appointment will have to be re-considered afresh by the NRC and board of the company, followed by a shareholders approval within 3 months.

3.Resignation of IDs

Through the Paper, it became clear that the intention of SEBI is to strictly monitor the resignation of the IDs where the real cause of resignation should be clearly known in place of the apparent cause the company and ID may try to show.

The Paper provided for a cooling off period of 1 year in two cases:

Where the ID resigns on account of discretionary reasons of pre-occupation, other commitments or personal reasons – Mandatory cooling period of 1 year before joining another Board as an ID;

Similar cooling period of 1 year in case of transition from ID to WTD in the same company.

Further, the Paper also proposed that the complete resignation letter of the outgoing ID needs to be disclosed to the stock exchange. The same has been made effective vide the Amendment Regulations.

While the proposal of cooling-off period in case of transition of an ID as a whole-time director in the same company has been implemented by means of insertion of sub-regulation (11) in existing Regulation 25, the requirement of such cooling-off period has been further extended to the joining of such person as a whole-time or executive director in the holding, subsidiary, associate or other group companies belonging to the same promoter(s) as well.

The first proposal with regard to the cooling-off period in case of resignation due to personal / discretionary reasons has not been brought into force on account of comments received from public raising concerns over showing ingenious reasons in resignation letter to avoid falling into the cooling-off requirements, or compelled to work in pressurizing circumstances.

Rationale for such Amendments

The cooling off period of 1 year before transition of an ID as a WTD in the same company has been proposed to ensure there is no compromise in the independence of the director during his term as an ID.

It is observed that IDs often resign for reasons such as pre-occupation, other commitments or personal reasons and then join the boards of other companies. There is, therefore, a need to further strengthen the disclosures around resignation of Independent Directors. However, considering the comments received from majority of public, such a proposal has not been implemented.

4. Role of NRC in selection of candidates for the role of ID

The NRC is required to recommend the persons to be appointed as IDs in the board of the company. Though the Listing Regulations already requires the NRC to formulate criteria regarding such appointment, the role of NRC, in practice, does not suffice the intent of law properly.

Therefore, vide the Amendment Regulations, SEBI has brought amendment to Para A of Part D of Schedule II of the Listing Regulations thereby specifying the following procedure for selection of candidates for the role of NRC. The procedure is in line with the proposal laid down in the Paper.

Evaluate the balance of skills, knowledge and experience
On the basis of above evaluation, prepare description of required roles and capabilities required for that particular appointment of ID
Identify the suitable candidate fitting the said description
For identifying persons, NRC may
- use services of external agencies
- May consider candidates from wide variety of backgrounds ( for diversity)
- And consider time commitment of appointees
The person identified and recommend to the Board should possess capabilities as per description.

Rationale for such Amendment

While the law requires NRC to lay down detailed criteria of qualifications and attributes for directors, apparently there is a lack of transparency in the process followed by NRC. There is therefore, a need to prescribe disclosures regarding the process followed by NRC for selection of candidates for the post of ID.

Actionable pursuant to the Amendments

Any ID appointed on the board of a listed company after the Amendment Regulations come into effect, shall be appointed after following the due procedure as provided in the Amendment Regulations. This implies that even where the meeting of NRC for recommendation of appointment of a person as an ID is held before the Amendment Regulations coming into force, due process will be required to be followed. This is also required to ensure that the additional disclosures required to be made in the notice of general meeting for appointing IDs are available with the company (discussed in later parts of the article).

5.Modification in composition of NRC and AC

The Paper also sought to bring in some changes in the constitution of NRC and AC. The following changes were proposed –

NRC to comprise of 2/3rds of ID (earlier atleast one-half IDs required)
AC to comprise of 2/3rds of IDs and 1/3rds of Non-executive directors(NED) that are not related to promoter (presently, the AC requires atleast 3 members of which atleast 2/3rds shall be IDs)

The proposals have been implemented partially. While the changes in composition of NRC as proposed in the Paper has been made effective vide the Amendment Regulations, the changes in composition of AC has been rejected on account of decreasing flexibility of the companies.

Approval of Related Party Transaction by AC

Rather, an important amendment has been made to balance out between the flexibility of the companies on one end and the efficiency of the AC on another. Post amendment, all related party transactions of the companies are required to be approved by only the IDs of the Audit Committee. The executive directors, who are a part of the AC, are not allowed to approve such transactions, however, restriction is not with respect to voting and it is understood that they may accord their dissent to a proposed related party transaction. However, practically, there may be rarely any instance, where the related party transaction, otherwise approved by the independent directors of an AC, has been dissented to by other members of the AC. Further, it shall apply to all the prospective related party transactions, and shall not affect the related party transactions which have already been approved prior to the amendments including the ones under omnibus approval.

A new proviso under Regulation 23(2) has been inserted as follows –

“Provided that only those members of the audit committee, who are independent directors, shall approve related party transactions.”

Rationale for such Amendment

Considering the importance of the Audit Committee with regard to related party transactions and financial matters, it was proposed that AC shall comprise of 2/3rd IDs and 1/3rd Non-Executive Directors (NEDs) who are not related to the promoter, including nominee directors, if any. However, the comments received from the public stakeholders have highlighted the risk of losing flexibility by the companies in case of such rigid composition. Therefore, in view of the same, while the composition of the AC has been kept intact, the requirement of only IDs approving the related party transactions have been made effective. The same serves as a balanced approach ensuring both flexibility of companies and efficiency of Audit Committee.

