Shareholder scrutiny for payout under Listing Regulations to directors

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– Understanding the capping rationale

Pammy Jaiswal | Partner

Shaifali Sharma | Assistant Manager

Vinod Kothari and Company; corplaw@vinodkothari.com

Background

The remuneration payable to the directors of a public company is regulated by the provisions of Section 197 read with Schedule V of the Companies Act, 2013 (Act). It provides a ceiling on the maximum remuneration that can be paid to the directors both in aggregate as well categorically, including Whole-time Director, Managing Director and the Manager.

Any payment to such directors within the said limits has to be approved by the shareholders by way of an ordinary resolution. Payment of remuneration in excess of the limits requires approval of the shareholders by way of a special resolution.

There were no specific provisions prescribed under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (‘Listing Regulations’) on maximum remuneration payable to directors of listed entities until SEBI, on the basis of recommendation of Kotak Committee on Corporate Governance, amended the Listing Regulations to put a ceiling on remuneration payable to executive promoter directors and non-executive directors.

This article tries to critically analyze the intent and deduce the interpretation of the aforesaid capping under the Listing Regulations.

Absolute versus relative limits- reading between the lines

Regulation 17 (6) (e) of the Listing Regulations reads as under:

“The fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if-

(i) the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or

(ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:

Provided that the approval of the shareholders under this provision shall be valid only till the expiry of the term of such director.

Explanation: For the purposes of this clause, net profits shall be calculated as per section 198 of the Companies Act, 2013.

On the very first reading of Regulation 17 (6) (e), we understand that in case the listed company has one executive promoter director, it can pay upto 2.5% of the net profits or INR 5 crore, whichever is higher, without passing a special resolution.

In case of more than one such director in the company, the relative limit of 2.5% is doubled to 5% of the net profits, however, the absolute limit of INR 5 crore has not been mentioned under sub-clause (ii) of the said sub-regulation.

This makes it all the more important for us to read between the lines and interpret the meaning as intended by the law-makers. As mentioned, the first sub-clause provides both a relative and an absolute limit for the purpose of securing shareholder scrutiny. In fact, the said clause clearly mentions that higher of the relative or absolute limit has to be considered while determining the need to approach the shareholders.

Accordingly, it may seem to be an incorrect reading if companies consider only the relative limit for the second sub-clause. In such a scenario, companies may end up considering a far lower limit than INR 5 crores which the law makers have already fixed for one promoter executive director in the first sub clause.

Approval requirements under the Act viz-a-viz requirements under Listing Regulations

 

A. Payment of remuneration to executive promoter directors of a listed public company

As per the Report[1] of the Kotak Committee constituted by SEBI, several cases of disproportionate payments made to executive promoter directors as compared to other executive directors were noted and therefore, the Committee with the view to improve the standards on Corporate Governance, suggested that this issue should be subjected to greater shareholder scrutiny. Accordingly, the amendment carved a parallel way for obtaining shareholder’s approval if the total remuneration paid to executive promoter director exceeds the prescribed limits.

The above recommendation has already come into effect from April 01, 2019 and therefore the listed entities, in addition to the threshold limits prescribed u/s 197 of the Act, have to adhere to the ceiling laid down u/r 17(6)(e) of the Listing Regulations.

Below is the comparison of the threshold limits prescribed under Act and Listing Regulations for payment of remuneration to executive promoter director, in excess of which shareholders’ approval by special resolution shall be required:

Special Resolution required if: Under the Companies Act, 2013 Under SEBI Listing Regulations
Remuneration payable to a single executive director* Exceeds 5% of the net profits of the company Exceeds Rs. 5 crore (absolute limit) or 2.5% of the net profit (relative limit), whichever is higher
Remuneration payable to all executive director* Exceeds 10% of the net profits of the company Exceeds 5% of the net profits of the company

* Listing Regulations caps the limit for executive directors who are promoters or members of promoter group

From above, it is evident that the Act allows public listed companies to pay remuneration to its executive directors upto 5% or 10% of its net profits, as the case may be, (without passing special resolution) which is double the relative thresholds prescribed under Listing Regulations i.e. 2.5% or 5% of the net profits.

Illustrations:

Illustration 1 –Payment within the limits laid down under the Act and also Listing Regulations

Type of shareholder approval required – Ordinary resolution under the Act

Illustration 2-Payment exceeds Listing Regulations limits but is within limits of the Act

Let us take a numerical example for this case:

Situation Permissible remuneration to a single executive promoter director Permissible aggregate remuneration to more than 1 executive promoter directors
Act LISTING REGULATIONS Act LISTING REGULATIONS
Company has profits of 10 crore

 

 ·    5% of NP

 

 

 

 

0.5 crore

 Higher of

·    2.5% of NP; or

·    5 crore

 

5 crores

 ·    10% of NP

 

 

 

 

1 crore

 ·    5% of NP

 

 

 

 

0.5 crore

 
Remarks:

In case of single executive promoter director: 

  • Permissible remuneration under Listing Regulations  (5 crore) is much higher than amount (0.5 crores) under the Act. In such cases, there is a clear cut conflict between the two legislations. On one hand where Listing Regulations  allows payment upto INR 5 crores to one such director (which in this case constitutes 50% of the NP), the company in question will be required to pass SR under the Act.
  • Accordingly, providing for a higher payout amongst the relative and absolute limit, in the first sub-clause does not seem to achieve the intent of SEBI to increase the Corporate Governance standards by scrutinizing disproportionate payments to this category.

In case of more than 1 executive promoter director:

  • As soon as we move to second situation, the amount available for payment of remuneration stands reduced drastically. The permissible remuneration under Listing Regulations will be INR 0.5 crore whereas, the Act allows payment upto INR 1 crore.

Illustration 3 – Payment exceeds the limits under the Act and automatically exceeds the limits under Listing Regulations (not considering the absolute limit)

Here the case is simple, SR is required to be passed.

Illustration 4 – Company has inadequate profits for the purpose of section 197 read with Schedule V of the Act

In case the minimum remuneration approved falls within the limits provided against the effective capital – OR is sufficient, however, for the purpose of Listing Regulations, SR will be required. In this case, Listing Regulations are stricter as it does not envisage inadequacy of profits and amounts that can be paid in case inadequacy.

However, if the minimum remuneration approved exceeds the limits provided against the effective capital, SR is required under the Act and such payment can be made only for three financial years with certain other disclosure requirements.

Having said that, it is important to note that once SR under the Act has been passed for payment of remuneration either in cases of adequate or inadequateprofits, there does not seem to be any need to pass another SR under Listing Regulations  for breach of the limits set therein.

 

B. Payment of remuneration to non-executive directors of a listed public company

The Kotak Committee on corporate governance further observed that certain non-executive directors (NEDs) (generally promoter directors) are receiving disproportionate remuneration from the total pool available for all other NEDs and recommended that if remuneration of a single NED exceeds 50% of the pool being distributed to the NEDs as a whole, shareholder approval should be required.

SEBI, in line with the above proposal and the requirement for special resolution for executive promoter directors, amended Listing Regulations and inserted following clause (ca) to Regulation 17(6):

“The approval of shareholders by special resolution shall be obtained every year, in which the annual remuneration payable to a single non-executive director exceeds fifty per cent of the total annual remuneration payable to all non-executive directors, giving details of the remuneration thereof”

The above amendment has also come into effect from April 01, 2019 and therefore, requires an action on the part of the listed entities to pass SR for such disproportionate payment to any one of its NED.

Some companies have already passed an SR in the AGM held for the financial year 2018-19 while other companies are preparing to pass the same in this year. The reason behind such two school of thoughts is based on the following reasons:

  1. Remuneration to a single NED for the FY 2018-19, which is basically profit linked commission, has been paid after 1st April, 2019. Some companies which have already taken the SR in the AGM held for the FY 2018-2019 have done so considering the payment being done post the advent of the aforesaid amendment.
  2. Remuneration to a single NED for the FY 2019- 2020 will be taken to the shareholders if it exceeds the limits. Here the companies which did not approach its shareholders in the AGM held for the FY 2018-2019 is based on the understanding that this amendment has come into force from 1st April, 2019 which means the same is to be complied with for the remuneration payable for FY 2019-2020. Therefore, according to the second school of thought, no SR is required for the disproportionate payment made in FY 2019-2020 for the FY 2018-2019[2].

Concluding Remarks

While the amendment of capping the limits for payout to executive promoter directors does not seem to meet the intent of the law makers, the amendment for passing SR for disproportionate payout to a single NED seems to be much more justified.

It was rightly mentioned in the Kotak Committee report that in future SEBI could review the status of the amendment relating to payout to executive promoter directors based on experience gained. As per the discussions above, it is imperative to draw attention firstly to the absence of the absolute limits in the second sub-clause of this sub-Regulation and even though the same is read with by inserting the same, it may seem to be futile for sole reason of SRs already passed by the companies under the Act. Further, clarity is needed for requirement to seek approval for payment of minimum remuneration in case of inadequacy of profits.

Since, MCA had already prescribed the limits and procedures under the Act for managerial remuneration, SEBI may relook at the capping scrutinylaid down for executive promoter directors and possible could align the same with the provisions of the Act. The intent is not to simply seek special resolution for every item of managerial remuneration as abundant caution.

Other reading materials on the similar topic:

  1. ‘FAQs on SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2018’ can be viewed here
  2. Presentation on ‘Appointment & Remuneration of Managerial Personnel & KMPs’ can be viewed here
  3. ‘Managerial Remuneration: A five decades old control cedes’ can be viewed here
  4. ‘Remunerating NEDs and IDs in low-profit or no-profit years’ can be viewed here
  5. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkotahri.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

 

[1]https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

[2]Read our related article on the topic, here

SEBI prescribes norms for structured digital database, system driven disclosures & CoC violations

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CS Vinita Nair, Senior Partner | Vinod Kothari & Company

July 23, 2020

Link to gazette notification: http://egazette.nic.in/WriteReadData/2020/220574.pdf

Effective date: July 17, 2020

Background

SEBI in the Board meeting held on June 25, 2020 (‘SEBI BM’) discussed amendments in PIT Regulations on Structured Digital Database, continual disclosures and amendments in the Code of Conduct (CoC).

This article discusses the position prior to amendment, relevant discussion at SEBI BM and actionable post amendment.

Structured Digital Database (SDD-1)

Prior to the amendment

Reg 3(5) of the regulations provided maintenance of SDD-1 with names of persons with whom UPSI was shared and PAN/ any other identifier of the person (where PAN was not available). SDD was required to be maintained with adequate internal controls and checks such as time stamping and audit trails to ensure non-tampering of the database.

