SEBI Intends To Do Away With The "Promoter" Label?

From a thorough reading of the definition of a promoter as per SEBI (ICDR) Regulations, 2018, we understand that a promoter of a listed company is one who controls the affairs of the company either as a shareholder, director, or otherwise. The definition further specifies that this control over affairs may be direct or indirect. It is therefore safe to assume that an individual who may appear as a mere shareholder or director (including MDs and CEOs) but has de-facto control over the affairs of a company at the time of listing can be considered a promoter. However, there has been no explicit test prescribed for identifying the individual(s) in control and designating them as ‘Promoter(s).’ Furthermore, the broad definitions of ‘control’ provided in the Companies Act, 2013 and the Takeover Regulations offer little help in navigating this grey area. This ambiguity regarding the extent of promoter-defining control has been used as a loophole by those going public, to gain undue interest by avoiding the liabilities accompanying the Promoter tag. Despite certain advantages like quicker decision making procedures and relatively cheaper management in Promoter-led companies, there has been a form of management that is gaining popularity in the recent times, one that requires no promoter holdings in a company; the growing practice of issuers being classified as Professionally Managed Companies (PMC) makes founding members (and other such persons) eligible for incentives that would otherwise be denied to promoters and members/directors of the board who exercise significant control over the affairs of the company. In the case of the earlier mentioned fintech company, where the founder, who holds the positions of the Chairman, CEO, and Managing Director is known to have reduced his shareholding to 9.1% from 14.7% before the IPO, it is alleged that the move was made to make him eligible for ESOP since directors holding (directly/indirectly) more than 10% of equity shares are prohibited from receiving stock options under the SEBI (ESOP & ESPS) Guidelines, 1999.

It is, however, not the mere transfer, but the fact that an institution acting on behalf of the founder’s Family Trust, had acquired shares to the same extent as the transferred shares that has attracted the attention of the regulator and other institutions. Sources have indicated that the founder is still in a position to direct and instruct the board of directors which suggests that he may be identified as a ‘Promoter’ according to the ICDR Regulations.^[1] SEBI has since been petitioned by a proxy advisory firm, to consider two critical questions (a) Does he meet the definition of promoter as defined under SEBI ICDR Regulations? (b) Is his aggregate shareholding less than 10% - direct and indirect?^[2]

Although the transfer of shares to a family trust structure is unique to the present case, the interpretation of the term ‘control’ and who can be identified as a promoter has been a long-running debate. In an attempt to address these issues, SEBI had initially suggested assigning the promoter tag to founders holding 10% or more stakes in their company at the time of listing. However, the problem with this proposal becomes apparent when one takes a good look at the definition of a promoter and compares the extent of control the founder, holding a mere 10% stake, would have on the affairs of the company to that of the prescribed 20% (for a promoter). In other words, a founder with a 10% stake cannot independently control the affairs of a company, which is inconsistent with the definition of a promoter. Furthermore, SEBI’s suggestion to rope in other parties or institutional investors to account for the additional 10% stake (i.e, to meet the prescribed 20% stake) may seem like a viable solution; however, institutional investors may not be enthusiastic about participating in such arrangements.

The other suggestion put forth by the regulator to overcome this issue was presented in a consultation paper issued in 2021, where SEBI proposed a shift from the ‘Promoter’ concept to a concept of ‘Person in Control’.^[3] However, nothing has been formalised yet, but this shift would require the regulator to make several amendments to the existing rules concerning the promoter. Liabilities and obligations that are currently enforceable on a promoter(s) should be extended to the ‘Person(s) in Control’ as the regulator deems fit. Apart from the cumbersome process of making necessary amendments, SEBI would be required to formulate a test similar to the bright-line test (applicable in Takeover proceedings) to determine the person in control in the case of Initial Public Offerings. Failure to do so would render the whole exercise futile, as the question of defining ‘control,’ with respect to IPOs, constitutes a major part of the issue that SEBI is attempting to overcome with this shift. As it is tricky to devise objective tests/solutions to identify the person in control, any considerations of the Board to make a case-based application of such tests should be expressed in clear terms to avoid further confusion. Nevertheless, this shift could be well-received by the corporates, as it could lighten the disclosure burden on issuers and shield promoters who may have no controlling rights from undue liability.

SEBI has been taking steps to address these issues in a cautious manner and a 20-member panel headed by the former Chief Justice of Punjab and Haryana High Court, Justice Shiavax Jal Vazifdar has been assigned to define a founder of a company among other things. Based on the available facts, we can anticipate significant amendments being made to the SEBI Act sometime this year.

The author is an associate at Swetcha Legal Associates in Vijayawada, AP. Views are personal.

[1] https://www.bqprime.com/business/davos-2023-paytms-vijay-shekhar-sharma-says-proxy-firms-advice-on-his-esops-ill-timed