'Promoter' vs 'person in control': How will Sebi's new proposal play out?

The rationale behind replacing the concept of "promoter" with "person in control" is to absolve entities, which, in real­ity, don't have any control over a company

Market regulator Securities and Ex­ch­a­nge Board of India (Sebi) has proposed to replace the concept of “promoter” with “person in control” for India Inc. Let’s find out what warrants such as move and how it could play out.

Who is a promoter?

A promoter can be an individual, a corporate entity or a group of entities with whom vest/s ownership and controlling rights of a company. Under Sebi’s ICDR Regulations (Issue of Capital and Disclo­sure Requirements), a “promoter” is someone who exercises direct or indirect control over a company.

Direct control can be in the form of significant equity ownership. Indirect co­n­trol can come from pow­ers to influence the board or the management of a company. The list of promo­ters is disclosed in the draft red herring prospectus (DRHP) that needs to be filed before any capital raising exercise such as an initial public offering (IPO). Sebi also has a concept of “promoter group”, which extends the “promoter” tag to relatives or other group companies.

What are the shortcomings of the current framework?

With the “promoter” tag comes certain privileges as well as obligations. The prime rationale behind replacing the concept of “promoter” with “person in control” is to absolve entities, which, in reality, don’t have any control over a company but still carry the “promoter” tag. Say, a family-run business is sold to a private equity (PE). In many cases, the family continues to be classified as promoters despite parting with their stake and ceding control.

More importantly, Sebi’s proposal is aimed at identifying entities that may not come under the traditional definition of a “promoter” but actually enjoy “control” such as the right to nominate directors or take other board decisions.

The issue assumes significance in the current context as increasingly companies are backed by PE or institutional investors. Sebi, in the discussion paper, highlights how the shareholding of institutional investors in the top 500 listed companies, in terms of market value, increased from 25 per cent in 2009 to 34 per cent in 2018. At the same time, the promoter shareholding has peaked at 58 per cent in 2009 and has come down to 50 per cent in 2018.

Also, new-age companies or start-ups don’t have identifiable promoters as is the case with traditional or family-run companies. In such cases it becomes necessary to identify or establish “persons in control”.

What are the issues with reclassifying promoters as ordinary shareholders?

“Once a promoter, always a promoter” is a phrase apt for the Indian markets. Reclassifying promoters as ordinary shareholders in India is a tedious process although Sebi has tried to relax and streamline it. A person having shareholding of less than 15 per cent and who may have been promoter but is no longer in day-to-day control may “opt out” of being classified as “promoter”. However, the process involves obtaining board and shareholder approvals.

What are the other implications?

Freezing of promoter shareholdings is presently an important tool of en­f­orcement in the securities market. In case of fraud or any violation, ag­e­ncies such as Sebi, Ministry of Cor­porate Affairs and the Reserve Bank of India can attach promoter stake as punitive action. Therefore, the new concept would necessitate re­o­rientation of enforcement strategies, Sebi says.

And the implementation challenges?

Experts say Sebi has taken a bold step by showing willingness to address this is­­sue. However, as the concept of “prom­o­ter” is so hardwired and intertwined with several other regulations, it will be a challenging task for Sebi to rewrite seve­­ral other legislations. “The definition of the term ‘promoter’ under Sebi regul­at­i­ons has an overarching impact on vario­us legislations, and any change to this co­ncept or its interpretation will have a trickle-down effect on several such legisl­a­tions,” says Gaurav Mistry, associate pa­r­tner at law firm DSK Legal. “There could be serious interpretation issues if the proposal is not implemented holist­i­cally, where similar as well as correspon­d­ing changes are not made across the board to other relevant legislations,” he adds.

Sebi may also have to approach the definition of “control” afresh.

“It is pertinent to note that the shift from ‘promoter’ to ‘person(s) in control’ will not serve its purpose if no corresp­o­nding change is made to the definition and usage of the term ‘control’ as currently defined in various legislations,” Mistry says, adding, “A distinction needs to be drawn between a person running the business and a person backing or financially supporting it. Only the former would be construed to be a ‘person in control’ of the business.”

Sebi has invited public comments on this issue until June 10. Based on the feedback, the regulator might decide the next course of action.