Saturday, March 14, 2009

Another Case Of Regulatory OverReach under the Take Over Code?

In a recent adjudicating order, Adjudicating Order No.VSS/AO-27-2009, that may be viewed here, SEBI found that the Directors of a "Non Promoter Controlled Company", Matra Realty Limited were obligated to disclose their share holdings pursuant to the Disclosure law in the Take over Code. The SEBI found that the Directors were "persons having control over the company" within the meaning of relevant regulations [6(3) & 8(2)] and therefore were required to disclose their share holding to the company. It seems to me that this is yet another case of regulatory overreach. Conceding that the relevant provisions of the take over code distinguish between promoters and persons having control over the Company; the expression, "persons having control over the company" cannot in the context of the take over Code disclosures mean Directors of the Company. Let us therefore analyse this latest juridical wisdom that comes from the regulator.

The adjudicating officer found that the expression "control" is defined inclusively in the Take over Code. Regulation 2(1)(c) defines Control as:

“control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

Thus Control includes the right to a) appoint majority of directors b) (the right to) control the management or policy decisions. Further such right(s) are exercisable bby a person acting individually or in concert. And lastly, such right(s) of Control as above stated were tracable to (should emanate from) such sources as their share holding, management rights, share holders Agreements, voting agreements or analogues thereof. Again here, the sources of the right to exercise control are inclusive.

The adjudicating officer found that the above definition meant:

"any person who controls the management of a company either individually or collectively with other persons or controls or influences the policy decisions, by virtue of his position can be said to be in ‘control’ over the affairs of the company... a Director is one of the controller of companies affairs. The Board Of Directors is the brain of the Company. When the Board functions, the Company is said to function. Thus the functioning of the Company is totally controlled by the Board..."

Further, having analysed the share holding pattern, he finds that the Directors and PACs were the largest share holders in the Corporation as they held 13.75% together with their PACs as of 2004.

"In view of the foregoing", he finds that the Directors are "in control" of the Corporation and having not disclosed, finds them not compliant with the law.

Thus the analysis seems to rest on two main premises: Firstly, the Directors had control over the Company by virtue of their position. Secondly, they were the single largest share holders of the Company, taken together with their PACs.

If this is the case, the analysis is faulty;

even conceding that the definition of control is inclusive and that the sources from which Control rights emerge is (also) inclusive, the analogues are to be considered ejusdem generis to the more particular words used in the definition. The sources of Control rights that the definition speaks of are :

a) share holding b) share holding agreements 3) voting agreements 4) management rights. So, the analogues, applying ejusdem generis, should only include Control rights that are "contractual" in orgin.

Directors of a Company, in contrast, receive their power/right to manage the corporation from the Companies Act. The Companies Act mandates that there should be a Board Of Director and articulates the powers of the Board (See for e.g. Section 291/292 of the Companies Act that speak of "Powers of the Board"). Their source of "Controlling power" (or Controlling Rights, leaving aside the jurisprudential difference between "Power" and "Right"), is the Statute and therefore those rights have a "in rem" origin rather than "in personam" origin that Contractual rights have. Consequently , the Control that they exercise over the Corporation pursuant to the powers under the Companies Act cannot be read in the understanding of control that we have under the Take Over Code. ( because the illustrative sources of Control rights in the Take Over code are only Contractual in origin).

Finally, the reliance of the adjudicating officer on the share holding of the Directors and the PACs taken together being the largest was incorrect.

It is clear that the powers that the Board exercised over the Company were traced to or emanated from their position/status as Directors ofthe Company. The source of the power to control the management or policy decisions emanated from their position as Directors. The source of that power/right was NOT their share holding. So,it need not have figured in the analysis at all. (indeed if the control rights emanated by virtue of them being the largest share holders, Control as understood in the take over Code is triggered. See, the definition of "Control" above. But the Right/Power of taking Management decisions emanates from the Statute as we saw earlier).

A case of regulatory overreach (again)?

Monday, February 2, 2009

Satyam Pricing Relaxation- Does SEBI Have Ex ante Competence "To Consider"?

