decisions taken at SEBI’s board meeting escaped attention until some recent
discussion in the financial press (here
and here).
The relevant paragraph in SEBI’s press
release is as follows:
entities shall frame employee benefit schemes only in accordance with SEBI
(ESOS and ESPS) Guidelines, 1999. Entities whose schemes are not in
conformity with the same would be given time to align with the said
Guidelines. Further, such schemes will be restrained from acquiring their
shares from the secondary market.
reasons generally propounded for SEBI’s ban include the following:
risk of stock manipulation, resulting in possible fraudulent and unfair trade
practices;
utilisation of company funds to make these acquisitions, since funding employee
welfare trusts constitutes an exception to the rules against financial
assistance;
lack of clarity in the SEBI guidelines on employee stock options and stock
purchases on whether they apply to secondary market acquisitions by employee
welfare trusts; and
lack of consistency on whether holdings of shares by such trusts fall within
promoter shareholding or not.
raises important issues regarding the use of employee welfare trusts. First, it is possible to utilise the
company’s funds to acquire shares in these trusts, since this constitutes an
exception under section 77, proviso (b) of the Companies Act. There is no limit
as to the amount that can be paid over by the company for such acquisition. Second, much would depend on the manner
in which the trust is constituted and managed. For example, if the trustees are
entirely independent, that would lend a certain amount of credence to the
process. However, if the trustees are largely the managers or promoters of the
listed company, that would give rise to issues regarding corporate governance.
legal perspective, there could be two issues that emerge. The first is what
SEBI seems from press reports to have zeroed in, which is the issue of price
manipulation. In case there is a close connection between the trustees and the
listed company’s management, that concern could be fairly valid. However, it is
not clear if a blanket ban by SEBI against all acquisitions is necessary and
warranted. SEBI may always initiate actions in specific cases under the SEBI
(Fraudulent and Unfair Trade Practices) Regulations. While this extreme step of
SEBI may have been occasioned due to reasons such as possible extensive use (or
abuse) of the employee welfare trusts, it has the incidental (and perhaps
unintended) consequence of affecting bona
fide trusts as well.
The second concern, which has arisen in other
jurisdictions too, is the possible use of the employee welfare trusts to shore
up holdings in the listed companies, which would effectively operate as a
takeover defence in favour of the promoters. This concern is valid in the
context of SEBI’s finding that there is no consistency in the disclosures made
by the trusts, i.e. whether they are treated as part of the promoter group or
not (particularly for disclosures made under the SEBI Takeover Regulations).
Moreover, this would also strike at the heart of directors’ duties, and whether
the board has acted “for proper purpose” in the establishment of the trusts.
Although the jurisprudence on this count is scant in India, there are landmark
rulings in the UK (e.g. Hogg v. Cramphorn,
[1967] Ch 254 – also Howard Smith v.
Ampol Petroleum, [1974] AC 821, although the latter was not in the context
of employee welfare schemes).
“Although the jurisprudence on this count is scant in India, there are landmark rulings in the UK (e.g. Hogg v. Cramphorn, [1967] Ch 254” – right. In India, sometimes these trusts may have been used in conjunction with a Scheme of Compromise and Arrangement approved by the respective High Court. In 2008, RIL held 70% stake in RPL, which was transferred to the Petroleum Trust. Later, RPL was merged with RIL, and the Trust received RPL shares as part of the Scheme. In practice, RIL as well as the media seems to treat the Trust holding as treasury stock, not permitted in India. http://business-standard.com/india/news/ril-to-resume-treasury-stock-sale-soon/404326/
In May 2012, Escorts proposed a complex Scheme for the merger of its subsidiaries / associate companies, again using the Welfare Trust structure. At least two proxy advisory firms issued `against’ recommendation, holding this to be an indirect way of increasing promoter control. I don’t know if this passed in the AGM. http://www.moneycontrol.com/news_html_files/news_attachment/2012/Escorts%20Limited%20CCM%2020%20May%202012.pdf and http://www.moneycontrol.com/news_html_files/news_attachment/2012/Escorts%20Restructuring%20-%20InGovern%20CG%20Alert.pdf
This seems to be problematic on two counts – unlike the Hogg case, where fresh shares were issued to the Trust, this method is complex, and the motive may not be transparent to some investors. Also, since the Scheme is approved by High Court, I’m not sure if SEBI can do anything about it.
The Escorts case is particularly instructive since this company was the target of one of the earliest hostile takeover bids in India – by Swaraj Paul in the 80s. Then, Escorts promoters survived the scare as the Public Financial Institutions (PFIs) held 60% stake. The huge PFI holding itself acted as an effective anti-takeover defense for many promoters.
-Mangesh Patwardhan