The regulation indicated that just the listed entity is required to maintain the same. However, SEBI clarified in the guidance note, pursuant to an insertion made on July 5, 2019, that the requirement to maintain SDD-1 was applicable to listed companies, and intermediaries and fiduciaries who handle UPSI of a listed company in the course of business operations.

Discussion in SEBI BM

As per the agenda of the SEBI BM It was proposed to specify following in relation to SDD:

  • Nature of UPSI;
  • Details of persons or entities who have shared;
  • Period of preservation of SDD-1;
  • Prohibiting entities from outsourcing the same.

Post amendment

  • SDD-1 is required to be maintained by the Board of directors or heads of organization of every person required to handle UPSI;
  • SDD-1 shall additionally contain the name of the person sharing the UPSI.
    • So the names of person sharing and the one with whom the same is shared will be recorded along with PAN/ any other identifier of the person (where PAN was not available).
  • SDD-1 shall be maintained internally and not be outsourced.
  • SDD-1 to be preserved for a period of 8 years after completion of relevant transactions or even longer in case of pending proceedings.

System Driven Disclosures (SDD-2)

Prior to the amendment

Continual disclosures under Reg 7 (2) (b) was required to be made by the promoters, member of promoter group and designated persons to the stock exchanges within two trading days of receipt of the disclosure or becoming aware of such information. System driven disclosure was implemented vide SEBI Circular dated May 28, 2018 only for The CEO and upto two levels below CEO of a company and all directors. The database was submitted to the depositories along with PAN of the individuals.

Discussion in SEBI BM

Investigation of delay or non-compliance due to manual submissions takes up considerable time and effort and clogs the system. In order to eliminate it was proposed to automate the process of filing such disclosures by way of SDD-2 thereby enabling timely and fair disclosure without intervention of entities involved. SEBI will be issued detailed circular on the same to the market participants.

Post amendment

Reg 7 (2) (c) inserted to provide enabling power for issue of format and manner of submitting SDD-2.

Exemption from trading window restrictions

Prior to the amendment

Trading window restriction was not applicable on transactions specified in proviso to Reg 4 (1), in respect of pledge for a bonafide purpose and transactions undertaken in accordance with respective SEBI Regulations such as acquisition by conversion of warrants or debentures, subscribing to rights issue, further public issue, preferential allotment or tendering of shares in a buy-back offer, open offer, delisting offer.

Discussion in SEBI BM

Offer for sale was not included in the said list despite SEBI having laid detailed procedure for the same.

Post amendment

Enabling clause inserted to include the transactions which are undertaken through such other mechanism as may be specified by the Board from time to time. SEBI vide Circular dated July 23, 2020 provided that trading window restriction shall not apply in case of rights entitlement and Offer for Sale.

Crediting the amount for CoC non-compliance to IPEF

Prior to the amendment

Only profits from contra trade were disgorged and credited to Investor Protection and Education Fund (IPEF) administered by SEBI. The listed entity had the option to take disciplinary action including by way of recovery, clawback.

Discussion in SEBI BM

The listed entity could take action against person violating the CoC by way of disciplinary actions viz. wage cut, collecting of certain amount etc. There was no uniform approach w.r.t. utilization of amounts levied by the listed entities/ intermediaries/ fiduciaries for other violations of CoC viz. trades during window closure, trade without pre-clearance etc.

Also, a clawback is generally a contractual agreement between the employee and the employer in which the employee agrees to return previously paid or vested remuneration to the employer under certain circumstances. However, every employment agreement may not have a “clawback” clause or provision. Whereas, disgorgement as an equitable remedy, aimed at depriving the wrongdoer of his ill-gotten gains. It was suggested to substitute ‘clawback’ with ‘disgorgement’.

Post amendment

Any amount collected for violation of CoC shall also be remitted to SEBI for credit to the IPEF. The word ‘clawback’ has been deleted in Schedule B and Schedule C. SEBI vide Circular dated July 23, 2020 has provided that such amounts shall be credited to the IPEF through the online mode or by way of a demand draft (DD) in favour of the Board (i.e. SEBI – IPEF) payable at Mumbai. The bank account details of SEBI – IPEF for online transfer is given below:

Informing violation of PIT Regulations to Stock Exchange

Prior to the amendment

Violation of PIT Regulations was required to be informed to SEBI. SEBI vide Circular dated July 19, 2019 prescribed format for standardized reporting of violations under CoC.

Discussion in SEBI BM

The intimations received from listed companies/ intermediaries/fiduciaries were maintained in non IT based environment. To ensure that such intimations were captured electronically in an IT based environment to create a data repository, which could be used for conducting examination of cases or for any other data analysis, in future, it was recommended to file intimations with the stock exchanges.

Post amendment

The violations will be required to be reported to the stock exchanges in the form and manner as may be prescribed by SEBI. SEBI vide Circular dated July 23, 2020 prescribed the format in supersession of July, 2019 circular.

Whether the intimations filed with the stock exchanges will be publicly available, is not clear.

Comparison of formats

The format is broadly similar to that prescribed in July, 2019, however, has following modifications:

Particulars

 July, 2020 Circular July, 2019 Circular

Remarks 
Details of DP Whether the DP is promoter or belongs to promoter group Whether the DP is promoter /promoter group/ holding CXO level position (e.g. CEO, CFO, CTO etc). The details highlighted is anyways provided under Designation of DP and Functional role of DP. This seemed repetition.
Details of transaction No of shares traded and value (Rs.) (Date- wise) No of shares traded (which includes pledge) and value (Rs.) (Date- wise). The legislative note under definition of ‘trading’ in the Regulations clarify that trade includes pledge.
Details of violations Details of violations observed under Code of Conduct. Details of violations observed under SEBI (PIT) Regulations, 2015. Reference aligned with Para 12 of Schedule B of the Regulations.
Amount collected for CoC violation ·       Mode of transfer to IPEF (Online/ DD)

·       Details of the transfer.

 No such field. It seems that the amount is to be first transferred and thereafter, reporting is to be done as payment details is required to be furnished.

Actionables for the listed entities/ intermediaries/fiduciaries

SDD-1

Maintenance of SDD-1 to be ensured with details of persons sharing the UPSI.  SDD to be preserved for minimum 8 years from completion of relevant transactions. Internal control manual/ SOP, if any, will be required to be updated to capture the amendment.

SDD-1 may be maintained by Compliance Officer or may be maintained by various functional heads who are in possession of UPSI and share the same for legitimate purpose. The Compliance Officer should have access to the same as that is required for deciding of pre-clearance for the trades by DPs.

SDD-2

Reporting continual disclosure in SDD-2 after the format is prescribed by SEBI. In case SEBI decides to implement SDD-2 in the manner it implemented in 2018, the listed entity will be required to furnish name and PAN details of promoter, member of promoter group and all designated persons to the depository.

CoC

The CoC will be required to be amended to capture the amendments by removing reference of clawback provision and specifying to deposit amounts collected for violation to IPEF.

Violation of the regulations and of CoC to be reported to the stock exchange instead of SEBI by listed entity/ intermediary/ fiduciary in the format provided by SEBI vide circulated dated July 23, 2020.

 

Partitioning of advisory services from distribution activities

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– Harshil Matalia (finserv@vinodkothari.com)

Updated as on July 04, 2020

The Securities and Exchange Board of India (SEBI) had notified SEBI (Investment Advisers) Regulations, 2013 (IA Regulations)[1] in 2013, to regulate activities of Investment Adviser (IA). IA is a person who provides investment advices with respect to financial and investment products to its clients for a consideration. Regulation 3 (1) of the IA Regulations mandates every person which acts as an IA or holds itself out as an IA to register itself unless the person is exempted from registration under regulation 4 of IA Regulations.

A series of consultation papers were issued in 2016, 2017 and 2018, which was followed by another consultation paper[2] proposing amendments in the IA regulations released by SEBI on January 15, 2020. Subsequently, SEBI in its meeting held on February 17, 2020[3] approved the proposals on regulatory changes based on comments received on consultation paper. On July 03, 2020, SEBI has amended IA regulations by introducing SEBI (IA)(Amendment) Regulations, 2020[4] (Amendment Regulations) which shall come into force on September 30, 2020. The main objective to bring such regulatory amendments is to protect the interest of investors and prioritize investors’ interest over the interest of IA.

This write-up provides a brief note on amendments brought by SEBI and its implications on the sector.

Segregation of Advisory & Distribution Activities

As per regulation 15(5) of the IA Regulations, there is an obligation on IA to disclose all conflicts of interest that arises while serving its clients. There is a possibility that IA would advise to invest in products which shall fetch maximum commission or products that may be risky and less sellable in the market. To overcome such a situation, IA must disclose potential conflict of interest to the client.

An IA may be engaged in activities other than investment advisory and hence it is necessary to ensure an arms-length relationship between its activities as an IA and other activities as prescribed under regulation 15(3). Individuals registered as IAs are not allowed to provide distribution or execution services under amended IA Regulations. However, corporate entities registered as IAs can offer execution or distribution services provided that the investment advisory services are offered through separate identifiable division or department.

Further as per recent amendments in Regulation 22 of IA Regulations, “family of IA” shall not provide distribution services to the same client advised by IA. SEBI has inserted a definition of ‘Family of IA’ which shall include individual IA, spouse, children and parents. SEBI has also prescribed the requirement for non-individual IAs to have client level segregation at a group level which means that client can either take advisory or distribution services from the IA and the same client cannot avail any other service, as the case may be, by the same IA or its group entities. Group for this purpose shall mean:

  1. For Company- an entity which is a holding, subsidiary, fellow subsidiary, associate or an investing company or venturer of the company as per the provisions of Companies Act, 2013 or;
  2. In any other case- an entity which has controlling interest or which is subject to controlling interest of a non-individual investment adviser.

Implementation of Advice (Execution)

IAs also offer implementation services to its clients i.e. execution of advice provided to the client by charging some reasonable consideration. Thus, the client finds ‘all in one shop’ by availing such services. It has been suggested that IA should clearly declare to the client that it will not seek any power of attorney or authorisations from its clients for auto implementation of investment advice. However, SEBI in Amendment Regulations emphasis that whether to avail implementation services would be sole choice of client and the IA cannot force its client to avail implementation services. Further, IA shall provide implementation services to its advisory clients only through direct schemes/products in the securities market. IA or group or family of IA shall not charge directly or indirectly any consideration including commission or referral fees for providing implementation services. SEBI has also mandated IAs to provide declaration that no consideration shall be received by IA for implementation of advice or execution services. The said declaration has been inserted under item 5 of the First schedule of IA Regulations.

