A recent important development reinforces the resolution of the Securities and Exchange Board of India (SEBI) to bring clarity and resolve identified lacunae in the securities and investor protection laws.
SEBI (Disclosure and Investor Protection or DIP Guidelines, 2000) were to regulate the issue of securities of a company to public, shareholders and institutional investors through the primary market. Over the years, subsequent amendments to DIP Guidelines coupled with several SEBI notifications and issue-specific SEBI observations made it a confusing and disorganised piece of legislation.
The reliability of the guidelines was compromised by their dependence on SEBI’s informal guidance, which constituted an indicative viewpoint and not a binding interpretation.
To provide these guidelines a statutory backing, SEBI recently notified the SEBI (Issue of Capital and Disclosure Requirements or ICDR Regulations, 2009) repealing the erstwhile DIP Guidelines. The ICDR Regulations attempts to streamline the framework for public issues by removing unnecessary stipulations, introducing market-driven procedures and simplifying the clutter of legality.
Deliberating Key Changes – A Comparative Analysis
The ICDR Regulations is not a fresh law regulating the public issue of securities. However, certain changes in the regulations are worthy to be discussed owing to their practical repercussions.
Eligibility to Access Public Money- Uniform Applicability
The exemptions available under the DIP Guidelines to certain banking and infrastructure companies from eligibility norms for making initial public offers (IPOs) have been done away with under ICDR Regulations, and thus eligibility norms have now been made applicable uniformly to all types of issuers. This is a logical move since these companies are now competitive and do not need such a privilege. Further, it now appears that, debarment from accessing capital markets pursuant to any order or direction of SEBI only applies to public or rights issue of specified securities i.e. equity shares/ convertible securities, unlike under the DIP Guidelines where it applied to issue of all securities for all types of issues. This qualification was needed as ICDR no longer governs the issue of debt securities.
Offer for Sale by Listed Companies Allowed
Under the DIP Guidelines, an “offer for sale” was permitted only for unlisted companies proposing IPOs. The ICDR Regulations now permits an “offer for sale” even by listed companies (subject to certain eligibility criteria) through a new definition of “follow on offer”. ICDR Regulations provides that such offer for sale can be made if the shares are held by the seller for a period of at least one year prior to the filing of draft offer document with the SEBI. The holding period now includes the period when a convertible instrument was held, which has subsequently been converted to an equity share. These changes are desirable since there appeared no rationale for barring shareholders of listed companies from accessing the market through an offer for sale and convertible instruments are essentially equity and should be treated as such from the date the convertible instrument is issued.
No More Firm Allotments
The DIP Guidelines provided for pre-IPO placements on firm basis to the maximum percentage of 10% shares, a maximum of 10% of the issue amount for employees and a maximum of 10% of the issue amount to the shareholders. The eligible subscribers for allotment on firm basis under the DIP Guidelines included Indian Mutual Funds, Foreign Institutional Investors (including non resident Indians and overseas corporate bodies), Indian and Multilateral Development Institutions and Scheduled Banks. Firm allotment, which was not frequently used by companies, has been removed in the ICDR Regulations providing a level-playing field to subscribers of a public issue. Often such firm allotments are bundled with several financial rights and privileges in favour of a single investor, which may hamper management decisions of a company having public money, post IPO. Further, introduction of alternatives like anchor investors portion, wherein, a company making a public issue is permitted to allocate upto 30% of the issue reserved for Qualified Institutional Buyers (QIBs) to anchor investors may serve the same purpose as firm allotment, without hacking the issue size available to general public. An anchor investor is a QIB, who is required to apply for a minimum issue of Rs 10 crores and hold the securities for a minimum period of 30 days after allotment. The concept of anchor investors seems to have the same objective as of the firm allotment, i.e. to give initial stability to the issue.
Minimum Promoters Contribution
Under the erstwhile DIP Guidelines, minimum promoter’s contribution in a public issue could be brought in by promoters/ persons belonging to promoter group/ friend/ friends, relatives and the associates of the promoters. Under the ICDR Regulations, only promoters are permitted to contribute the minimum promoters’ contribution. While this may compromise the ability of promoters to make this contribution, this provision is more meaningful since it recognises the importance of a promoter in a company by increasing the onus on such person to show his commitment to the company, which is raising funds from the public.
