Introduction
The past few years have witnessed a silent revolution in India where the government has woken up to the power of minority shareholders who vote with their wallets. In response to this power, the more progressive companies are voluntarily accepting tougher accounting standards and more stringent disclosure norms than are mandated by law. They are also adopting more healthy governance practices. It is evident that these tendencies would be strengthened by a variety of forces that are acting today.
Historically, most matters relating to the rights of shareholders were governed by the company law. Over the last few decades, in many countries, the responsibility for protection of investors has shifted to the securities law and the securities regulators at least in case of large listed companies. In India, the Securities and Exchange Board of India (SEBI) was set up as a statutory authority in 1992, and has taken a number of initiatives in the area of investor protection. Similarly, the Securities Contracts Regulation Act, 1956 (SCRA) was enacted to prevent undesirable transactions in securities. In order to achieve these objectives, the Central Government has framed the Securities Contracts (Regulation) Rules, 1957 (SCRR). The SCRR provides for the requirements which shall be complied with by public companies for the purpose of getting their securities listed on any stock exchange. One requirement seeks to ensure the availability of a minimum portion/number of shares (floating stock) of the listed securities with the public so that there is a reasonable depth in the market and the prices of the securities are not susceptible to manipulation. The SCRR seeks to achieve this by prescribing a minimum part of the issue to be offered to public by the company seeking listing on a recognized stock exchange in rule 19(2)(b). The Securities Contracts (Regulation) (Amendment) Rules, 2010, notified on June 4, 2010, has implemented the government decision, as mooted by the Finance Minister in his Budget speech in July 2009, to increase the public float in listed companies to at least 25%.
Notification Dated 4 June 2010
The Finance Ministry said that its new rule requiring listed companies to have a minimum 25% public holding will boost capital markets and help the government's divestment programme. It envisages equity dilution in companies such as Reliance Power, MMTC, SAIL, NTPC and Indian Oil. Consequently, it would be compulsory for at least a quarter of shares in all listed companies to be owned by public, including investment and financial institutions. A large number of shares distributed among a large number of shareholders is essential for the sustenance of a continuous market for listed securities to provide liquidity to the investors and to discover fair prices. Further, the larger the number of shares and the number of shareholders, i.e., the larger the public float, the less is the scope for price manipulation.
Ministry of Finances’ press release accompanying the aforesaid notification of 4 June 2010 summarized the new requirements:
- The minimum threshold level of public holding will be 25% for all listed companies;
- Existing listed companies having less than 25% public holding have to reach the minimum 25% level by an annual addition of not less than 5% to public holding;
- For new listing, if the post issue capital of the company calculated at offer price is more than Rs. 4000 crore, the company may be allowed to go public with 10% public shareholding and comply with the 25% public shareholding requirement by increasing its public shareholding by at least 5% p.a.;
- For companies whose draft offer document is pending with the Securities and Exchange Board of India on or before these amendments, are required to comply with 25% public shareholding requirement by increasing its public shareholding by at least 5% p.a., irrespective of the amount of post issue capital of the company calculated at offer price;
- A company may increase its public shareholding by less than 5% in a year if such increase brings its public shareholding to the level of 25% in that year;
- The requirement for continuous listing will be the same as the conditions for initial listing; and
- Every listed company shall maintain public shareholding of at least 25%. If the public shareholding in a listed company falls below 25% at any time, such company shall bring the public shareholding to 25% within a maximum period of 12 months from the date of such fall.
Studies show that there are close to 180 companies that have minimum public shareholding of less than 25%. Therefore, all these companies are required to dilute their promoters’ shareholding. They may dilute their stake by sale of shares, further public offering, preferential allotment, open market sale etc. Hence it is evident that this amendment is going to bring huge supply of stocks in the market. However, implementing the new rules is challenging because of several factors. Mr. V. Anantharaman, M.D. Credit Suisse Securities India cautions, “The supply of paper over the next 12 months, following the new rules, coupled with the existing backlog of equity issuance, would be more than twice the historical maximum equity issuance volume in India, recorded in 2007. What is more, market volatility could make it hard to attract investment in the amounts required and it would be unfair, even to minority shareholders, to force dilution at sharp discounts.
The government should consider a few aspects when it reviews the rules. One, companies with market caps higher than a certain level could be allowed a longer timeframe to meet the 25% threshold. This would mitigate the supply issue. Two, the timing of dilution or fresh external capital infusion could be determined at managements’ discretion rather than forcing 5% each year. This would provide a larger window for companies to transact at better terms than in a forced sale. Three, ADRs and GDRs may be considered as part of the 25% public float. Four, diluted ownership may be considered in cases where there are Esops and FCCBs outstanding. In parallel, the existing delisting guidelines should be reviewed.”
Conclusion:
From a legal and regulatory point of view, there are certain elements in the free float regulation that requires elucidation and clarity. For instance, the expressions “public, promoter and promoter group, public shareholding” have wide connotations and require judicial interpretations. Moreover, the remedies provided in the SCRA for bringing the violators to the book being delisting, penalties and fines, are wide and general in nature and would have to be effectively utilized by the market regulators. Enforcement of the provisions of the amendment would ultimately determine the effectiveness of this new streamlined requirement of minimum public float.
By: Ranjana Iyer, Partner