Terms and Conditions of Investment Advisory Services

As per regulation 19, an IA shall maintain copy of agreement with the client, if any, along with other records specified under the said regulation. Since the requirement of advisory agreement is not mandatory under the erstwhile IA Regulations, most of the clients always remain unaware about the terms and conditions of the advisory services that they are going to obtain from IAs.

SEBI has been receiving numerous investor complaints against IAs that they charge exorbitant advisory fees, promising false returns, non-disclosure of detailed fees structure etc. In absence of written agreement between adviser and client, client may not be able to prove his claim.

Therefore, SEBI has mandated an execution of agreement between IA and client which shall specify key terms and conditions, as may be prescribed by SEBI, regarding investment advisory services and this would in turn facilitate transparency.

Advisory Fees

As per the Code of Conduct for IAs prescribed under third schedule of IA Regulations, IAs shall charge fair and reasonable fees to the clients in lieu of providing advisory services. There have been several complaints received by SEBI regarding unreasonable fees being charged by IAs. To restrain such instances and unfair practices, SEBI has inserted Regulation 15A regarding advisory fees that can be charged by IAs to its clients.

The discussion paper has provided two modes of charging fees to clients. IAs can either charge fees by opting Assets under Advice (AUA) mechanism or they can charge fixed fees. SEBI inserted the definition of AUA in Regulation 2(aa) of IA Regulations which shall mean aggregate net asset value of securities and investment products for which IA has rendered investment advice irrespective of whether the implementation services are provided by investment adviser or concluded by the client directly or through other service providers. Under AUA mechanism, fees shall be charged on the basis of underlying assets under advice subject to maximum 2.5 percent of AUA per annum per family across all schemes/ products/ services provided. On other hand, as per fixed fees terms, IA can charge maximum Rs. 75,000 p.a. per family across all schemes/ products/ services provided. The option of choosing mode for charging fees is available with IA, however, change of mode can be effected only after 12 months of on boarding/last change of mode.

In practice, it would be difficult to implement maximum ceiling limit proposed by SEBI. There are certain portfolios that contain high risk products which requires effective skills and essential time to provide any investment advice. In such cases, maximum ceiling would be discouraging for IAs to charge a particular fees to compensate for their efforts. Therefore, in Board memorandum, SEBI has proposed to reconsider and enhance fixed fees from Rs. 75,000 to Rs. 1,25,000 p.a. per ‘family of client’ and fees under AUA mechanism shall be 2.5 percent of AUA per annum per ‘family of client’ across all schemes/ products/ services offered by IA. SEBI inserted a definition of ‘Family of client’ which constitutes individual, dependent spouse, dependent children and dependent parents. IAs would also be required to mention detailed fees structure along with adequate calculations under terms and conditions of advisory agreement. The above-mentioned proposed fees structure is not yet finalised; and is expected to be specified by the SEBI at the earliest. Also, SEBI is expected to bring more clarity that whether IA can charge fees using different fees structure to different categories of customers.

Eligibility Criteria for IAs

The eligibility criteria for IA includes qualification and net worth requirement. Under the erstwhile IA Regulations, regulation 7 and 8 deals with the qualification and net worth requirements respectively. IAs or a principal officer of non-individual IAs shall have minimum qualification as prescribed under the regulation 7.

SEBI has amended the qualification and net worth requirement. SEBI has introduced the definition of “persons associated with investment advice” and “principal officer” in Amendment Regulations. All client facing persons such as sale staff, service relationship managers, client relationship managers, etc. shall be deemed to be persons associated with investment advice, whereas principal officer shall mean managing director/managing partner, designated director etc. who is responsible for overall business operations of non-individual IAs. In terms of the erstwhile IA Regulations, IA shall have either professional qualification/post-graduation or graduation along with five year experience of advisory as mentioned in regulation 7(1). However, as per recent amendments, an individual IA and principal officer in case of non-individual IA shall be required to meet both the criteria that is to have professional qualification/post-graduation along with 5 years experience at all times. The requirement of certification on financial planning (NISM) remains unchanged.

In terms of the erstwhile IA Regulations, IAs which are body corporate shall have a net worth of not less than twenty-five lakh rupees and for IAs who are individuals or partnership firms shall have net tangible assets of value not less than rupees one lakh. However, SEBI has increased minimum net worth criteria to rupees fifty lakhs and rupees five lakhs for non-individual and individual IAs respectively. However, all persons associated with investment advice shall comply with the qualification requirements with minimum two years of experience. The existing IAs shall comply with new eligibility norms within 3 years from the date of commencement of Amendment Regulations. The summary of erstwhile eligibility criteria along with recent amendments is given below:

For Individual IAs

Requirement

 Erstwhile

Amended

 Persons associated with Investment Advice including representatives

Education

 Professional qualification/post-graduation Professional qualification/post-graduation with 5 years of experience Professional qualification/post-graduation with 2 years of experience
Graduation with 5 years of experience

Certification

 NISM NISM NISM

Net Worth

 Rs. 1 lakh Rs. 5 lakhs

Not applicable

For Non-individual IAs

Requirement

 Erstwhile for representatives

Amended for principal officer

 Persons associated with Investment Advice including representatives

Education

 Professional qualification/post-graduation Professional qualification/post-graduation with 5 years of experience Professional qualification/post-graduation with 2 years of experience
Graduation with 5 years of experience

Certification

 NISM NISM NISM

Net Worth

 Rs. 25 lakhs Rs. 50 lakhs

Not applicable

 

Use of Nomenclature

In order to obviate misunderstanding and confusion amongst investors regarding the roles and responsibilities of distributors including mutual fund distributors who refer to themselves as ‘independent financial adviser’ or ‘wealth adviser’, it is relevant that the nomenclature should not mislead the investors. Therefore, SEBI has inserted Regulation 3(3) which specifies that any person other than IA registered with SEBI, dealing in distribution of securities shall not use the nomenclature “Independent Financial Adviser (IFA) or Wealth Adviser or any other similar name.

Conversion of Individual IAs to Non-individual IAs

SEBI has inserted additional criteria under regulation 13 which directs individual IA to apply for registration as non-individual IA, in case number of clients of such individual IA exceeds 150 in total.

Conclusion

With these amendments, SEBI took efforts to make robust regulation for investment advisers. Some of the changes would definitely pick up the slacks, however, SEBI should reassess the proposal for ceiling limit on advisory fees and bring more clarity.

[1]https://www.sebi.gov.in/web/?file=https://www.sebi.gov.in/sebi_data/attachdocs/jun-2020/1591597643206.pdf#page=1&zoom=page-width,-15,842

[2]https://www.sebi.gov.in/reports-and-statistics/reports/jan-2020/consultation-paper-on-review-of-regulatory-framework-for-investment-advisers-ia-_45685.html

[3] https://www.sebi.gov.in/media/press-releases/feb-2020/sebi-board-meeting_46013.html

[4] http://egazette.nic.in/WriteReadData/2020/220363.pdf and https://www.sebi.gov.in/media/press-releases/jul-2020/sebi-notifies-amendments-to-sebi-investment-advisers-regulations-2013_47006.html

SEBI’s measures towards resuscitation of financially “stressed” companies

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Henil Shah | Executive

corplaw@vinodkothari.com

Introduction & Background

In layman’s term, a company with falling share prices, inability to pay off its obligations is said to be a company with financial distress. In most of the times, it is seen that the conventional means of fund raising such as borrowings, issuance of debt securities etc. do not work for such companies due to their ongoing stressed status even though generating cash is the foremost priority for them to fund their operations. Additionally, insolvency/ bankruptcy also becomes a matter of concern which may be caused due to the lack of funding and the resultant disruption in operation.

SEBI’s Primary Market Advisory Committee (PMAC) deliberated on the topic and came out with a Consultation Paper dated April 22, 2020[1] providing for the proposed measures for resuscitation of the stressed companies. The changes so proposed were w.r.t certain amendments under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) and SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 2011 (SAST Regulations). Based on the public comments, SEBI vide Notifications dated June 23, 2020 has prescribed the final text of the amendments under the ICDR Regulations[2] and SAST Regulations[3]

The article covers a brief synopsis and the relevant impact/ actionable pursuant to the said amendments.

Rationale behind the proposed changes

Preferential issue seems to be one of the most sought options of fund raising by the companies due to the administrative as well as regulatory convenience it carries. Further, knowing the probable investors ready to invest in the company makes a preferential issue one of the most commonly used ways for raising funds.

For a listed company, under a preferential issue, the issue price has to be determined as per the pricing provisions of Chapter V of ICDR Regulations. The ICDR Regulations provides the pricing mechanism for both frequently traded shares and infrequently traded shares.

In case of frequently trades shares, the price shall be determined as per the provisions of Regulation 164(1) (a) & (b) of the ICDR Regulations which are as follows.

Even though a preferential issue may be a convenient way of fund raising for a well performed company, the same may not be the case for a company with financial distress for the following reasons:

1.      Onerous pricing mechanism

Considering the continuous falling prices of the shares over a period of 26 weeks due to the company being in stress, the determination of the price as per the pricing mechanism provided in Regulation 164(1) (a) becomes too onerous for the investor. Further, the price under Regulation 164(1) (a) is much higher than that as determined as per Regulation 164(1) (b). Hence, the pricing mechanism acts as a major deterrent for the investors from subscribing to the shares offered under the preferential issue.

2.      Exemptions only to 5 QIBs restricting investor pool

Though the ICDR Regulations allow issuance to QIBs at a price determined as per regulation 164(1) (b) however, the same is restricted to only 5 QIBs and is not applicable to the investors other than QIBs thereby restricting the investor pool.

3.      Open offer obligations for the acquirer

Another roadblock which the issuers tend to face is from the view point of the investors i.e. an incoming investor who has an impending burden on complying with an open offer obligation in case where the subscription to the preferential offer leads to the triggering of the open offer obligations under SAST Regulations. In view of the procedural requirements and the huge costs involved, making an open offer discourages the investors seeking to have a substantial stake in the company in order to take control and thereby reverse the stress.

As per the extant provisions, the acquisition pursuant to a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 is exempted from meeting the open offer obligations but no such exemption has been provided in case for acquisition in the financially distressed entity which are not under any resolution plan.

Rescue mechanism brought through the amendments

Insertion of regulation 164A in ICDR Regulations

The newly inserted provisions incorporate the changes that were proposed by PMAC into the existing regulations as discussed below:

When to consider a company at ‘stress’?

For a company to be classified as financially stressed and issue equity share in pursuance of regulation 164A of ICDR regulations it has meet certain conditions. Below is a comparative presentation between the text of the Consultation Paper and the final text of the Regulations. Further, any two of the three conditions shall have to be satisfied for considering a company as stressed.

