28 August 2012

Public shareholding norms – the right exit norms

I have a piece in today's Economic Times advocating not a reform, but a dismantling  of methods prescribed by SEBI in order for promoters to dilute their shareholding to comply with the minimum shareholding norms of 25% public float. SEBI is considering liberalising it further and I argue, it is necessary that it does and it does so without losing time. Here is the full piece (the printed one has some grammatical errors):

"A few days back, I attended a seminar on the government mandate to listed companies to comply with the rule of minimum 25% public shareholding (10% for listed public sector companies). The SEBI Chairman made an emphatic statement that the three years’ time given to companies and their promoters to comply was sufficient, and in any case companies were on notice from 2001 that they must dilute their shareholding, now by June 2012.

So all is well right? Not really. SEBI has allowed promoters and companies to reduce promoter holding only through 5 methods (3 till today, and 2 additional routes introduced today). Public issue/offer, something known as institutional placement program (IPP) and another acronym known as OFS or offer for sale and select bonus and rights offerings. Most of these routes have convoluted scheme of how disclosures are made, cooling off periods, maximum shares of offer, nature of buyers amongst others. To put it in other words if a promoter wants to sell his shares in the secondary markets that would not be a recognized method of reducing promoter shareholding. This of course begs the question why five routes are kosher and others are not.

Given my limited imagination, I took recourse to two sources to understand the rationale. The first was a hypothesis of a co-panelist at the seminar, who thought it could be because of SEBI’s suspicion that promoters are likely to be involved in self dealing and covertly sell to friends and relatives which would defeat the purpose of promoters mandated to divest to the public. The second source is the SEBI board’s agenda which discusses this, and cryptically gives the reason as the “twin principles of broad basing ownership and transparency”.

The first hypothesis suffers from two problems. First, it is a rule drafted on the assumption that all promoters are crooks and if allowed to sell in the open market evade a genuine sale to the public. Much as I strongly disagree with such a view, even if many promoters are crooked, the prescribed routes are not the answer. Crooked promoters will put their dummies as buyers during the IPP and OFS process or five seconds later from the exchange market. Thus, if SEBI is trying to substitute enforcement action against the crooks with rules, these rules are not effective for the purpose sought to be achieved.

The second hypothesis as stated by SEBI, though cryptic, is equally fallacious. There is no higher transparency, wider distribution or further fairness in these routes. First, IPP is available only to institutions, this is contrary to the stated object of widening the investor base. Second, there is substantial time, planning and cost involved in the two processes. Given one of the most liquid secondary market in the world (according to last week’s ET, NSE is the world’s number one exchange for the six month period by number of trades), it is wrong to bar such a secondary market which gives a certain Rs. 100 in this second to both the buyer and the seller and substitute it with an uncertain price after two months (an eternity in the stock market) and which must be offered at a discount (why would anyone buy at the market price when you can buy at the market price from the exchanges) and pay half a dozen intermediaries (including our legal tribe) making the process costly to the buyer, the seller and the company. Third, the processes may impose an obligation on a company to raise capital even when it doesn’t need the money. This could easily have been substituted by a simple sale by promoter. Forth, if capital is needed, the well established route of qualified institutional placement, which is a cheap and quick form of raising money without the tedious and expensive public issue process could have been permitted. However, QIP is not permitted because, the current interpretation has been that a company not fulfilling the minimum public shareholding norms is ineligible to issue capital under this route as it is in violation of the same rule. In other words, if you are driving on the wrong side of the road, the law will prohibit you from changing lanes as you are a violator.

Given either assumption, the routes prescribed neither solve any problem and on top create a huge hurdle to achieving the now well accepted rule of achieving the goal in a time bound manner. SEBI needs to seriously relook at the routes provided and not just rationalize them but wholly dismantle them. So long as the drivers are not driving on the wrong side of the road, they should be free to take any road to the goal of 10/25% shareholding. Punish them if they drive on the footpath. While today’s board meeting permits this on a case by case basis, the rules should be liberalised for all.

Allow any of the manners of sale by promoters or issue by the company to be used to change the percentage shareholding of promoters. Of these the most obvious are sale in the exchange or issue by QIP, but other methods of broad-basing as well like issue of ESOPs, block trades or an ADR issue. SEBI should of course ensure under any process no transfer or issue is made to friends and relatives – which it should do with strict enforcement action."

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