In a far-reaching decision, the Securities and Exchange Board of India has ruled in an adjudication order that members of the board of directors of a listed company (“Target Company”) would be persons having control of the Target Company. Consequently, directors of the Target Company ought to make disclosures of their holdings under the disclosure requirements set out in the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (“Takeover Regulations”).
Adjudication proceedings had been initiated against members of the board of directors of Matra Realty Limited, the Target Company, for failure to comply with disclosure requirements under Regulation 6(3) in 1997 and Regulation 8(2) of the Takeover Regulations. The noticees took a stance that the Target Company did not have promoters and it was a board-driven company. Moreover, the members of the board of directors did not have a controlling stake in the Target Company, and therefore, they were not in control over the Target Company. Therefore, it was argued that there was no obligation to disclose any promoter shareholding in terms of Regulation 6(3) and Regulation 8(2) of the Takeover Regulations.
Regulation 6(3) of the Takeover Regulations reads as under: –
“A promoter or any person having control over a company
shall within two months of notification of these Regulations disclose the number
and percentage of shares or voting rights held by him and by person(s) acting in
concert with him in that company, to the company.”
(Emphasis Supplied)
Regulation 8(2) of the Takeover Regulations reads as under: –
“A promoter or every person having control over a company shall, within 21
days from the financial year ending March31, as well as the record date of the
company for the purposes of declaration of dividend, disclose the number and
percentage of shares or voting rights held by him and by persons acting in
concert with him, in that company to the company.”
(Emphasis Supplied)
It will be seen that two phrases are used in these provisions – “promoter” and “persons having control over a company”. The term “promoter” is itself defined in Regulation 2(1)(h) of the Takeover Regulations as a any person who is control over the company and any person named in a securities offer document or in a filing with stock exchanges as a “promoter” of the Target Company.
In the order, SEBI has ruled that since the Target Company was a board-managed company, the directors alone could have exercised control over the Target Company. Therefore, their own shareholding ought to have been disclosed since they were “persons having control over a company”.
SEBI took note of the definition of the term “control in Regulation 2(1)(c) of the Takeover Regulations, which is as under:-
“control” shall include the right to appoint majority of the directors
or to control the management or policy decisions exercisable by a person or
persons acting individually or in concert, directly or indirectly, including by
virtue of their shareholding or management rights or shareholders agreements or
voting agreements or in any other matter.
(Emphasis Supplied)
SEBI has also cited the definition of “control” in the Black’s Law Dictionary, 8th Edition, which is as follows: –
“the direct or indirect power to direct the management and policies of a
person or entity, whether through ownership of voting securities, by contract,
or otherwise; the power or authority to manage, direct or oversee”.
(Emphasis Supplied)
The SEBI order notes that “any person who controls the management of a company either individually or collectively with other persons or controls or influences the policy decisions by virtue of his position, can be said to be in ‘control’ over the affairs of the company. In the present case, the Noticee was a part of the Board of Directors which controlled the affairs…..A director is one of the controllers of the company’s affairs. The Board of Directors is the brain and the company is the body. The company can and does act only through the Board. When the brain, i.e., the Board, functions, the company, i.e. the body, is said to function. Thus, the functioning of the company is totally controlled and directed by the Board.”
SEBI noted that the Target Company was a board-managed company, the board had only three directors at the relevant time, and these directors along with persons acting in concert indeed held shares at the relevant time. SEBI has ruled that being “persons having control over” the Target Company, the three directors ought to have made their disclosures under Regulation 6(3) and Regulation 8(2) of the Takeover Regulations. For failure to make such disclosure, monetary penalty has been imposed.
The decision has implications not only for board-managed companies that do not have promoters (for example, ICICI Ltd. and Larsen & Toubro), but also for every listed company in which directors have any shareholding. One is not sure if these companies even aggregate the shareholding of all directors and disclose their shareholding under Regulation 8(2) of the Takeover Regulations.
Now that SEBI has given this ruling, every listed company would have to report the shareholding of its directors under the head “persons having control” – quite distinct from the holding of the “promoters.
As long as the judgment is read in the context of disclosure requirements, it may make some sense. But, if one extends the logic further, does it mean that change in Board will also lead to change in control under the Takeover Code? If that be the case, then change in Board each time will have to be accompanied with a Public Announcement. That seems ridiculous.
Because the expression “control” is defined inclusively,The SEBI is (ARGUABLY) right in asking the Directors on Board the Companies to make the disclosures under the relevant regulations.
Although, it is clearly a jurisprudential fallacy to mistake “Right” and “Power”.
The latter generally is a rough proxy for discretion that is conferred to carry out some responsibility.
The Directors have “Power” to influence the management and policy of the Company; that power is derived from being fiduciaries of the corporation. Further the origin of this “Power” is the Companies Act. One may by way of illustration point to Section 291 that speak of “Powers of the Board”.
A “Right” is distinct and different from “Power”.
If we analyse the definition of “control” in the Code, it refers to “Right” to appoint majority of directors; the “Right” to influence policy etc.
Further this “Right” can emanate from voting agreements, share holding agreement or in any other manner as the Code tells us.
The regulator seems oblivious to this distinction betweeen “Power” and “Right”; A Distinction that the CA, 56 itself recognises. (for e.g.S/291 as pointed out above) and therefore is wrong in construing the law of disclosure in the take over code so as to include Directors as well.
But as Economics of agency costs tells us, this is only natural; the delegate of the sovereign will look to appropriate as much power as it can.(and impose agency costs on its principal) And so, the fiat of dislosing Director’s share holding (as well) will necesarily follow.
One hopes that sooner or later this issue is settled by the SAT clarifying this technical but nonetheless vital difference between “Power” and “Right” and set the course right. One has seen enough of SEBI’s expansive interpretations.
Thanks.