The rules introduced earlier this year by the Securities and Exchange Board of India (“SEBI”) that impose restrictions on profit sharing arrangements in respect of listed companies have already provoked interpretational controversies. In an earlier informal guidance (relating to Accelya Kale Solutions Limited), SEBI clarified profit sharing arrangements that involved employees being provided benefits that emanated from the performance of a group of companies as a whole (and not solely that of the listed company) did not fall within the purview of rule 26(6) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the “LODR Regulations”) that impose the restrictions. However, in a guidance published yesterday (in relation to Mphasis Limited), SEBI took a rather expansive view of rule 26(6) and clarified that it applies to employees of an unlisted subsidiary.
The recent case involved the divestment by the HP/EDS group of its shares in Mphasis Limited, a company listed on Indian stock exchanges. Certain eligible employees of Mphasis as well as employees of unlisted subsidiaries of Mphasis, most of which were foreign incorporated, were entitled to certain incentives based on the exit of HP/EDS from Mphasis. While Mphasis proposed to comply with regulation 26(6) as far as its own employees are concerned, it sought SEBI’s guidance on the applicability of the provision to the employees of the unlisted subsidiaries. The company’s argument was that the regulation applies only to employees of a listed company, and that the requirements of disclosure and transparency apply largely to listed companies and not to unlisted entities.
However, SEBI responded unfavourably to the request for informal guidance, stating as follows:
“… our view is that employees of the subsidiary of the listed entity would fall under the scope of Regulation 26(6) of LODR Regulations, 2015. Therefore, the payments of amount by HPE to eligible subsidiary employees would also fall within the scope of Regulation 26(6) of LODR Regulations.
Unfortunately, SEBI’s cryptic response is shorn of any reasoning, thereby leaving one to surmise the rationale for its conclusion.
It is useful here to extract the relevant portions of regulation 26(6):
No employee including key managerial personnel or director or promoter of a listed entity shall enter into any agreement for himself or on behalf of any other person, with any shareholder or any other third party with regard to compensation or profit sharing in connection with dealings in the securities of such listed entity, unless prior approval for the same has been obtained from the Board of Directors as well as public shareholders by way of an ordinary resolution:
…
[Emphasis supplied]
At least two requirements need to be satisfied before the regulation can be invoked. The first is that the key managerial personnel, director or promoter must be that “of a listed entity”. Here, the argument was that the employees of the unlisted subsidiaries do not qualify this criterion. Of course, there is phraseology to suggest an employee of a listed entity may “enter into any agreement for himself or on behalf of any other person”. However, it is nobody’s case that in this case the employees of Mphasis entered into the agreement on behalf of the employees of the subsidiaries. The subsidiaries’ employees likely entered into the agreements on their own. Hence, this limb does not stand satisfied on the face of it.
The second limb relates to the fact that the profit sharing must relate to the dealings in the securities of a listed entity. In this case, even though the employees of the subsidiaries were entitled to the incentive, that was benchmarked to the exit event relating to Mphasis shares, i.e., that of a listed company. Hence, this limb stands satisfied.
In the earlier case relating to Accelya Kale, SEBI examined the text of regulation 26(6) and came to the conclusion that the second limb was not satisfied in that case, namely that the profit sharing did not pertaining to dealing in shares of the listed entity. In the present case, however, SEBI has adopted an expansive approach by invoking the regulation even through the situation does not satisfy the first limb, at least textually. In its interpretation (devoid of reasoning), SEBI seems to have equated a listed company with its subsidiaries as well. In other words, SEBI has gone by the spirit of the regulation than the text. Whether such an approach is legally sustainable or not is another question. If an expansive interpretation was indeed the intention, perhaps it is best rectified through an amendment rather than resolved (in the interim) through unreasoned guidance.