The ICDR Regulations explicitly provide that the underwriting obligations would not be restricted to the minimum subscription level but to the whole issue, where applicable. The rationale to such change appears to be that while minimum subscription clause is valid for determining the success of any issue from legal point of view, an issuer may agree to have the issue underwritten with an understanding to get the full amount of funds. Thus, where 100% of the offer through offer document is underwritten, the underwriting obligations shall be for the entire amount underwritten, except cases where compulsory allotment to QIBs is prescribed. This provision gives a public issue greater reliability.
Though the ICDR Regulations have introduced a new exception for preferential issue of equity shares pursuant to convertible debt instruments under sub sections (3) and (4) of section 81 of the Companies Act, 1956. This exemption recognises the need to do away with dual regulation since such conversion is subject to Central Government approval and specific rules. The Stock Exchange is now empowered to order revaluation of non-cash consideration for preferential allotment to promoters, their relatives, associates and related entities for consideration other than cash, if the Stock Exchange is not satisfied by the valuation submitted to it by the issuer This ensures genuine valuations and guards against artificiality.
Efficient Procedure and Adequate Disclosures
Book Building Process: Under the DIP Guidelines, two type of book building was allowed, being 100% book building and 75% book building. The ICDR Regulations does away with the 75% book built route which was hardly used.
Issue, allotment and Refund Period: Under the DIP Guidelines, in case there is a revision in the price band in a book building issue, issue period was not clear but the ICDR Regulations clarifying this lacuna has specifically provided the total issue period not to exceed 10 days, including any revision in the price band. Further, 30 days period for allotment/ refund in case of fixed price issue as provided under DIP Guidelines have been replaced with 15 days, as there was no valid reason to give an extra 15 days to complete the process in case of a fixed price issue, making the public issue process speedier and accountable to investors’ interest.
Other Disclosures and Definitions: Unlike the DIP Guidelines, where in case of a fix price public issue, the issuer was required to disclose price or price band for the shares, under the ICDR Regulations there is no requirement to disclose the price or price band in the draft red herring prospectus (DRHP). This is an important change from the issuer’s perspective as in a fixed price issue it will allow the issuer to take into account market dynamics in determining the price closer to the issue date.
Now the ICDR Regulations require that any pledge of shares by promoters should be disclosed in the prospectus for the public issue. This change is in line with the recent changes in the Equity Listing Agreement and in SEBI (Substantial Acquisitions of Shares and Takeovers) Regulations, 1997 and is an important indicator of the level of control exercised by the promoters in a company. This information coupled with the financial data would give a reasonable indicator of the likelihood of the promoters losing control of the company to the lenders/lender nominees.
The definition of ‘employee’ under the ICDR Regulations excludes permanent employee director of the subsidiary or holding company of the issuer and promoters and immediate relatives of the promoters. So in an IPO, the employee’s reservation portion will only be available to employee/ director of the issuer company and benefit of no-lock-in on options allotted to employees shall extend only to employee/ director of the issuer company and the group companies.
A controversial change in the ICDR Regulations is to prevent forecasts/projections to select investors outside the offer document. This change is in line with US practice. This move is being resisted by institutional investors who argue that in developing markets many companies approaching the market lack a proven track record necessitating financial projections to gauge company potential. The counter view is that a level-playing field is necessary so that the same information is available to all prospective investors. SEBI is yet to decide on the suitability of this change. A good via media may be to publish such projections in the public domain rather than restrict such disclosures to certain investors.
With the notification of the ICDR Regulations, the dilemma which unnerved the market players was on the status of the pending offer documents with the SEBI for proposed issue of securities. However, maintaining the scale up on practicality, which seems to be the highlight of the ICDR Regulations, no re-filing of draft offer documents is required by the SEBI. A checklist of compliances for the already filed DRHPs can be submitted under the ICDR Regulations, compliance of which is to be ensured at the stage of filing the red herring prospectus by the issuer.
Though in the first reading, the ICDR Regulations may appear to be a mere reshuffle of the old provisions, these Regulations appear to remove the fissures in the erstwhile DIP Guidelines to protect investors. The ICDR Regulations represent a leaner and more contemporary set of rules, which should stand the test of time in the vibrant world of capital markets. Now only time will tell whether ICDR Regulations plug the loopholes on a stand alone basis or whether frequent SEBI intervention would be required to address the evolving issues.
(The views expressed in this article are authors own.)