Once a promoter always a promoter?

Shareholders in a listed company are classified under two broad categories, i.e. those that belong to the promoter/promoter group and those shareholders who are members of the public with no family or formal business ties with the promoter/promoter group. SEBI vide Regulation 31A under Chapter IV of Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“SEBI LODR Regulations 2015”) has allowed the reclassification of a shareholder from promoter category to public category and vice versa. The Regulation 31A requires shareholders’ approval for reclassification of a promoter as public shareholder, except in case of acquisition of the promoter’s stake through transmission/succession/inheritance. However recently M/s. Alembic Pharmaceuticals Limited has sought guidance from SEBI under the SEBI (Informal Guidance) Scheme, 2003 wherein SEBI has taken a view that the company may not be required to obtain approval of the shareholders for the proposed reclassification.

To analyse the subject, it would be necessary to understand the term ‘Promoter’, ‘Promoter Group’ stipulated under Regulation 2 (1) (za) and Regulation 2 (1) (zb) of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 respectively and the spirit of Regulation 31A of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

‘Promoter’ and ‘Promoter Group’

“promoter” includes:

person/s who are in control of the issuer;
person/s who are instrumental in the formulation of a plan or programme  pursuant to which specified securities are offered to public;
person/s named in the offer document as promoters:
If a director or officer of the issuer or a person, is acting as such merely in his professional capacity, shall not be treated as promoter.

“promoter group” includes:

the promoter;
an immediate relative of the promoter (i.e. any spouse of that person or any parent, brother, sister or child of the person or of the spouse); and
in case promoter is a body corporate:
a subsidiary or holding company of such body corporate;
any body corporate in which the promoter holds 10% or more of the equity share capital or which holds 10% of the equity share capital of the promoter;
any body corporate in which a group of individuals or companies or combinations thereof which hold 20% or more of the equity share capital in that body corporate also holds 20% or more of the equity share capital of the issuer; and
in case the promoter is an individual:
any body corporate in which 10% or more of the equity share capital is held by the promoter or an immediate relative of the promoter or a firm or Hindu Undivided Family in which the promoter or any one or more of his immediate relative is a member;
any body corporate in which a body corporate referred in (A) above holds 10% or more, of the equity share capital;
any Hindu Undivided Family or firm in which the aggregate shareholding of the promoter and his immediate relatives is equal to or more than 10% of the total; and
all persons whose shareholding is aggregated for the purpose of disclosing in the prospectus under the heading "shareholding of the promoter group"
It is to note that a financial institution, scheduled bank, foreign institutional investor and mutual fund shall not be deemed to be a Promoter / Promoter Group merely by holding 10% or more of the equity share capital of the issuer. However, they would be treated as Promoter / Promoter Group for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them;

Regulation 31A of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.

A promoter’s shareholding may be reclassified and can become public shareholding in three situations, i.e. (a) when there is a change in the promoter subsequent to an open offer or in any other manner pursuant to SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011; or (b) due to transmission /succession/inheritance; or (c) when a company becomes professionally managed with no identifiable promoter.

In case of reclassification of promoter’s stake into public under (a) and (c) above, following conditions are required to be followed:

Approval of Shareholders to be obtained in General Meeting
Any special rights held by the promoter through any formal or informal arrangement or any shareholder agreement shall be discontinued
If the shareholder’s resolution has authorised the promoter or his relative to act as a Key Managerial Personnel (KMP) of the entity, pursuant to the provisions of the Companies Act, 2013, the appointment will be maximum up to 3 years from the date of resolution.
In case of (a) above, a promoter can hold maximum upto 10% of paid up equity capital of the entity along with Promoter Group /Persons in concert (PAC), after reclassification as public shareholder.

In case of (c) above, a promoter can hold maximum upto 1% of paid up equity capital of the entity along with Promoter Group /Persons in concert (PAC), after reclassification as public shareholder, including any holding of convertibles/outstanding warrants/Depository Receipts. However, any mutual fund, bank, insurance company, financial institution, foreign portfolio investor may individually hold up to 10% paid-up equity capital of the entity including any holding of convertibles/outstanding warrants/Depository Receipts.

Other conditions for promoter undergoing reclassification due to change of promoter or due to company becoming professionally managed.

Promoter will have no direct or indirect control over company’s affairs
Increase in the level of public shareholding due to this reclassification will not be counted for fulfilling 25% minimum public shareholding criteria prescribed under Rule 19A of the Securities Contracts (Regulation) Rules, 1957.
Intimation to Stock Exchange is required to be given about the reclassification, being material event.
The Regulation also empowers SEBI to relax any of the above condition if it is satisfied that outgoing promoter or PAC will not be exercising any control over the entity.