6.Enhanced disclosure requirements

The Amendment Regulations provide for some additional disclosure requirements in line with the amendments as follows:

At the time of appointment –

Details of companies from which the listed entities have resigned in the previous three years
Skills and capabilities required for the role
Manner in which the proposed appointee meets such requirements

At the time of resignation –

Complete letter of resignation
Names of listed entities in which the resigning director holds directorships, indicating the category of directorship and membership of board committees, if any

Actionable pursuant to the Amendments

In the light of the amendments, additional details shall be required to be made available to the shareholders for appointment of independent directors.

Similarly, in case of resignation, the letter of resignation and details of continuing directorship shall be made filed with the stock exchanges by the listed entity as received from the resigning ID.

7. Requirement of D&O Insurance

	Earlier requirement	Requirement post amendment
Applicable to	Top 500 listed entities	Top 1000 listed entities
With effect from	1^st October, 2018	1^st January, 2022

Conclusion

The changes brought vide the Amendment Regulations are extremely significant and will have a remarkable impact on the corporate governance of listed entities. More transparency may be achieved by means of these amendments like enhanced disclosure on resignation, appointment, selection of candidates as IDs, etc. of all, the amendments seek to check the interference of promoters at all levels of corporate governance and ensures much more independence to the IDs where the IDs will be independent in both letter and spirit. In areas where the proposals under the Paper seemed to be more rigid, the Amendment Regulations have allowed the companies to take breath in line with the comments received from the public shareholders. However, some amendments required immediate actionable, and especially, at this point of time, when most of the companies are having their AGMs, which was creating a hassle for the listed companies. However, SEBI has come up with a clarification deferring the applicability of the Amendment Regulations. Further, a proposal with respect to remuneration of IDs allowing stock-options to them has been dropped, atleast for the time being in the said Amendment Regulations.

[1] http://www.nfcg.in/UserFiles/ciicode.pdf

[2] http://www.nfcg.in/UserFiles/kumarmbirla1999.pdf

[3] https://www.sebi.gov.in/legal/circulars/feb-2000/corporate-governance_17930.html

[4] https://www.sebi.gov.in/reports-and-statistics/reports/mar-2021/consultation-paper-on-review-of-regulatory-provisions-related-to-independent-directors_49336.html

Our other articles on related topic can be accessed here –

Introduction

Independent Directors – Evolution in India

Who is an Independent Director – The Indian Viewpoint

Tenure and re-appointment of IDs

Cooling-off Period for appointment/reappointment of IDs

Conclusion

Brief Background

Post amendment in Listing Regulations

Regulatory requirements in case of one-to-one meet

Whether sharing of UPSI is allowed in a group meet or one-to-one meet?

Guidance Note of Analyst/ Institutional investors’ meet

Disclosure requirements w.r.t. Analyst meets

Best practices that may be adopted by companies

Disclosure of schedule of meet/ call

Disclosure of transcripts of the meet/ call

Do’s and Don’ts to be ensured by the companies

Conclusion

Background

Background

Scope and time of applicability

Financial Permutations covered

Critical Aspects

Actionable on the part of the listed entity

Entities controlled by Promoters/ PG

Ambit for covering directors and controlled entities for the purpose of disclosure

Nature of book debt covered

Meaning of direct and indirect financial accommodation

Difference between LoC and co-borrowing arrangement

Affirmation for being in economic interest of listed company

Comparison between section 185 of the Companies Act, 2013 and Annexure IV

Exclusions

Concluding remarks

The Concept of ‘Material Subsidiary’

Special Situation in case of Regulation 24 (1)

Obligation of the Listed Entity with respect to its Material Subsidiary(ies)

Role of Policy on determining Materiality of Subsidiary

Can a section 8 company be treated as ‘Material Subsidiary’?

Concluding Remarks

Background

Compliance requirements under SEBI Regulations

Discussion in working group/ committee reports

Discussion in SEBI Board meeting of March 25, 2021[5]

Anomaly in the LODR Amendment

Regulatory regime in other countries

Conclusion

Introduction

1. Applicability of the Listing Regulations

2. Risk Management Committee

Actionables –

3. Overriding powers of LODR Regulations

4. Reclassification of promoters into public – related exemptions and procedural changes

5. Alignment with the provisions of the Companies Act, 2013

6. Mandatory website disclosures

7. Analyst meet

8. Consolidation of various SEBI circulars

Conclusion

Introduction

1.Widening the criteria for independence

Amendments in line with the Paper

Amendments not proposed in the Paper

Rationale behind the Amendment Regulations:

Actionable arising pursuant to the Amendments

2.Process for appointment/ re-appointment and removal of independent directors

Rationale for such Amendments

Actionable pursuant to the Amendments

3.Resignation of IDs

Rationale for such Amendments

4. Role of NRC in selection of candidates for the role of ID

Rationale for such Amendment

Actionable pursuant to the Amendments

5.Modification in composition of NRC and AC

Approval of Related Party Transaction by AC

Rationale for such Amendment

6.Enhanced disclosure requirements

Actionable pursuant to the Amendments

7. Requirement of D&O Insurance

Conclusion

Subscribe to receive regular updates!