PMCA Recommendations Final text of the Regulations Remarks
A listed company which has made disclosure of defaults on payment of interest/ principal amount of loans from banks/ financial institutions and listed and unlisted debt securities for 2 consequent quarters in terms of the SEBI Circular dated November 21, 2019[4] issued in this regard.

 

 The issuer has disclosed the default relating to the payment of interest/ repayment of principal amount on loans from banks/ financial institutions/ NBFCs- ND-SI and NBFCs-D and/ or listed on unlisted debt securities in terms of SEBI circular dated November 21, 2019 and such default is continuing for a period of at least 90 days after occurrence of such default.

 

 The amendment regulation in slight contrast to the PMAC recommendations provided shorter timeline for calculating continuity of the default.

 

Further, even though NBFCs-ND-SI and NBFCs- D already get covered under the definition of Financial Institution provided under RBI Act, they have been specifically covered under the list of creditors.
Existence of Inter-Creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019[5] (RBI Directions)

 

 Same as PMCA Recommendations Inter-Credit agreement as provided in the RBI Directions stands for the agreement executed among all the lenders of a defaulting borrower, providing for ground rules for finalisation and implementation of resolution plan in respect to the borrower.
Credit rating of the listed instruments of the company has been downgraded to “D”. The credit rating of the financial instruments (listed or unlisted), credit instruments/ borrowings (listed or unlisted) of the listed company has been downgraded to “D” The final text of the amendments, in addition to the listed instruments, also brings unlisted instruments and as well as borrowings under its purview.

Pricing of preferential issue of shares of companies having stressed assets

Unlike the current pricing requirements as provided in Regulations 164(1) (a) & (b) of ICDR Regulations for a preferential issue, the price of the shares to be issued by a stressed company as aforesaid shall be a price which shall not be less than the average  of  the  weekly  high  and  low  of  the volume  weighted  average  prices  of  the  related  equity  shares quoted  on  a  recognised  stock  exchange  during  the  two  weeks preceding the relevant date. Therefore, the price as determined under Regulations 164(1) (a) & (b) of ICDR Regulations shall not be considered.

Negative list of proposed investors

The following person(s) shall not be eligible to participate in the preferential issue under Regulation 164:

  1. Persons/entities part of promoter or promoter group will not be eligible to participate in the preferential issue;
  2. Undischarged insolvent in terms of Insolvency and bankruptcy Code, 2016 (IBC, 2016);
  3. Wilful defaulter as per RBI guidelines issued under the Banking Regulations Act, 1949;
  4. A person disqualified to act as director as per Companies Act, 2013
  5. Person debarred from trading in securities or accessing securities market by SEBI and period of debarment has not been over
  6. Person declared as fugitive economic offender
  7. Person is convicted of offence punishable with imprisonment
    1. For a period of 2 years or more under any as specified under 12th schedule of IBC, 2016
    2. 7 years or more under any law for time being in force

and a period of 2 years has not been subsisted from his release form imprisonment.

  1. Person who has executed a guarantee in favour of a lender of the issuer and such guarantee has been invoked by the lender and remains unpaid in full or part.

Approval from shareholders falling under ‘public’ category

For companies with identifiable promoters

The amendments provides for an approval for the preferential issue by the majority of the shareholders in the ‘public’ category. The ‘public’ category of shareholders does not include promoter shareholders and also any proposed allottee who is already a holder of specified securities of the issuer. Therefore, the same is said to be an approval with majority of the minority.

For companies with identifiable promoters

For companies with no identifiable promoters, the resolution shall have to be passed by 3/4th majority. Though in this case, there is no specific mention in the Regulation as regards the eligibility of voting by the proposed allottees being a security holder in the issuer, the same should apply here also.

Contents of explanatory statement annexed with the notice of shareholder’s meeting

The proposed use of the issue proceeds shall be mentioned in the explanatory statement sent for the purpose of the shareholders resolution. This requirement is already in existence as the provisions of regulation 163 of ICDR Regulations and Rule 13 of the Companies (Share Capital and Debenture) Rules, 2014 do provide for mandatorily mentioning object for which the preferential issue is being made in the explanatory statement of the notice.

Restriction on use of proceeds

Additionally it’s restricted to use the issue proceeds for the purpose of repayment of loans from promoters/ promoter group/ group companies effectively deterring the companies to raise funds to pay-off its promoters.

Appointment of public financial institution or schedule commercial bank as monitoring agency:

As per the amendments, it shall be mandatory for the issuer company to appoint a monitoring agency whoc shall be responsible to submit report on quarterly basis to the issuer until 95% of the proceeds are utilised in the format as specified in Schedule XI ICDR Regulations. All though there is no requirement of appointing a monitoring agency as per the provisions of chapter V (Preferential Issue) requirement of ICDR Regulations, the concept of the monitoring agency is not new as several chapters of the regulations provide for appointment and functions to be performed by the monitoring agency in case where offer size exceeds a predefined limit.  However the considering issue by a financially stressed company there is no monetary limit set for the purpose of appointment of monitoring agency.

Responsibilities of Board of Directors

The board of directors and the management of the issuer shall be required to provide their comments on the findings in the report of monitoring agency and disseminate the same within 45 days of end quarter by publishing it on the website of the company as well as submitting the same with the stock exchange(s) were equity shares of the company are listed.

Responsibilities of Audit Committee

Additionally the audit committee of the issuer is entrusted with responsibility to monitor the utilization of the proceeds. This is nothing new the same already falls under the responsibility of the audit committee as laid in the SEBI (Listing Obligations and Disclosure Requirements), 2015.

Further, the audit committee of the company shall also be required to certify about the meeting of all conditions at the time of dispatch of notice and at the time of allotment.

Responsibilities of statutory auditors

The amendments require the statutory auditor also to certify about the meeting of all conditions at the time of dispatch of notice and at the time of allotment.

Lock in period

The allotment shall be lock-in for a period of 3 years from the date of trading approval.

Amendments to SAST Regulations

On same lines as mentioned in the Consultations Paper, SEBI has vide its amendments under the SAST Regulations inserted regulation 10 (2B) of SAST Regulations thereby granting immunity from open offer obligations to the investors under the preferential issue in compliance with regulation 164A of ICDR Regulations. Irrespective of the fact that equity shares are frequently traded or not.

Conclusion

Considering the stressed status of the company, it is believed that aligning the pricing requirement with that of pricing requirement in case of preferential issue to QIBs, shall effectively increase the pool of investors. Similarly, the proposed exemption from making of an open offer shall lessen the additional burden on an incoming investor to comply with the stringent requirements thereby attracting investors to put in money in such companies.

Accordingly, SEBI’s intention behind the changes may be said to be a welcome move as it will definitely help the financially stressed companies to revive.

Link to our other articles:

SEBI’s proposal to aid financially “stressed” companies: http://vinodkothari.com/2020/04/sebis-proposal-to-aid-financially-stressed-companies/

Prudential Framework for Resolution of Stress Assets: New Dispensation for dealing with NPAs: http://vinodkothari.com/2019/06/fresa/

[1] https://www.sebi.gov.in/reports-and-statistics/reports/apr-2020/consultation-paper-preferential-issue-in-companies-having-stressed-assets_46542.html

[2] http://egazette.nic.in/WriteReadData/2020/220093.pdf

[3] http://egazette.nic.in/WriteReadData/2020/220094.pdf

[4] https://www.sebi.gov.in/legal/circulars/nov-2019/disclosures-by-listed-entities-of-defaults-on-payment-of-interest-repayment-of-principal-amount-on-loans-from-banks-financial-institutions-and-unlisted-debt-securities_45036.html

[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11580&Mode=0

Limits on creeping acquisition by promoters increased during COVID-19 crises

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Shaifali Sharma | Vinod Kothari and Company

Introduction

SEBI has been taking several proactive measures to relax fund raising norms and thereby making it easier for companies to raise capital amid the COVID-19 pandemic. With a view to further facilitate fund raising by the companies, SEBI vide its notification dated June 16, 2020[1], has relaxed the obligation for making open offer for creeping acquisition under Regulation 3(2) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (Takeover Code).

The relaxation allows creeping acquisition upto 10% instead of the existing 5%, for acquisition by promoters of a listed company for the financial year 2020-21. The relaxation is specific and limited to acquisition by way of a preferential issue of equity shares and therefore excludes acquisitions through transfers, block and bulk deals etc. Also recently, SEBI in its Board Meeting[2] held on June 25, 2020 has proposed to provide an additional option to the existing pricing methodology for preferential issue under which the minimum price for allotment of shares will be volume weighted average of weekly highs and low for twelve weeks or two weeks, whichever is higher.However, this new rule shall apply till December 31, 2020 with 3 years lock-in condition for allotted shares. Further, by way of the same notification, SEBI has also relaxed the provisions of voluntary open offer where an acquirer together with PAC will be eligible to make voluntary offer irrespective of any acquisition in the previous 52 weeks from the date of voluntary offer, this will promote investments into various companies in future.

This article tries to discuss on whether the relaxation given by SEBI to the promoters are as encouraging as it seems to be, when connected with the pricing norms for preferential issue under the SEBI (Issue of Capital and Disclosures Requirement) Regulations, 2018 (‘ICDR Regulations’) and how the new pricing methodology proposed by SEBI can leverage the situation.

What is Creeping Acquisition?

Creeping acquisition, governed by Regulation 3(2) of the Takeover Code, refers to the process through which the acquirer together with PAC holding more than 25% but less than 75%, to gradually increase their stake in the target company by buying up to 5% of the voting rights of the company in one financial year. Any acquisition of further shares or voting rights beyond 5% shall require the acquirer to make an open offer. Further, for the purpose of creeping acquisition, SEBI considers gross acquisitions only notwithstanding any intermittent fall. The same is projected in Figure 1 below. Also, in all cases, the increase in shareholding or voting rights is permitted only till the 75% non-public shareholding limit.

Figure 1: Creeping acquisition limit increased from 5% to 10%

Rationale for easing the norms of Creeping Acquisition

While the companies are currently struggling to manage their cash flows due to the financial challenges faced on account of COVID-19, the amendment will allow companies to raise funds from promoters to tide over their difficulties for the financial year 2020-21. This revision will also boost the sagging stock market and help sustain the stock prices of the company.

Promoters, on the other hand, owning 25% or more of the shares or voting rights in a company will be able to increase their shareholdings up to 10% in a year versus the previously allowed threshold limit of 5%.

Permutations and Combinations of Creeping Acquisition during FY 2020-21

Since the enhanced 10% limit applies only in case of acquisition under preferential issue, the total acquisition of 10% may be achieved by any of the following combinations:

Option 1: Acquire upto 5% shares via open-market purchase or any other form and the remaining 5% shares can be acquired through subscribing to a preferential issue.

