Abstract
An offer document constitutes of various material information about the company going public and has to disclose all material information considering the Companies Act, 2013, SEBI (Issue of Capital and Disclosure Requirement {ICDR}) Regulation, SEBI (Listing Obligations and Disclosure Requirement {LODR}) among others, wherein few such frameworks seemed indefinite and inadequate. Such inadequacy didn’t slip the eyes of SEBI and the working group while under several interactions, SEBI came up with key amendments in 2021 to mitigate such inadequacy. This paper shall discuss amendments around Related Party Transactions (RPTs) and growth initiatives of companies going public, in addition to its existing shortcomings and its influence on investors’ decisions.
Introduction
SEBI has issued few disclosure related amendments such as RPTs-related disclosure, reduction/expansion in lock-in periods, limitations for company’s usage of IPO proceeds for “General Corporate Purposes” (GCP) as well as other regulations to tighten the IPO process and norms, especially amidst the new age technology companies filing DRHP with SEBI[2], wherein those regulations which were bound to get attention from investors as to their “dubious” existing framework hence, the need to analyse the existing framework around RPTs, the mitigation of strategies to overcome regulatory bodies and to bypass regulations and the amendment for the same.
Amendments: RPTs
Reg. 2 (ZB) of SEBI(LODR) regulation defines “related party” (RP) as ensued under S.2(76) of Companies Act, 2013 or under applicable accounting standards while also deeming any entity belonging to promoter or promoter group of the listed company, additionally holding 20% or more of the entity as an RP, however, it was observed by the working-class group that the scope of “promoters” and “promote group” was a bit restrictive and was to be expanded irrespective of the shareholding while also forwarding the notion that any entity, direct or indirect (including relatives) holding 20% or more of the company’s stake has to be deemed as an RP.[3]
Another consideration was “what was to be constituted as material?”. Reg. 23(1) of LODR regulations, referred to “material” as “if the transaction(s) entered either individually or taken together exceeds 10% of the annual consolidated turnover of that company was to be considered as “material”, however, the working group noted that the same threshold for “material” shall be changed to transaction exceeding Rs. 1,000 Crore or 5% of the annual total revenues, or net worth of the company whichever is lower while such regulation should not apply to those companies which have a negative net worth while SEBI countered the working group’s suggestions and stated that the existing framework for 10% would go on, however, SEBI did state the possibility of amendment to include the “Rs. 1,000 crores” threshold.[4]
Further, Reg. 23(2) of LODR regulation necessitated all RPTs to acquire approval from the audit committee wherein the working group suggested to add approval requirement for further material modifications as well, in addition to the suggestion regarding “information provided to shareholders for consideration of RPTs”, “exemptions from the applicability of provisions for RPTs” among others.[5] Given that these suggestions were strengthening transparency and structural norms, SEBI took into consideration 4 aspects[6]:
- Definitions of RPTs
- Approval needed by the audit committee
- Shareholder’s approval and materiality threshold
- Enhanced Disclosures
It was understood that the existing RPT framework was insufficient to cover transactions wherein the companies could transfer assets to a subsidiary, in India or overseas and then that entity could transact with the RP of the company to move assets in addition to other innovative structures so that the entity doesn’t come under the framework of RPTs, hence, no RPT regulatory compliance or disclosure, however, the definition for RPTs changed in April 2021 and was expanded to include any person or entity, irrespective of shareholding, who formed part of the promoter group of the listed entity would be considered as RP while also including any such entity holding 20% or more equity holder as RP at any time for the preceding financial year (which is to be reduced from 20% to 10% from April 2023).[7]
Further, SEBI understood that transactions issued by unlisted subsidiaries with related listed entities would not consider prior approval of the audit committee or for that matter, shareholders of the company, except in the case of the sale of 20% or more of the assets of a material subsidiary for which shareholder’s approval is required [under Reg. 24(6) of LODR]. This transaction route could be used as a channel to move assets, which belong to the shareholders, out from the company’s consolidation without any disclosure hence, the same was to be made stringent too.[8]
