Sebi norm on profit-sharing puzzles firms

Norms issued by the Securities and Exchange Board of India (Sebi) on profit-sharing agreements have forced companies to seek clarifications.

Around six companies have sought informal guidance over applicability of the provisions in various situations. 

An informal guidance is a method for entities to seek interpretation from the market regulator on any regulation, circular or guideline. Although Sebi acts in accordance with an informal guidance, it is not a binding obligation.

Legal experts say there are many grey areas in the circular issued by Sebi in November last year to curb profit-sharing arrangements, which are typically side-deals between the managements of companies and private equity investors.

One of the key issues is how “profit” is interpreted because there is no standard definition, experts point out. Further, it is unclear whether the provisions are applicable to payments made in unlisted subsidiaries of listed companies. Also, whether a payment made by an investor after exiting the stock can be construed as a profit-sharing agreement.

Many such situations have cropped up in the past year, forcing companies to seek clarity from Sebi. Section 26(6) of the Listing Obligations and Disclosure Requirements (LODR), which deals with profit-sharing agreements, states: “No employee, including key managerial personnel or director or promoter of a listed entity, shall enter into any agreement for himself or on behalf of any other person…..with regard to compensation or profit sharing…unless prior approval has been obtained from the board of directors as well as public shareholders.”

According to Sumit Agrawal, partner, Suvan Law Advisors, this regulation permits scope for interpretation. “There are at least two views available. An agreement which is not for ‘compensation or profit sharing’ and in connection with dealings in the securities of such listed companies that are allowed without approval of the board or public shareholders. Even the revenue-sharing agreements require pre-approval. Some structures are also available for non-employee consultants,” he pointed out.

“Sebi has kept the provisions open to interpretation because if it lays out specific conditions, companies will find a way around them. The middle path is for Sebi to release an FAQ on the subject,” said another lawyer. In a recent application for informal guidance, PNB Housing Finance said Destimoney Enterprises held a 49 per cent stake in the NBFC since 2009. It made a complete exit from PNB Housing Finance in 2015 and it wanted to pay the top management some money as a token of its appreciation for the appreciation of its investment. The issue was not taken up at that time as there was no regulatory clarity.

In 2016, PNB Housing was listed and Destimoney proposed to offer the incentive again. PNB Housing asked Sebi if it could accept the offer. In its reply, Sebi stated although all the events occurred when the company was unlisted, the consideration for payment was being made when the company was listed and hence it had to comply with the regulation.

In another case, the EDS group, a subsidiary of Hewlett Packard (HP), recently sold its stake in Mphasis to private equity investor Marble. After the deal, HP issued incentive letters to employees of unlisted subsidiaries of Mphasis. The regulator was asked if this would also come under the ambit of Clause 26(6) of the LODR. In its reply, Sebi said transactions in unlisted subsidiaries would require shareholder approval.
 

According to Sandeep Parekh, founder, Finsec Law Advisors, mandatory disclosure of such agreements is welcome; however, there should not be any additional restrictions. “Profit sharing agreements are a common practice internationally and there should not be any further curbs on such arrangements,” he added.
 

Taking a view that such agreements provide special treatment to senior managers and raise the risk of misuse, Sebi asked all listed companies to seek shareholders’ approval. Existing agreements, if any, were to be also made public for shareholder approval.

Grey areas

Companies seek further clarity from Sebi for “profit sharing” agreements

•PNB Housing Finance

Will the compensation be treated as profit-sharing if the consideration was for the time when the company was unlisted?

•Mphasis 

Is shareholder approval needed for the incentives to management of unlisted subsidiaries of a listed company?

•MAPE Investment Advisors 

Would incentive letters issued by a strategic investor that place specific conditions (which are not in the hands of the management) in order to receive consideration be construed as profit- sharing agreement?

•Accelya Kale Solutions 

Would the compensation received in exchange to warrants issued by parent company of global subsidiary in another group company be considered a profit- sharing arrangement?