[Shikha Rawal is an Associate at a law firm in Mumbai. The views in this post are personal.]
In June this year, the Securities and Exchange Board of India (“SEBI”) constituted a committee under the Chairmanship of Mr. Uday Kotak (“Kotak Committee”) to propose reforms to regulations governing listed companies. After careful deliberations, the Kotak Committee submitted a report on October 5, 2017 (“Report”). The purpose of the Report is to enhance the standards of corporate governance of listed companies in India.
The present critique of the Report is based on the issue relating to the sharing of unpublished price sensitive information (“UPSI”) with promoters/ controlling shareholders and the effect thereof. Amendments have been proposed to the following regulations: (a) Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”) by way of insertion of a new chapter IV-A;[1] and (b) Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”), by way of insertion of a new sub-regulation (2A) under Regulation 3 of the PIT Regulations.
Set out below is a key analysis of the proposals laid out by the Kotak Committee in relation to sharing of UPSI.
Sharing of UPSI with Promoters
(a) The current PIT Regulations prohibit an insider from communicating any UPSI unless that communication is found to be in “furtherance of legitimate purposes, performance of duties or discharge of legal obligations.” Apart from the above, the PIT Regulations do not explicitly permit a listed entity to share UPSI with the promoter of the company.
(b) By way of an amendment to the LODR Regulations, the Report proposes three classes of persons to whom a listed entity may provide access to material information (including UPSI), namely, any person who:
(i) qualifies as promoter of the listed entity and holds, by itself or together with the members of the promoter group, shareholding of more than 25% in the listed entity;
(ii) is in direct or indirect control[2] of the person specified in point (i) above; or
(iii) has nominated a director on the board of directors of the listed entity.
(c) The Report proposes an amendment to the PIT Regulations, pursuant to which it will be deemed that sharing of UPSI as aforesaid shall be “in furtherance of legitimate purposes”.
Under the extant PIT Regulations, for sharing of UPSI, a listed entity is required to meet the ‘legitimate purpose’ test, which is subjective and determined on a case-to-case basis. Pursuant to the amendment proposed to the PIT Regulations, the legitimacy of the purpose for sharing UPSI will not be required to be tested. This will reduce the risk of regulatory scrutiny on the listed entity and the insider. The amendment legitimizes a channel for the constant information flow between the promoters /controlling shareholders and the listed entity.
Terms of Sharing of UPSI
The Report proposes certain conditions for sharing of UPSI by a listed entity with its promoters/controlling shareholders:
(i) The listed entity and the promoter are required to execute an ‘access to information agreement’ (“Agreement”). Such Agreement is required to be for a period of not less than one year.
(ii) The promoter of the listed entity which meets the 25% shareholding threshold and a person in control of such promoter may be provided access to any material information, including UPSI, in accordance with the terms of the Agreement. However, a person who has been nominated as a director on the board of the listed entity may be provided only such material information including UPSI as is shared with the nominee director in the normal course, by virtue of his directorship in the listed entity.
(iii) The Agreement would require the promoter to maintain strict confidentiality of all UPSI and any onward communication of UPSI by the promoter/controlling shareholders is to be in compliance with PIT Regulations.
(iv) The listed entity may unilaterally terminate the Agreement, with the consent of majority of directors of the listed entity, representing three-fourths in number.[3]
(v) The individual representative of the promoter entity who would generally receive the UPSI shall be categorized as “Designated Person”. In other words, the individual representations of the promoter would need to comply with the code of conduct/internal guidelines of the listed entity framed pursuant to the PIT Regulations. Consequently, the Designation Person would (A) not be able to trade during the period when the trading window is closed; (B) need to get a pre-clearance from the compliance officer of the listed entity when the trading window is open; (C) be restricted from undertaking contra-trades; and (D) need to disclose their trades in accordance with the PIT Regulations; and
(vi) The promoter entity may itself get categorized as a “Designated Person” at any time during the subsistence of the Agreement. The decision to categorize the promoter entity as a “Designated Person” shall be the sole discretion of the board of directors of the listed entity.