Contemporarily, SEBI aligned with the working group Report (WG Report) when it came to the Audit committee approval, and this was also sought to straighten out the LODR regulations related to RPTs seeking audit committee approval with compliances under the Companies Act while also strengthening the framework.[9]
SEBI amended the ambit of “material RPT” s as well, which was also in consonance with the working group’s suggestion while also ascribing significant changes to the disclosure regime such as, listed entities were to submit “disclosures” within 15 days in the manner prescribed by the stock exchange(s) and the listed company was to do so, every 6 months in the format specified by SEBI. Apart from the same, there were different disclosures for non-convertible securities, loans, and advances as well as additional information to the audit committees.[10]
Organic and Inorganic Growth Initiative
With more companies going public in 2021, new issues with prospectus grew too. For instance, several companies going public, like Zomato, considers “Funding organic and inorganic growth initiatives” and “general corporate purposes” (GCP) under company’s purposes to utilize Net proceeds however, Zomato’s intention for future acquisitions wasn’t even vaguely clear to the investors desisting them in making informed decisions as Zomato may acquire a company in future which isn’t in the investor’s best financial or even ethical interest and even if not, there was certainly an information asymmetry where companies could raise money without identifying specific investment targets. However, on the other hand, those companies that did specify the nature of companies that they wanted to acquire had more transparency which is why an amendment was needed for the former.
Objects of the issue fall under the ambit of SEBI (ICDR) reg. 2(1)(r) read with reg. 7(2) of ICDR regulations wherein the company going public is permitted to use 25% of the IPO proceeds for general corporate purposes or other such purposes while not having any specified structure or purpose which is why SEBI issued amendments for the same stating that the amount issued by the issuer company for growth initiative and GCP must not exceed 35% of the IPO proceeds and those earmarked for inorganic and organic growth shall not exceed 25%.
This can be looked at as a welcome step given that this restriction did not apply to those companies who had structured their investment targets, hence, now companies had an incentive to list all their future growth initiatives and give their investors a fair view of what the company intends for future, therefore, attracting informed decisions as well as symmetry in information. SEBI also issued amendments related to the monitoring of IPO proceeds and proceeds for GCP which was to be done by credit rating agencies instead of commercial banks/public finance institutions while monitoring 100% of the IPO proceeds as opposed to 95% of proceeds pre-amendment.[11]
Conclusion
Majority of the aforementioned amendment incentivized companies going public to have a mutual ground for company-information disclosure and the investors, thereby, inducing more information and trust to the investors. The covid era can be seen as SEBI’s battleground for acquiring transparency wherein several IPO related amendments were observed, be it change in lock-in provision for Anchor investors and preferential allotment, regulations around “offer for sale” among aforementioned others, and the intention is explicitly observed: strengthening of transparency, symmetry of information, and informed decisions so that the investors don’t feel like they have been fed incomplete information and thereby making apt investments promoting growth in the retail investment industry.
[1] Yashasvee Kumar, Jindal Global Law School, 4th year of BA. LLB, 2018-2023.
[2] Press Trust of India, SEBI Tightens Rules Governing Utilisation of IPO Proceeds; Tweaks OFS norms (Jan 18 2022, 01:12 IST) https://www.business-standard.com/article/markets/sebi-tightens-rules-governing-utilisation-of-ipo-proceeds-tweaks-ofs-norms-122011700598_1.html.
[3] SEBI, Review of Regulatory provisions on Related Party Transactions (November 2021) https://www.sebi.gov.in/sebi_data/meetingfiles/nov-2021/1635849275396_1.pdf.
[4] Supra note 2.
[5] Id.
[6] SEBI, SEBI Notified Amendments to Related Party Transactions (KMPG November, 2021) https://home.kpmg/in/en/home/insights/2021/12/firstnotes-sebi-related-party-transactions-listing-regulations.html.
[7] Sharad Abhyankar et al., SEBI Tightens Governance for Disclosure Requirements for Related Party Transactions (1st December 2021) https://www.mondaq.com/india/shareholders/1136582/sebi-tightens-governance-and-disclosure-requirements-for-related-party-transactions.
[8] Supra note 2.
[9] Supra note 6.
[10] Id.
[11] Supra note 6.
