Sebi on the right path over control of companies

Its decision to desist from amending the Takeover Regulations is acknowledgement of the fact that one size doesn’t fit all

The (Sebi) has announced that it would refrain from amending the Takeover Regulations to specify situations in which it would rule that there is no change of control over a listed company. This is a right step for a variety of reasons.

When one acquires control over the management and policy decisions of a listed company, an offer to buy shares from other is mandatory.   Likewise, acquisition of shares with voting rights of 25 per cent or more mandatorily triggers an open offer. Typically, acquisition of control occurs along with acquisition of shares. However, the regulations contain a provision that makes it an obligation to make an open offer when acquiring control regardless of the quantum of shares acquired.

This is an important regime. One can acquire control without crossing the 25 per cent voting rights that would trigger an open offer. This could take shapes and forms that cannot be predicted in advance — through contractual rights and arrangements embedded in documents to which the listed company is bound. Now, when investors execute investment agreements with listed companies and desire a degree of say in decisions that could alter the very foundation of the company they invested in, the question often arises whether they have taken over control.

For example, if a company that manufactures paper seeks to change its activity to manufacturing steel, and an investor secures a contractual right to stop it, that would not represent the capacity to control the day-to-day management of the company. It would only be a right to insist that a company stays its course truthfully. On the other hand, if an investor were to have a right to approve every contract above a threshold value, it would point to control over how to manage the company.

Life is never led in either extreme, but there is a lot of truth in between the two extremes. For example, an investor may secure a right to object to a transaction that is a substantial component of the value of the net worth of the company — in other words, the right to scuttle a risky proposition.  What the size of the net worth is and how much percentage of it is the threshold, what nature of transaction is sought to be covered — these are all factors that would answer the question of whether such a right constitutes control over management and policy decisions. For example, the right to approve the room tariff policy of a hotel owned by a listed company could be control over the company if the only business of the company was to run that one hotel. Such a right over one hotel, which does not constitute a major source of revenue for a company that owns multiple hotels, would not constitute control.

Now it would be impossible to stipulate by legislation what constitutes control in a manner that wold cover all possible factual situations. Therefore, beyond stating that rights, which merely constitute some influence over material and fundamental changes to the ordinary course of conduct would not necessarily constitute control, it would not be possible to stipulate more. Such guidance could emerge from rulings and case law rather than by legislation that would lay down hard rules, which may not fit every situation. That even undertook a public exercise of considering these issues points to its acknowledgement that a one-size-fits-all approach of alleging control would be wrong — just as it would be impossible to provide immunity that certain types of rights would never constitute control.

In recent orders, has adopted a mature stance of acknowledging this position. Other legislation, too, have references to “control” and pretty much sail in the same boat. To legislate that unless 25 per cent is owned there would be no control would be a lazy option and can have a deleterious effect, with an incentive to fly just under the radar and actually wield control. To legislate that certain types of rights can never ever constitute control or that they would always and necessarily constitute control would also be fundamentally flawed. This is why the Achuthan Committee, whose draft is the basis of the current version of the Takeover Regulations (Disclosure: The author was a member), consciously left this to case law to evolve on the facts of each case.

Indeed, can issue guidance notes explaining the principles that it would apply in its approach to enforcement in this regard. Beyond that, whether or not any person has acquired control will necessarily be left to a “question of fact” to be answered from the facts and circumstances of each case. It may well sound like a fallback on the Justice Potter Stewart’s famous ruling in a case involving a charge of “hard-core pornography” against a movie. He ruled: “I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description, and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.”

This column was published as Without Contempt in editions of Business Standard dated September 21, 2017

A tale of two jurisdictions

By Somasekhar Sundaresan
The standard for treating as illegal, by those tipped off with price-sensitive information by insiders, underwent yet another yo-yo in the last week. The constant change in standard on what constitutes illegal insider is a hallmark of insider law in that country.

 

An appellate court has ruled that it would not be necessary to show that the person, who receives a tip-off from an insider, has to have a “meaningfully close personal relationship” with the latter. The same court had ruled in December 2014 that such a relationship would be vital to hold that insider took place. In that case, two men, who had traded in securities, were held to have had only vague and casual acquaintance with the source of the inside information. In the absence of any meaningfully close personal relationship, it was held that they could not be said to have been gifted or sold the tip by the insider for the to be violative. In short, no benefits could be inferred for those giving them the information.

 

Two years later, in December 2016, the ruled in a case that involved by a person, based on information received from a sibling who was the insider, that there would be no need to look for a benefit or gain to provide the tip. Applying that rationale, the appeals court has now ruled that there is no real need for any “meaningful close personal relationship” to exist to render the illegal. The court has gone on to say that if an insider were to give a tip to a doorman instead of a tip in the form of money, he would still be achieving his objective of providing gratification and, therefore, the by the person receiving the tip would be illegal.

 

Cut to India. Virtually every man on the street here would believe that the US has a far greater regime for punishing insider and that India is lax on the matter. The truth is far more nuanced. First, under Indian law, by definition, any person receiving unpublished price-sensitive information becomes an “insider”. Therefore, by the recipient of any price-sensitive inside information would become violative “insider trading”. Second, the very act of communicating unpublished price-sensitive information has been rendered illegal by law in India — unless, of course, a legitimate purpose for such communication can be shown, for example, providing an auditor with draft accounts.

 

In practice, how this is enforced makes in securities quite dangerous in India. It is now becoming routine for any trade by any person to be rendered vulnerable to attack as being illegal if a link between the person who traded and an insider, however tenuous, is found. It is this extreme that the is zealously wary of — an exposure of innocent traders to the charge of insider leads that system to err on the side of caution in favour of presuming bona fides by those  The Indian regulator has chosen to err on the side of caution in favour of presuming mala fides by those trading: So long as some form of link is found, it would be presumed to be illegal motivated by inside information, regardless of whether information was actually communicated.

 

Surprisingly, despite the law having been amended to empower the regulator to demand and get call data records from telecom companies to demonstrate circumstantially the communication links between the insider and the person who has traded, the regulator never uses this power. Usage of such power would bring with it the necessity of having to prove the intensity of the link. Worse, informal guidance has been issued to say that without even going into evidence of communication between a discretionary portfolio manager and his client who may be an insider, trades on behalf of an insider by the portfolio manager, even if made without reference to his insider client, would be illegal (not “could be illegal if the client indeed exercised his own discretion in the decisions”).

 

The legal status of a person, who has actually received unpublished price-sensitive information from an insider, as an “insider” is easy to understand if evidence (circumstantial evidence) reasonably shows that the person who traded indeed received such information. However, for those who are actually insiders themselves, the treatment becomes even more dangerous. A “connected person” is one who is reasonably likely to have access to inside information. Whether such a person indeed had access and who would need to show that she had such access are questions that are routinely given the go-by, hoping that courts would give enforcement a long rope.

 

This is the kind of outcome that a dissenting judge in the appeal judgment has warned against. According to her, prosecutors would “seize on this vagueness and subjectivity”, which, to her mind, “radically alters insider law for the worse”.

 

There is one material distinction that makes the problem exponentially worse in India. US enforcement agencies have to satisfy a neutral judge of the strength of their charges, with cogent evidence. This leads to the finely nuanced and, at times, abstruse judicial analysis of the standards necessary to bring home a charge. In India, the regulator has to convince no one for declaring a person to be guilty of insider  How well it has to explain itself depends on the quality of the challenge mounted in an appeal that can only be filed after the event of being held guilty.

 

Twitter: @SomasekharS

This column was published under the head Without Contempt in the Business Standard editions dated September 7, 2017