Option 2:Acquire 10% shares through preferential issue

Accordingly, in a block of 12 months of financial year 2020-21, if the promoterwants to acquire share through open market, bulk deals, block deals or in any other form, the 5% threshold shall remain in force and additional 5% can be acquired through preferential issue.

Identified below are the permitted acquisitions through open market, transfers or other forms in case promoter opts for preferential issue:

Whether the relaxation in open offer is actually encouraging when read with the pricing norms under ICDR Regulations?

As stated above, the relaxation can be availed only in the cases where the investments are done undera preferential issue. Regulation 164 of the SEBI (Issue of Capital and Disclosures Requirement) Regulations, 2018 (‘ICDR Regulations’) deals with the pricing norms under preferential issue. It provides that the issue price in cases where the shares have been listed for more than 26 weeks on a recognized stock exchange as on the relevant date, the issue price has to be higher of the following:

  1. the average of the weekly high and low of the volume weighted average price of the related equity shares quoted on the recognized stock exchange during the twenty six weeks preceding the relevant date; or
  2. the average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date.

The computation of the prices as per the above stated regulation will lead to a wide gap between the pricing at the beginning of the twenty-six week period and the current price when the company raises funds.

During this time of stock market crises, the stock prices of many companies have dropped sharply from their respective all-time high values recorded 6 months back. Further, in the cases where the market price is lower than the minimum price calculated as per ICDR Regulations for preferential issue, the promoters will be discouraged to acquire shares under preferential allotment as they will end up paying higher values.

Due to the challenges faced by the economy in view of COVID-19, the trading prices of the listed companies have gone down sharply. Accordingly, the price determined under ICDR Regulations may not be a motivating factor for the promoters to subscribe to the additional shares though, elimination of the costs involved in a public offer may compensate the same.

However, to curb the above situation, SEBI in its Board meeting held on June 25, 2020, has proposed an additional option to the existing pricing methodology for preferential issuance as under:

In case of frequently traded shares, the price of the equity shares to be allotted pursuant to the preferential issue shall be not less than higher of the following:

  1. the average of the weekly high and low of the volume weighted average price of the related equity shares quoted on the recognized stock exchange during the twelve weeks preceding the relevant date; or
  2. the average of the weekly high and low of the volume weighted average prices of the related equity shares quoted on a recognized stock exchange during the two weeks preceding the relevant date.

The new option will consider the weighted average price of equity shares preceding 12 weeks instead of the preceding 26 weeks and therefore reflect the accurate price during the pandemic period.  This may prove to be the solution to above crises,making fundraising through preferential issue easier for the corporates and simultaneously encouraging the promoters as well to infuse funds.

Compliances for preferential issue to promoters under PIT Regulations

Considering the fact that promoter is one of the designated person as per the SEBI (Prohibition of Insider Trading) Regulations, 2015 (‘PIT Regulations’), the companies, in addition to the procedural requirements for preferential issue prescribed under the Companies Act, 2013, ICDR Regulations and other applicable laws, shall also comply with the provisions of PIT Regulations.

Closure of trading window in case of preferential allotment

Designated persons and their immediate relatives shall not trade in securities when the trading window is closed. The trading restriction period shall apply from the end of every quarter till 48 hours after the declaration of financial results.

Further, the trading window shall also be closed when the compliance officer determines that a designated person (DP) or class of designated persons can reasonably be expected to have possession of unpublished price sensitive information (UPSI). Therefore, the trading window shall be closed and communicated to all DPs as soon as the date/notice of board meeting to approve issue of share via preferential allotment is finalized upto 2nd trading day after communication of the decision of the Board to the Stock Exchanges.

Accordingly, promoter/ class of promoters acquiring shares under preferential issue shall conduct all their dealings in the securities of the company only in a valid trading window i.e. once the trading widow is open subject to the pre-clearance norms prescribed under PIT Regulations and the Code of Conduct for prevention of insider trading of the Company.

Concluding Remarks

Given the lack of liquidity in the market, the proposed amendments maybe seen as an opportunity for target companies to raise capital from its promoters. Further, promoters can also infuse funds through equity issuance and will be able to increase their shareholding in the target company without the formalities of making the open offer.

Having said that since the market might take some time to recover, this relaxation provides a gateway for promoters to avoid open offer requirements which would otherwise have involved compliance burden on the promoter. However, the pricing factor may seem to be the only hindrance or a demotivation for actually availing this relaxation which seems to be resolved through the new pricing method proposed by SEBI in its Board meeting.

[1]To view the notification, click here

[2]https://www.sebi.gov.in/media/press-releases/jun-2020/sebi-board-meeting_46929.html

Other reading materials on the similar topic:

  1. ‘SEBI revisits Takeover Code’ can be viewed here
  2. ‘Takeover Code 2011’ can be viewed here
  3. ‘Decoding Takeover Code’ can be viewed here
  4. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkothari.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg

Transacting by exception: Listed cos in India give substantive carve outs for RPTs

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The article has been published in ICSI – WIRC-E Newsletter (June-July 2020 edition):
Refer page 43 of ICSI – WIRC-E Newsletter

Webcasting in virtual AGM

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by Smriti Wadehra & Qasim Saif

(smriti@vinodkothari.com) (executive@vinodkothari.com)

Background

MCA considering the COVID-19 pandemic and the social distancing norms issued by the Government, realized that conducting physical AGM by companies within the prescribed timeline shall be difficult for this financial year. Accordingly, the Ministry vide its circular dated 5th May, 2020 has permitted holding of Annual General Meetings (AGM) through video conferencing[1] for all meetings conducted during the calendar i.e. till 31st December, 2020. The said circular read with previous circulars dated 13th April, 2020[2] and 8th April, 2020[3] prescribed a detailed procedure as to how companies can conduct their general meetings virtually.

While these circulars dealt with various perplexities arising from the thought of virtual general meetings, however, there was still some clarification pending on applicability of other requirements applicable on companies, for instance, the requirement of webcasting under regulation 44(6) of SEBI (Listing Obligation and Disclosure Requirements) Regulation, 2015.

We discuss the same as below.

Webcast vs Video conferencing

The very basic differentiation in the term webcast and video conferencing is that, the former only provides one-way participation rights but the later provides for a two-way communication. In reference to providing webcasting facility during the AGM, the shareholders can only watch and listen to the proceedings of the meeting but cannot participate in voting or ask queries whereas in video conferencing the shareholders have complete participation as in case of a physical general meeting. Webcasting is merely “live streaming” of the AGM.

Intent of webcast

The requirement for providing webcast facility was recommended by Kotak Committee[4] on Corporate Governance which provided:

“Reg 44A. Meetings of shareholders

The top 100 listed entities by market capitalization, determined as on March 31 of every financial year, shall provide one-way live webcast of the proceedings of all shareholder meetings held on or after April 1, 2018”

The aforesaid recommendation was in addition to the recommendation w.r.t. e-voting facility which as per the existing provision of law, is closed at 5 p.m. of the previous day of the meeting, however, the committee recommended to shift the closure of e-voting facility to the day of meeting itself. The intent behind the recommendation was that the e-voting timeline expires before the meeting is held, accordingly, shareholders not attending the meetings in person are unable to take into account discussions at the meeting in order to make informed decisions.

Whereas, SEBI accepted the recommendations made by the Kotak Committee on 9th May, 2018 w.r.t. webcasting facility and inserted a new sub-regulation, however, the recommendation w.r.t e-voting is still in draft form. The provisions relating to webcast were made applicable to top 100 listed entities from 1st April, 2019.

The whole intent of conducting annual general meetings is the indispensable right to the shareholders of companies to meet the directors and auditors of the Company, at least once in a year. This has been the feature of corporate laws over the decades – based on the fact that the “managers” (directors) at least face the “owners” (shareholders) once. The law therefore, mandates physical meetings. However, with the rise of technology, call it necessity or evolution, the law embraced e-voting as a recognised means of voting (but not participation). Later, SEBI introduced the concept of providing one-way webcast facility for shareholders so as to increase participation of shareholders at meeting (though one-way).

The data shows that attendance of shareholders at AGMs is even less than 5% of total number of shareholders at Meeting. Further, most of the shareholders (especially those residing in state other than where the AGM is conducted) find it more feasible to vote by way of e-voting. In the data[5] below, we can observe that on an average 95% of members of some well reputed companies vote through e-voting while on-site voting percentage is negligible. Therefore, it can be said, that the members do not really depend on meeting discussions to take a decision. However, webcast enables them to be apprised of the conduct of the meeting, shareholder queries, concerns, etc. raised at the meeting, etc.

Globally, countries like United States of America, Canada, United Kingdom, France, China and many such countries have permitted conducting meeting through video conferencing during the crisis. Further, the concept of webcasting is new for India. However, for many foreign countries including those named above have included providing of webcasting facility in shareholder’s meeting as a requirement of law.

Webcast facility in virtual AGM, whether required?

Now, the question is, where the AGM has itself gone ‘virtual’ (as mentioned above), is there really a requirement of webcasting? Note that SEBI has not provided any relaxation from webcasting as such.

It may be noted that video conferencing is nothing but participation through electronic means by shareholders remotely i.e. other than the venue of AGM. Therefore, where the company has already provided the facility of video conferencing to shareholders, webcast may not actually be needed. The purpose which the webcast intends to serve (dissipation of conduct of meeting) is well-served by the video-conferencing. In fact, in webcast the shareholders get only participation rights i.e. to hear and view the proceedings of meeting. However, in case of virtual AGM, the shareholders are provided with two-way participation rights i.e. can speak as well. Hence, provided two options, the shareholders will mostly opt for the latter.

The webcast, however, can be of relevance where the participation capacity is limited. In this regard, MCA circular dated 8th April, 2020 has prescribed minimum capacity allowance by companies conducting virtual AGM. For companies that are required to provide e-voting facility has to arrange capacity of minimum 1000 members at virtual AGM on first come first basis. This limit is minimum 500 members for companies not required to provide e-voting facility. Hence, the platform for conducting virtual AGM should provide for aforesaid minimum.

We all know that mostly large companies have lakhs of shareholders.  Therefore, if companies restrict the entry of shareholders on first come first basis i.e. does not allow participation right to all shareholders in virtual AGM (due to software limitations, etc.), in that case webcast facility should be provided (if required). However, if companies do not restrict any shareholder from participation in virtual AGM and is open for all shareholders irrespective of the number, in such cases providing separate facility for webcast may turn out to be a futile exercise.