News Paper reports suggest that the securities regulator is "considering" a proposal to link the open offer price of Satyam Computer Services, to the average price of the stock in a shorter and more recent period. This is apparently been done because potential "white knights" who "d want to acquire Satyam, under the extant take over regulations, face the prospect of coughing up Rs. 270 per share; this is as required by the formula prescribed under regulation 20 that prescribes higher of the average price of the stock for 26 weeks or two weeks.
Basically therefore, The price of Rs.270 is causing a "chilling effect" on potential white knights and so the regulator is contemplating this "regulatory discount"...

There are many issues that arise from this chain of events; But implicit and the more important of these is that of regulatory competence to allow such waivers from the provisions of Chapter III of the Take over Code. SEBI seems to have assumed that such a power is existent ; but thats not entirely clear.

The scheme of the Take over Code is clearly indicative of the fact that Regulation 3 of the same is complete code so far as exemptions go. Now, within the scheme of Regulation 3, we have a residual clause 3(1)(f) that reads as under :

"Other cases as may be exempted from the applicability of Chapter III by the Board under Regulation 4"

Regulation 4 then provides that

"The Board shall for the purposes of this regulation constitute a panel of majority of Independent persons from....."

The later sub clauses of Regulation 4 then carve out the procedure to seek an exemption under the above referred sub clause. The scheme of this procedure is such that the Board is merely a "Conduit" to allow passage of the application from the acquirer to the Panel and it is the Take Over Panel ( Not the SEBI Board) that has the first power to "Recommend" whether the exemption ought to be given or not. It is only after the Panel has communicated its views to the Board, the Board shall..... after considering all the relevant facts including the recommendations, if any, pass a reasoned order on the appplication.

It seems therefore that the powers of the Regulator to "Consider" the exemption are triggered at a stage after and not before the recommendations from the take Over panel are received.

Before the Take Over panel is seised, Its role is merely that of a "conduit" to relay the application from the acquirer.

Also, even this power to decide on the exmption is exercisable by the regulator, only in the specific context of an application from the acquirer. At the present instant, No acquirer has made a formal application for exemption. It seems from the reports that the regulator is contemplating the two week average as a floor price that potential acquirers will have to improve upon. Clearly then, it does seem that the nature of the exemption contemplated by the regulator is blanket in character..

One might rightfully then question the regulator's own "Corporate governance and compliance" when it engages in this exercise of exempting potential white knights from the rigour of the law....?


Saturday, January 10, 2009

The Vexed Issue Of Independent Directors-II- The Solutions


I think one of the policy alternatives that the State ought to consider is by way of tightening the ex post law activation and enforcement.

Say have a law to provide Class action litigations.

Once the Directors know that there are expedited judicial processes to aid the share holders which disperse litigation costs and risks, ex ante, there will be considerable incentives to act in a manner befitting their fiduciary status. The Independent Directors also will be more agile in monitoring the executive component of the Board.

The problem with placing too much reliance on Institutional Share holders to do the monitoring and to let retail share holders to piggy back is that with portfolio holdings, Institutional share holders hardly have any inclination to monitor their agents. (Although there are instances recently where activist hedge funds did a very good job of monitoring. (Sterlite's failed restructuring).

But its not going to be easy to bring a Class action law on the statute books. For one, its going to add to the cost for Corporates. I see an immediate uopward revision in the D& O liability Insurance premium for example. Also, the possibilty of being found party to a law suit at a later date will act as an ex ante disincentive for the Independent Director to accept the post. ( we have a very recent example of Nimesh Kampani in Nagarjuna Finance)

Also, easier access to remedy ex post might lead to ex ante laxity in monitoring the Boards among the share holders. Clearly, the field is ripe for research!

Should the SRO have a say in appointment of Independent Directors, that might be quasi nationalisation ; management rights to an enterprise are after all a form of property.

May be a peer review mechanism that uses reputation costs as a tool for deterrence can be used in appointment of Independent Directors. That will augment the formal deterrence mechanisms that the legal system provides. This is especially because, Satyam showed that investors factor in corporate governanxce standards in the secondary market. We saw the sensex reacting negatively and FIIs pulled ouit their money. The peer review mechanism will act as an ex ante hedge against the Company appointing Independent Directors with suspect affliation.