Nature and Purpose of Sharing UPSI
(a) Pursuant to the PIT Regulations, communication of UPSI is strictly prohibited, except in furtherance of legitimate purpose. Accordingly, in the event of regulatory scrutiny, parties sharing or procuring UPSI are required to demonstrate that such communication was ‘in furtherance of legitimate purpose’, which is determined on a subjective/ case to case basis.
(b) As stated earlier, a deeming fiction has been proposed pursuant to which any UPSI to be communicated will be deemed to be communication or procurement of UPSI “in furtherance of legitimate purposes”.
(c) Excerpts from the rationale provided in the Report indicate scenarios envisaged by the Kotak Committee for the purpose of communication and use of UPSI by a listed entity:
– (In the context of Indian companies)…“Information flow occurs through informal channels, matrix structures and through nominees. Generally, these may be for genuine business reasons, such as strategic transactions, including acquisitions, mergers, divestments, financing, etc., which often require the support of the promoter to be successful.”
– “Given the absence of a formal green channel on information access and an explicit framework recognizing a legitimate right to information of promoters and significant shareholders, all communication of UPSI to promoters and significant shareholders (including those for legitimate purposes and on a need-to-know basis) are open to regulatory scrutiny on a post facto basis.”
– … “this regulatory white space has so far possibly been filled in by virtue of legal interpretation (of terms such as “legitimate purpose”, “need to know”, etc.), market practice and pragmatism. Whilst derivative economic interest may suffice for some entities to constitute legitimate purpose, other companies may need clarity on each issue.”
[Emphasis added]
In light of the deeming fiction proposed in relation to disclosure of UPSI to promoters, it may be construed that there is no requirement to demonstrate that the ‘furtherance of legitimate purpose’ test is met. Further, the listed entity may provide access to “any material information” with the promoters/controlling shareholders. Therefore, it does not seem entirely clear whether such UPSI which is communicated should be only that which will be in the interest of the listed entity.
It is pertinent to note that the proposals in the Report do not contain any restrictions on the use of the UPSI by the listed entity. However, from the deliberations of the Kotak Committee, it appears that the nature of ‘legitimate purpose’ may have been envisaged to be communication of information on a ‘need to know’ basis, in furtherance of ‘strategic transactions’ or having a ‘derivative economic interest’. One cannot rule out the possibility of SEBI taking such a position.
Board’s Right to Withhold Information
The listed entity is not required to mandatorily enter into an Agreement with its promoter/controlling shareholders for sharing of material information including UPSI. However, if the Agreement is entered into, it is possible for the listed entity to restrict sharing of all UPSI in the event the board of directors of the listed entity determines that: (i) providing access to the material information is not in the interest of the listed entity; (ii) sharing of material information results in a conflict of interest; or (iii) there has been a breach of the agreement for sharing of UPSI.
There is a possibility of a constant sharing of information between the board of directors and the listed entity. It is not clear whether it is the intention that the board of directors of the listed entity evaluate such information on a continuous basis. Since it is not feasible to do, the board of directors of the listed entity may consider issuing internal guidelines in relation to sharing of material information. Such guidelines may specify the nature of information that would typically (a) not be in the interest of the listed entity; and (b) conflict with the interest of the listed entity.
To conclude, the amendments proposed by the Kotak Committee, especially in so far as UPSI is concerned, would aid in bringing about transparency in operation of the listed entities. Due to the presence of a green channel and an explicit framework for sharing of UPSI, the ‘information flow’ between the promoters/ controlling shareholders and the listed entity would now be properly administered subject to the legitimacy test.
– Shikha Rawal
[1] Paragraph A of Part A of Schedule III to the LODR Regulations has also been proposed to be amended, to mandate certain additional disclosures in relation to the sharing of UPSI.
[2] The term ‘control’ shall have the same meaning as assigned to it under the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
[3] It is proposed that the promoter or a nominee of the promoter on the board of directors of the listed entity would not be permitted to vote on such matter.