[1] http://www.mca.gov.in/Ministry/pdf/Circular20_05052020.pdf

[2] http://www.mca.gov.in/Ministry/pdf/Circular17_13042020.pdf

[3] https://www.mca.gov.in/Ministry/pdf/Circular14_08042020.pdf

[4] https://www.sebi.gov.in/reports/reports/oct-2017/report-of-the-committee-on-corporate-governance_36177.html

[5]Source: https://www.livemint.com/opinion/online-views/covid-19-need-to-re-look-at-pre-digital-era-compliances-under-companies-act-11588585274712.html

New CSR avenues, innovative bonds and much more in the Social Stock Exchange package!

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Timothy Lopes, Executive, Vinod Kothari Consultants

finserv@vinodkothari.com

– with updates as on 30-07-2022

In the Union Budget of 2019-2020 the Hon’ble Finance Minister proposed “to initiate steps towards creating an electronic fund raising platform – a Social Stock Exchange (‘SSE’) – under the regulatory ambit of Securities and Exchange Board of India (‘SEBI’) for listing social enterprises and voluntary organizations working for the realization of a social welfare objective so that they can raise capital as equity, debt or as units like a mutual fund.”

A Working Group was subsequently formed on 19th September, 2019 to recommend possible structures and mechanisms for the SSE. We have tried to analyse and examine what the framework would look like based on global SSEs already prevalent in a separate write up.

On 1st June, 2020, the Working Group on Social Stock Exchange published its report for public comments. In this write up we intend to analyse the recommendations made by the working group along with its impact.

The idea of a Social Stock Exchange

Social enterprises in India exist in large numbers and in several legal forms, for e.g. trusts, societies, section 8 companies, companies, partnership firms, sole proprietorships, etc. Further, a social enterprise can be either a For-Profit Enterprise (‘FPE’) or a Non-Profit Enterprise (‘NPO’). The ultimate objective of these enterprises is to create a social impact by carrying out philanthropic or sustainable development activities.

Certain gaps exist for social enterprises in terms of funding, having a common repository able to track these entities and their performance. The sources of funding for social enterprises have been philanthropic funding, CSR, impact investing, government agencies, etc.

Funding is important in terms of the effectiveness of NPOs in creating an impact. The funding, however, is contingent upon demonstration of impact or outcomes.

Here comes the idea and role of a social stock exchange. An SSE proposed to be set up is intended to fill the gaps not only in terms of funding, but also to put in place a comprehensive framework that creates standards for measuring and reporting social impact.

Who is eligible to be listed on the SSE?

The SSE is intended for listing of social enterprises, whether for-profit or non-profit. Listing would unlock the funds from donors, philanthropists, CSR spenders and other foundations into social enterprises.

There is no new legal form recommended by the working group which a social enterprise will have to establish in order to get listed. Rather, the existing legal forms (trusts, societies, section 8 companies, etc.) will enable a NPO or FPE to get listed through more than one mode.

Is there any minimum criteria for listing on the SSE?

In case of NPOs, the minimum reporting standards recommended to be implemented, require the NPO to report that it has received donations/contributions of at least INR 10,00,000 in the last financial year.

Further, in case of FPEs, it must have received funding from any one or more of the impact investors who are members of the Impact Investors Council. Certain eligibility conditions for equity listings would also apply in case of FPEs, as per the SEBI’s Issue of Capital, Disclosure Requirements (ICDR).

The working group has requested SEBI to look into the following aspects of eligibility and recalibrate the existing thresholds in the ICDR:

  • Minimum Net Worth;
  • Average Operating Profit;
  • Prior Holding by QIBs, and;
  • Criteria for Accredited Investor (if a role for such investors is envisaged).

Listing, compliance and penalty provisions must be aptly stringent to prevent any misuse of SSE platform by FPEs.

What is a social enterprise? Is the term defined?

Social enterprises broadly fall under two forms – A For-Profit Enterprise and a Non-Profit Enterprise.

For-Profit Enterprise – A FPE generally has a business model made to earn profits but does so with the intent of creating a social impact. An example would be creating innovative and environmental friendly products. FPEs are generally in the form of Companies.

Non-Profit Enterprise – NPOs have the intention of creating a social impact for the better good without expecting any return on investment. These are generally in the form of trusts, societies and Section 8 companies. These entities cannot issue equity. The exception to this is a section 8 company which can issue equity shares, however, there can be no dividend payment.

The working group defines a social enterprise as a class or category of enterprises that are engaging in the business of “creating positive social impact”. However, the group does not recommend a legal/regulatory definition but recommends a minimum reporting standard that brings out this aspect clearly, by requiring all social enterprises, whether they are FPEs or NPOs, to state an intent to create positive social impact, to describe the nature of the impact they wish to create, and to report the impact that they have created. There will be an additional requirement for FPEs to conform to the assessment mechanism to be developed by SEBI.

Therefore, an enterprise is “social” not by virtue of satisfying a legal definition but by virtue of committing to the minimum reporting standard.

Since there would be no legal definition to classify as a social enterprise, a careful screening process would be required in order to enable only genuine social enterprises to list on the exchange.

Who are the possible participants of the SSE?

What are the instruments that can be listed? What are the other funding structures? What is the criteria for listing?

In case of Section 8 companies, there is no restriction on issue of shares or debt. However, there is no dividend payment allowed on equity shares. Further, there is no real regulatory hurdle in listing shares or debt instruments of Section 8 companies. However, so far listing of Section 8 companies is a non-existent concept, as these avenues have not been utilized by Section 8 companies apparently due to their inherent inability to provide financial return on investments.

The working group recognises that trusts and societies are not body corporates under the Companies Act, and hence, in the present legal framework, any bonds or debentures issued by them cannot qualify as securities under the Securities Contracts (Regulation) Act 1956 (SCRA).

In this regard the working group suggests introducing a new “Zero Coupon Zero Principal” Bond to be issued by these entities. The features and other specifics of these bonds are discussed further on in this write up.

Further, it is recommended that FPEs can list their equity on the SSE subject to certain eligibility conditions for equity listings as per the SEBI’s Issue of Capital, Disclosure Requirements (ICDR) and social impact reporting.

Funding structures and other instruments are discussed further on in the write up.

What are the minimum reporting standards?

One of the important pre-requisites to listing on the SSE is to commit to the minimum reporting standards prescribed. The working group has laid down minimum reporting standards for the immediate term to be implemented as soon as the SSE goes live. The minimum reporting standards broadly cover the areas shown in the figure below –

The details of the minimum reporting standard are stated in Annexure 2 to the working group report. The working group states in its report that over time, the reporting requirements can begin to incorporate more rigour in a graded and deliberate manner.

Overall, it seems as though the reporting framework at the present stage is sufficient to measure performance and identify truly genuine social enterprises. The framework sets a benchmark for reporting by NPOs and FPEs and will provide the requisite comfort to investors.

Innovative bonds and funding structures

The SSE’s role is clearly not limited to only listing of securities and trading therein. The working group has recommended several innovative funding mechanisms for NPOs that may or even may not end up in creation of a listable security. Following are the highlights of the proposed structures –

1. Zero coupon zero principal bonds –

The exact modalities of this instrument are yet to be worked out by SEBI.

2. Mutual Fund Structure –

  • Under this structure, a conventional closed-ended fund structure is proposed wherein the Mutual Fund acts as the intermediary and aggregates capital from various individual and institutional investors to invest in market-based instruments;
  • The returns generated out of such fund is will be channelled to the NPOs who in turn will utilise the funds for its stated project;
  • The principal component will be repaid back to the investors, while the returns would be considered as donations made by them;
  • There could also be a specific tax benefit arising out of this structure;
  • The other benefit of this structure is that the role of the intermediary can be played by existing AMCs.

3. The Social/ Development Impact Bond/ Lending Partner Structure –

These bonds are unique in a way that they returns on the bonds are linked to the success of the project being funded. This is similar to a structured finance framework involving the following –

  • Risk Investors/ Lenders (Banks/ NBFCs) – Provide the initial capital investment for the project;
  • Intermediary – Acts as the intermediating body between all parties. The intermediary will pass on the funds to the NPO;
  • NPO (Implementing Agency) – will use the funds for achieving the social outcomes promised;
  • 3rd party evaluator – An independent evaluator who will measure and validate the outcomes of the project;
  • Outcome Funder – Based on the third party evaluation the outcome funders will pay the Principal and Interest to the risk investors/ lending partners in case the outcome of the project is successful. In case the outcome is not successful the outcome funders have the option to not pay the risk investors/ lending partners.

Although banks may not be looking into risky lending, the structure provides incentive to the bank in the form of Priority Sector Lending (PSL) qualification. In order to meet their PSL targets, banks may choose to lend under this structure.

4. Pay-for-success through grants –

This structure is where a new CSR aspect comes in. The working group recommends a structure which is similar to the pay-for-success structures stated earlier however, this required the CSR arm of a Company to select the NPO for implementation of the project. The CSR funds are then kept in an escrow account earmarked for pay-for-success, for a pre-defined time period over which the impact is expected to be created (say 3 years).

The initial capital required by the NPO to achieve the outcomes, will be provided by an interim funding partner (typically a domestic philanthropic organization, and distinct from the third-party evaluator).

If the CSR funder finds that the NPO has achieved the outcomes, then it pays out the CSR capital from the escrow account partly to the interim funding partner (similar to the earlier mentioned pay-for success structures), and partly to the NPO in the form of an accelerator grant up to 10% of the program cost in case the NPO exceeds the pre-defined outcome targets. The grant to the NPO is designed to provide additional support for non-programmatic areas such as research, capacity building, etc.

If the CSR funder finds that the NPO has not achieved the outcomes, then it either rolls over the CSR capital in the escrow account (if the pre-defined time period is not yet over), or routes the CSR capital to items provided under Schedule 7 of the Companies Act such as the PM’s Relief Fund (if the pre-defined time period is over).

An avenue for Corporate Social Responsibility

The implementation of the SSE will provide a new platform, not just for CSR spending but also a trading platform for trading in a “CSR certificates” between corporates with excess CSR expenditure and those with a deficit in a particular year.

Investment in securities listed on the SSE are likely to qualify as CSR expenditure. However, necessary amendments in the Companies Act, 2013 will also be required to permit the same to qualify as CSR expenditure. The working group has made the necessary policy recommendations in its report.

Trading platform for CSR spending –

India is one of the only countries that has mandated CSR spending. In a particular year, a Company may fail to meet its required spending obligations owing to several reasons. The High Level Committee on CSR had recommended the transfer of unspent CSR funds to a separate account and the said amount should be spent within 3 years from the transfer failing which the funds would be transferred to a fund specified in Schedule VII. The necessary provisions were inserted by the Companies (Amendment) Act, 2019, however, the same is yet to be notified.

