Related-party rule dilution panned as anti-investor

Critics rap this as anti-investor, against legislative intent, as already borne out at AGMs; seek review of MCA decisions

Two rounds of dilution to the rules governing related party transactions (RPTs) under the new Companies Act are loaded against small investors. And, subvert the legislature’s intent to regulate such transactions, many of which often end up enriching promoters at the cost of small investors.

Governance firms and institutional investors have criticised the ministry’s move and have demanded a review.

The Companies Act, 2013, enacted in August last year had made RPTs a focus area. The ministry of corporate affairs (MCA) had come up with stringent rules governing these, in March this year. These rules provided for several rounds of approval and disclosures of a wide range of transactions that companies enter into with relatives of promoters, entities controlled by promoters and entities controlled by relatives of promoters. Governance activists and small investors celebrated these moves as empowerment of the small guy.

However, their joy was short lived. Following representations from the companies, which claimed that these rules will hamper the ‘ease of doing business’, the ministry made substantial changes to the rules, not just once but twice.

The first such change came on July 17, when the ministry in a lengthy circular clarified the definition of what constitutes a related party for the purpose of voting. Through this circular, MCA clarified that a shareholder will be considered a related party only with reference to a contract/arrangement for which the ‘said special resolution’ is being passed.

“This has led to a more aggressive interpretation being applied by corporates who now take it to mean interested parties. This enables a large set of shareholders who are likely to benefit but are not “related” in a legal sense, to vote their shares,” proxy advisory firm Institutional Investor Advisory Services (IiAS) said in a note.

This was not all. On August 14, the ministry came up with a fresh round of dilution, wherein it revised the thresholds for approvals through special resolutions.

J N Gupta, managing director, Stakeholders Empowerment Services, said, “I feel RPTs are misused by companies and the new law was a welcome change. However the two dilutions we have seen in recent past would make the law ineffective specially the defining the related party as the person interested in transcation. This would facilitate all family owned companies using it effectively to thwart the law. Relaxing the rules relating to definition of RPTs, unless there are serious procedural issues the same shall not be diluted. A new law always brings teething problem, solution lies in facilitating teething rather than taking teeth out.”

Navneet Munot, director, advocacy, Indian Association of Investment Professionals, said: “Significant dilution would not go down well with the investors.” Munot, who is also the chief investment officer at SBI Funds Management, one of the largest mutual funds in the country, added the regime was intended to build the trust of investors in the market and such moves would be detrimental to the trust.

Minority investors, including institutional investors, had successfully blocked a resolution proposing high remuneration for top executives of Tata Motors in July this year. However, following the dilution of the rules, not many such efforts would be successful. Both Gupta and IiAS pointed out how in recent annual general meetings of JSW group firms, the dilution of rules came to the rescue of a proposal to pay a significant sum as brand royalty to an entity owned by wife of the promoter.

In the AGM of JSW Energy, the promoters voted only 0.1 per cent of their holding. By July 31, when JSW Steel’s AGM came, the promoters were able to absorb the changes of the July 17 circular better and voted 85.4 per cent. This was because under the new rules, only the wife’s firm did not vote, whereas all other firms could.

IiAS has called for the ministry to review its stand. “In passing the 2013 Act, the MCA promised to raise the bar on corporate governance, with RPT being an area of focus. This tweak tilts the balance significantly against investors and away from the goals the MCA set for itself. “The ministry needs to review its current stance, and renew its promise to investors,” it said.