Waiver to Alembic Pharmaceuticals from Shareholders’ approval

M/s. Alembic Pharmaceuticals Limited had sought guidance from SEBI under the SEBI (Informal Guidance) Scheme, 2003 vide its letter dated September 21, 2016 regarding requirement of shareholder approval for reclassification of shareholding from promoter group to public category. Their submission was based on the fact that 5 out of 25 persons who were part of the promoter group were desirous of reclassification of their shareholding from promoter group to public category who were not directly or indirectly connected with any activity of Alembic as they were senior citizens leading their lives and occupations independently. Other reasons given for reclassification were that such persons never held any position of key managerial personnel in Alembic and they did not have any special rights through formal or informal arrangements with Alembic or any person in the promoter group, etc. After the reclassification, the promoter group shareholding was to be at 72.68%. In this matter, SEBI vide its interpretative letter of opinion dated October 17, 2016, under the SEBI (Informal Guidance) Scheme, 2003 clarified that shareholder’s approval is not required for reclassification of shareholding from promoter group to public category. Our observation is that as reclassified promotor persons are not privy to information of the company, any insider trading regulations, requirement relating to promoters for fresh issue etc should not be applicable to such reclassified promoter persons. Just to be fair to small and public shareholders and also to maintain enough liquidity in the market, those reclassified promoters will continue to be considered as promoters for the said limited purpose and in all other cases they will be non-promoters.

SEBI in the said letter to Alembic also stated that different facts or conditions might lead to a different result. It mentioned that the letter does not express a decision of SEBI on the questions referred. SEBI considered the fact that the entities who wished to be re-classified are senior citizens and are not holding any control over the affairs and management of the Alembic.

SEBI’s view in this regard was that the company may not be required to obtain approval of the shareholders for the proposed reclassification. However, such reclassification may be allowed by the stock exchanges under Regulation 31A (2) and (3) of the Listing Regulations subject to compliance of the Regulation 31A.”

Uday Kotak Committee’s review of the subject

Recently, the Uday Kotak Committee appointed by SEBI to look into corporate governance issues, came out with a recommendation on this issue. It stated that where there is no identifiable promoter/promoter group, the 1 % threshold to be able to classify the entity as professionally managed is too low. It argued for increasing this to 10 % for the following reasons:

From the listed entity’s perspective, if a promoter along with the group in aggregate holds less than 10%, it is unlikely to be able to exercise de facto
From the promoter’s perspective, even after ceasing to be in control, a ‘promoter’ may want to continue as a financial investor with a shareholding of more than 1 %. In such cases, he/she should not be required to reduce his/her shareholding to 1 per cent or lower just to be declassified from promoter category
The Committee also opined that there ought to be a mechanism to enable such reclassification, to ensure that persons who may have been promoters but are no longer involved in day-to-day control and management and have a low shareholding, should have an “opt-out” option from being classified as “promoters.”

Conclusion

With this development of issuance of informal guidance by SEBI, following can be concluded:

SEBI has taken this view of allowing relaxation considering the control aspect of the Company’s management as persons’ whose shareholding is reclassified never had any control nor they were participating in the management hence it is ensured that the control is not going to shift consequent to the said reclassification. The said relaxation is not available if it is proposed to appoint the promoter as a KMP up to a further period up to 3 years as stipulated in Regulation 31A.
Waiver offered by SEBI from the requirement of obtaining of Shareholders’ approval in General Meeting will help the Listed entity and the promoter to save procedural time and cost.

If a promoter’s stake is acquired through transmission/succession/inheritance leading to reclassification of the promoter’s shareholding into public, no condition under Regulation 31A is required to be observed.

This reclassification window will not help to raise the public shareholding to its minimum required limit of 25% as prescribed under Rule 19A of the Securities Contracts (Regulation) Rules, 1957.

Which special rights will be discontinued after the reclassification of promoter holding into public is not yet clarified by SEBI or Stock Exchanges and hence what would be the status of the promoter after the said reclassification is yet to be established.
Under the Companies Act, 2013 what would be the liability for the said reclassified Promoter for any untrue statement given in the prospectus issued for issue of securities in terms of Section 35, what would be the liability of the said promoter in terms of NCLT Order for his examination pursuant to Section 300 & 317, is yet to be established.

SEBI Takeover Code requires promoter to comply with Transitional, Event Based, Annual and Pledge Disclosures with Target Company and Stock Exchange, which whether required to be made by the Promoter reclassifying his holding to Public is not yet clear. Further, whether compliance requirement of various initial and continuous disclosures to be made by promoters under Insider Trading Regulations including dealings restrictions during the period of closure of trading window, will be applicable to the promoters reclassifying holding to public, is yet to be established.

This clarification by SEBI assumes particular significance considering the recent trend observed as emerging in the country whereby several promoters in various companies want to re-classify their shareholding from promoter group to public category. Promoters not involved in the day-to-day operations of companies would like to re-classify themselves as public shareholders. The purpose behind such reclassification is clear, to avoid the constant legal scrutiny and be exempt from possible litigation on charges like insider trading and other legal responsibilities involving the company. This trend will now intensify with the SEBI informal guidance that shareholders' approval is no longer required for re-classification of promoter group members to public category.

Though listed entities and their concerned Promoters may now be in a position to go for such a reclassification from promoter to public without obtaining Shareholder’s approval, there should be a mechanism, where if any shareholder has any objections to the classification, he/she shall be allowed to air his/her grievance. Stock Exchanges can create a window (say, one month from the request received from promoters) for minority shareholders to raise their grievances.