The working group has proposed a new model that could solve the issue of unspent CSR funds. It is recommended that CSR Certificates [may be negotiable instruments, somewhat similar to Priority Sector Lending Certificates (PSLCs)], be enabled to be bought and sold on a separate trading platform. This will allow Companies which have unspent CSR funds to transfer these funds to those Companies that have spent excess for CSR in a particular year. This in turn motivates Companies to spend more than the minimum required CSR amount in a particular year.

The certificates are recommended to have a validity of 3-5 years but may be used only once. In order to avoid any profit making on excess CSR spends, it is recommended that these transactions must involve only a flat transaction fee that gets charged to the platform and involves actual transfer of funds.

Further, the working group has recommended that If the platform as described above succeeds in facilitating the trading of CSR certificates, the government might then consider licensing private platforms that provide an auction mechanism for the trading of CSR certificates (similar to the RBI’s licenses for Trade Receivables Discounting Systems or TReDS). However, this would require additional clarifications on whether CSR certificates must have the status of negotiable instruments or not and on how companies are to treat any profits from the sale of such certificates.

Conclusion

The recommendations of the working group has given an expanded role to the SSE. The working group also attempted to address the role of the SSE in terms of COVID-19 by proposing the creation of a separate COVID-19 Aid Fund to activate solutions such as pay-for-success bonds which can be used to provide loan guarantees to NBFC-MFIs that wish to extend debt moratoriums to their customers.

Necessary changes in law have also been recommended, while several other tax incentives have been recommended by the working group.

The SSE framework seems to be interesting in the Indian context. Nevertheless, the implementation of the same is yet to be seen.

Developments taken place since the WG report

Subsequent to the Working Group Report published on 1st June, 2020, several developments have taken place relating to a framework for SSE. A Technical Group on SSE was constituted by SEBI on 21st September, 2020 which submitted its report on 6th May, 2021[1].

The key recommendations of the Technical Group (which built upon the recommendations of the WG) included recommendations relating to eligibility of social enterprise for SSE, on-boarding of NPOs and FPEs, various instruments available for NPOs and FPEs, offer document content for social enterprises, social venture funds, capacity building fund, social auditors, information repositories and disclosures on SSE.

Our article on the recommendations of the Technical Group can be viewed here.

Public comments were invited and received on the report of the Technical Group. Subsequent to this, SEBI in its Board meeting dated 28th September, 2021, discussed the agenda relating ‘Framework for Social Stock Exchange’[2] which was considered and approved and amendments to several regulations were proposed. Further, SEBI in its Board meeting dated 15th February, 2022, discussed the agenda relating to ‘Regulatory Framework for Social Stock Exchanges’[3] which was also considered and approved.

On 15th July, 2022[4], the Central Government in exercise of the powers conferred by sub-clause (iia) of clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (‘SCR Act’) declared “zero coupon zero principal instruments” as “securities” for the purpose of the SCR Act.

Further, pursuant to these developments, on 25th July, 2022, SEBI has amended the following regulations to lay down a framework for SSE –

  1. Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015[5];
  2. Securities and Exchange Board of India (Alternative Investment Funds), 2012[6];
  3. Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018[7].

Amendments to other Acts (as proposed in the Working Group and Technical Group reports) that fall outside the purview of SEBI, such as the Companies Act, 2013, Income Tax Act, 1961, etc. are yet to be made.

[1] https://www.sebi.gov.in/reports-and-statistics/reports/may-2021/technical-group-report-on-social-stock-exchange_50071.html

[2] https://www.sebi.gov.in/sebi_data/meetingfiles/oct-2021/1633606607609_1.pdf

[3] https://www.sebi.gov.in/sebi_data/meetingfiles/feb-2022/1645691296343_1.pdf

[4] https://www.sebi.gov.in/legal/gazette-notification/jul-2022/declaration-of-zero-coupon-zero-principal-instruments-as-securities-under-the-securities-contracts-regulation-act-1956_60875.html

[5] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-fifth-amendment-regulations-2022_61169.html

[6] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-alternative-investment-funds-third-amendment-regulations-2022_61156.html

[7] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-issue-of-capital-and-disclosure-requirements-third-amendment-regulations-2022_61171.html

A Guide to Disclosure on COVID-19 related impacts

/2 Comments/in , , , , /by

| SEBI seeks transparency from listed entities in times of COVID crises

Shaifali Sharma | Vinod Kothari and Company

corplaw@vinodkothari.com

Introduction

The impact of COVID-19 on companies is evolving rapidly not only in India but all over the world. In times of increased volatility and uncertainty in the capital market, detailed information regarding any material impact on the company’s business will not only assist the investors in making informed investment decisions but will also be fundamental formarket integrity and functioning.

Pursuant to the requirements of Listing Regulations, many listed entities have made disclosures, primarily intimating shutdown of operations owing to the pandemic and the resultant lockdowns. However, such probable information may be relatively less relevant and investors are more interested to know where these companies stand today, what are their estimated future impacts, strategiesadopted by these companies for addressing the effects of COVID-19, etc.

Given the information gaps in the market, SEBI, highlighting the importance of timely and adequate disclosures to investors and other stakeholders, issued an advisory[1]on May 20, 2020 (‘Advisory’), asking all the listed entities to evaluate the impact of COVID-19 on their business, performance and financials, both qualitatively and quantitatively, and disseminated the same to the stock exchange.

This article discuss in detail the disclosure requirements under Listing Regulations and provides a quick guide for the listed entities in evaluating and disclosing impact of pandemic on their business.

Existing disclosure norms under Listing Regulations on impact of COVID-19

The existing requirements prescribed under Listing Regulations in relation to the disclosure of impact of COVID-19 on listed entities are summarized below.The same is applicable to the following entities:

  • companies listed with specified securities i.e. equity shares and convertible securities
  • companies listed with Non-convertible Debt Securities (NCDs) and/or Non-Convertible Redeemable Preference Shares (NCRPSs)
Entities having specified securities listed Entities having NCDs/NCRPS listed
What is the disclosure requirements prescribed under Listing Regulations?
The events can be divided into two broad categories a. Deemed Material Events and b. Material Events based on application of materiality criteria as provided in Regulation 30(4).

In the first category, the events specified in Para A of Part A of Schedule III get covered and requires mandatorily disclosure on the occurrence and in the second category, events under Para B are disclosed based on the application of the guidelines for materiality prescribed under sub-regulation (4) of Regulation 30.

 Unlike Regulation 30, Regulation 51 does not provide for any test of materiality.

Part B of Schedule III requires disclosure of all information either,

  • having bearing on the performance/ operation of the listed entity; or
  • is price sensitive; or
  • shall affect the payment of  interest/ dividend on NCDs/ NCRPSs; or
  • shall affect the  redemption of NCDs/ NCRPSs.
Whether disclosure on COVID impact required by Listing Regulations?
Yes.

Disclosure w.r.t. disruption of operations of any one or more units or division of a listed entity due to natural calamity (earthquake, flood, fire etc.), force majeure or events such as strikes, lockouts etc. falls under second category.

Therefore, disruption of operations due to COVID-19 is required only if the same is considered material after applying the materiality guidelines.

 Yes.

Since disruption caused by COVID may be said to have the aforesaid effects.
What are the actionables as per Listing Regulations?
In terms of sub- regulation (5) of Regulation 30, the Board of Directors (BoD) is required to authorize one or more KMPs for the purpose of determining materiality. Therefore, such authorized KMP(s) shall determine if the impact of COVID on company’s operations is material based on the criteria prescribed under sub-regulation (4) and the policy framed by company for said purpose.

On determination of the materiality, the same shall be disclosed to stock exchange and also host the disclosure on company’s website.

 For this category of companies, the law does not provide for the similar requirements as provided for companieshaving specified securities listed eg. framing of policy, determination of materiality by Board authorized person etc. Therefore, the disruption caused by COVID-19 shall be intimated to the stock exchanges(s) as per Regulation 51 of the Listing Regulations.

In this case, disclosure on website is not mandatory; however, company may do so for better reach of information to investors and stakeholders.
When is the disclosure required?
Regulation 30 provides for disclosure as soon as reasonably possible, but not later than 24 hours from the occurrence of the event. The guidance on when an event is said to have occurred has been provided in SEBI Circular[2] dated September 09, 2015. In terms of the said Circular, the same would depend upon the timing when the listed entity became aware of the event/information or as soon as, an officer of the entity has, or ought to have reasonably come into possession of the information in the course of the performance of his duties. Regulation 51 provides for prompt dissemination i.e. as soon as practically possible and without any delay and that the information shall be given first to the stock exchange(s) before providing the same to any third party.
What all disclosures have been suggested by SEBI vide its Circular dated September 09, 2015?
As per SEBI circular dated September 09, 2015, companies shall disclose:

At the time of occurrence of disruption:

  • expected quantum of loss/ damage caused at the time of occurrence of the event;
  • whether loss/damage covered by insurance or not including amount
  • estimated impact on the production/operations
  • factory/unit where  the  lock  out  takes  place  with reasons

Regularly, till complete normalcy is restored

  • Insurance   amount   claimed   and   realized   by   the   listed   entity   for   the loss/damage;
  • actual amount of damage caused
  • details of steps taken to restore normalcy and impact on production/operations, financials of the entity
 Though the said Circular refers to only Regulation 30, however, the same requirements should apply to this category of companies also which should additionally disclose the impact on servicing of interest/ dividend/ redemption etc.

Similar disclosure requirement are prescribed for entities which has listed its Indian Depository Receipts, Securitized Debt Instruments and Security Receipts where all information which is price sensitive or having bearing on the performance/ operation of the listed entity and other material event as prescribed under Chapter VII, VIII, VIIIA read with Schedule III of the Listing Regulations shall be disclosed

Disclosure requirements as per SEBI Advisory

As mentioned earlier, SEBI Advisory is an addition to the above requirements of Listing Regulations. Though, one may argue that the Advisory is recommendatory in nature and it does not mandate the companies to make the disclosure, however, in our view, the same is not a mere recommendation. Keeping this in mind, the probable questions that one can have with respect to SEBI Advisory have been captured below:

What is the intention of the SEBI behind issuing such Advisory?

As mentioned in the SEBI Advisory, the outbreak of COVID-19 pandemic and the consequent nationwide lockdown has lead to distortions in the market due to the gaps in information available about the operations of a listed entity and therefore, it is important for a listed entity to ensure that all available information about the impact of pandemic on the company and its operations is communicated in a timely and cogent manner to its investors and stakeholders.

These disclosures ensure transparency and will provide investors an opportunity to make an accurate assessment of the company. So, the idea behind the disclosures is to give an equal access to the information to all the stakeholders at large.

Which all entities are covered by SEBI Advisory?

Due to the COVID-19, a global pandemic, all kinds of businesses are impacted in one way or another. Unlike the Listing Regulations, SEBI Advisory does not differentiate the disclosure requirements for the companies listed with specified securities and companies listed with NCDs/NCRPS, and the Advisory is applicable to all the listed entities.

Whether the requirements of Advisory are mandatory for listed entities?

Considering the purpose of making fair and timely disclosure of any material impact on the companies, the disclosures as mentioned in the Advisory shall be treated as mandatory in nature.

Whether disclosure required if the thresholds as set out in company’s materiality policy are not met?

The materiality of an event is generally measured in terms of thresholds laid down by the companies in their ‘policy for determination of materiality’ however, such criteria should not be considered as an absolute test to determine the materiality of an event like COVID pandemic

In times of the ongoing crises, investors would be interested to know all the inside information about the impact of pandemic on the company’s business operations, financial results, future strategies, etc. i.e. every qualitative or quantitative factors.

Since every person is doing an assessment of the impact of the crisis, it is intuitive to say that the management of the companies must also have done some assessment. Considering that the idea is to provide general and equal access to the information to all the stakeholders at large, the management must disclose every positive/negative/neutral impact of the crises on the company, irrespective of the fact that it qualifies the prescribed materiality threshold or not.

What if there no impact on the business caused by the pandemic? Whether the same is also required to be disclosed?

In our view, not getting affected by the pandemic at the time when the entire world is otherwise getting affected is also material. Therefore, the disclosure shall have to be made.

Further, it is not always necessary that the pandemic will have to have a negative impact e.g. decrease in sales volume. For example, companies in pharmaceutical sector or in the sector of manufacturing of essential items such as, mask, sanitizer etc. will have a boost in sales, thereby carrying a positive impact on them.

Whether Board meeting is required to be conducted in this regard? Or will the company be required to wait till the Board decision to make the disclosure?

While an internal assessment is required at the management level, however, a Board meeting is not mandatory to be conducted. Yes, the estimates already made may be changed at a later stage which may be disclosed at that stage again.

Is it ok to say for the management to take a position that they have not analyzed the impact of the crisis?

Considering the current risk and challenges as a result of COVID-19, it is very unlikely to say that companies have not done any internal assessment to determine the current and potential impact on the company’s financial and business operations.

What are the steps involved in making the disclosure?

Step 1: Evaluate the impact of the pandemic on the business, performance and financial

Before making any disclosure to the stock exchange(s), the management of the company must properly assess the impact of COVID-19 on its business, performance and financials, both qualitative and quantitative impact.

Step 2: Dissemination of impact of pandemic to stock exchange

The following information shall be disseminated to the stock exchange:

  1. Impact of the pandemic on the business;
  2. Ability to maintain operations including factories/ units/ office spaces functioning and closed down;
  3. Schedule, if any for restarting the operations;
  4. Steps taken to ensure smooth functioning of the operations;
  5. Estimation of future impact on the operations;
  6. Details of impact on the listed entity’s
    • capital and financial resources;
    • profitability;
    • liquidity position;
    • ability to service debt and other financing arrangements;
    • assets;
    • internal financial reporting and control;
    • supply chain
    • demand for its products/services;
  7. Existing contracts/agreements where non-fulfilment of the obligations byany party will have significant impact on the listed entity’s business;
  8. Any other information as the entity may determine to be relevant and material;

While making the above disclosure to stock exchanges, entities shall also adopt the principle of disclosure and transparency prescribed under Regulation 4(2)(e) of the Listing Regulations.

Who is responsible to evaluate and make disclosures to the stock exchange(s)? What is the role of the Board in the process of assessment and/or disclosure?

  1. Responsibility of KMP(s) as per Listing Regulations

Pursuant to Regulation 30 of the Listing Regulations, the KMP(s), as may be authorized by the Board, is responsible to determine the materiality of the impact of pandemic on the company based on the on the guidelines for materiality and the materiality policy of the company and disclose the same to the stock exchange

  1. Role of Board in the assessment of other material qualitative and quantitative impacts

Considering the language of the Advisory issued by SEBI, in addition to the KMPs authorized to test the materiality, the Board will also have a role in determining the COVID impact as the same requires disclosure in which management intervention may be necessary, e.g. future plans for business continuity, capability of running the business smoothly, material changes expected during the year, impact of the financial position etc.

However, as discussed above, a Board level discussion is not a prerequisite of making the disclosure.

Is there any timeline prescribed for making disclosers to the stock exchange(s)?

There is no specific timeline provided in the Advisory for making disclosures, however, in the present situation, the disclosure is required to be made as soon as an assessment is done on the probable impact by the management.

Whether the disclosures a one-time requirement for the listed entities?

Since the operations of the company will recommence soon, question arises if the companies should continue with its assessment and disclosure process. As stated in Advisory, to have continuous information about the impact of COVID-19, listed entities may provide regularupdates, as and when there are material developments. Further, since the disclosures will be made based on estimates, any changein those estimates or the actual position shall also be disclosed in regular intervals.

Therefore, disclosure is required not only at the time of occurrence but also on a continuous basis till the normalcy of the situation.

Whether impact on an unlisted subsidiary company shall also be disclosed? 

To get an overall view of company’s performance, we always evaluate consolidated figures. Sometimes, company’s standalone performance is strong as compared to its performance at consolidated level. Accordingly, if the pandemic’s impact on unlisted subsidiary is such that it is having a material impact at the group level, the same shall be disclosed to the stock exchange.

Whether effects of COVID-19 be also reported in Financial Results?

In the coming days, companies will be disclosing their quarterly and yearly financial results. This time, however, investors will be interested inknowing the impact of COVID-19 on the company’s financial positions. Therefore, while submitting financial statements under Regulation 33 of the Listing Regulations, companies should mention about the impact of the CoVID-19 pandemic on their financial statements.

What will be the consequences for not complying with the SEBI Advisory?

Since no separate penal provisions are prescribed under the Advisory, non- compliance of the same may not lead to any penal consequences.

What is the global position as regards disclosure of COVID impact?

Market regulators worldwide have taken various steps to ensure transparency related to the impacts of the pandemic on the listed companies. In United States, the Securities Exchange Commission has issued guidance[3] regarding disclosure and other securities law obligations that companies should consider w.r.t the COVID-19 and related business and market disruptions. Similarly, for listed companies and auditors in Hong Kong, the Securities and Futures Commission and the Stock Exchange of Hong Kong Limited issued a joint press release[4] in relation to the disclosure requirements in response to the COVID-19 outbreak

Our write-up giving an insightful analysis on the said SEBI advisory drawing an inference from the global perspective can be viewed here

What kind of information be disclosed to the stock exchange?

The table below is a quick guide for the listed entities in determining and disclosing the impact of COVID-19 on their businesses:

 

Sr. No. Subject of Assessment and Disclosure Broad Contents (Illustrative list)

 
I.                     Current status (both financial and operating status)

 
  • Status of closure and reopening of branches/units/ stores in different parts
  • Areas in which the company is operating
  • Current liquidity position
  • Impact on productions, sales, profits, stock prices, credit rating, assets, etc.
  • Internal financial reporting and control
  • Impact in capital and financial resources
  • Current trading and outlook
  • Impact on working staff
  • Layoffs during the period
  • Areas of business most impacted
  • Status of business in other countries (say China)
  • Delay of important projects
  • Suspension of dividends
  • Impact of Government imposed measure/restrictions (e.g. for logistic companies, border closures may impact ability to operate)

 
II.                  Steps taken to address effects of COVID Steps taken to:

  • reduce business/operating cost or cost cutting measures adopted
  • conserve cash and ensure liquidity
  • secure safety of employeesensure business continuity
  • address the immediate impact and ensure future positioning
III.               Future operational and financial status (estimates)
  • Estimation of future impact on the operations
  • Estimated trends in demand for its products/services
  • Expected financial resource needsFuture expectations of financial and operating conditions
  • Any material impairment (e.g. impairment of goodwill)
  • Forecasts for the year
  • Material changes expected during the year
  • Business continuity plans
  • Future operating/ financial long-terms or short-term  strategies to address future risk/challenges
  • Other forward-looking disclosures
IV.               Company Specific Focusing on the sectors in which the company deals in, the impact of crises varies from company to company and shall be assessed accordingly. For example:

  • Closure of unit/factory/company
  • Breach of contract significantly impacting the company’s business

 

The above list is illustrative but not exhaustive and each company will need to carefully assess COVID-19’s impact and related material disclosure obligations.  

Concluding Remarks

In light of the effects and uncertainties created by COVID-19, disclosure about shutdowns and safety measures against COVID will not help the investors in making an informed assessment about the company’s financial position. Timely and adequate information about company’s current operational and financial status with future plans to address the effects of COVID-19 will better equip the investors to make an investment decision. Therefore, the Advisory should not be considered as a mere recommendation of SEBI as a transparent communication by the companies will allow the investors and other stakeholders to evaluate current and expected impact of COVID-19 on company’s businesses, financial and operating conditions and future estimated performance.

[1]https://www.sebi.gov.in/legal/circulars/may-2020/advisory-on-disclosure-of-material-impact-of-covid-19-pandemic-on-listed-entities-under-sebi-listing-obligations-and-disclosure-requirements-regulations-2015_46688.html

[2]https://www.sebi.gov.in/legal/circulars/sep-2015/continuous-disclosure-requirements-for-listed-entities-regulation-30-of-securities-and-exchange-board-of-india-listing-obligations-and-disclosure-requirements-regulations-2015_30634.html

[3] https://www.sec.gov/corpfin/coronavirus-covid-19

[4] https://www.hkex.com.hk/-/media/HKEX-Market/Listing/Rules-and-Guidance/Other-Resources/Listed-Issuers/Joint-Statement-with-SFC/20200204news.pdf

Other reading materials on the similar topic:

  1. ‘Listed company disclosures of impact of the Covid Crisis: Learning from global experience’ can be viewed here
  2. ‘Resources on virtual AGMs’ can be viewed here
  3. ‘COVID-19 – Incorporated Responses | Regulatory measures in view of COVID-19’ can be viewed here
  4. Our other articles on various topics can be read at: http://vinodkothari.com/

Email id for further queries: corplaw@vinodkothari.com

Our website: www.vinodkothari.com

Our Youtube Channel: https://www.youtube.com/channel/UCgzB-ZviIMcuA_1uv6jATbg