By 10 June, 2013
A very harsh freeze

In a major blow to the promoters and the directors of defaulting private sector listed companies which failed to meet the minimum public shareholding of 25% by June 3, 2013, SEBI has passed a very stringent order. The order, which could have far reaching effects, directs the freezing of voting rights and other corporate benefits such as dividend, entitlement to rights and bonus shares, share split, etc, with respect to the excess of proportionate promoter/promoter group shareholding in such companies.

There is a specific formula provided in the SEBI order to determine the proportionate promoter/promoter group shareholding which is not a simple mathematical calculation of excess of promoters’ shareholding over the permitted 75%. Rather it is relatively complex and will result in freezing of a major part of the promoters’ shareholding. This adds to the blow on the promoters and to some extent on the companies because devoid of voting rights these shares cannot be put to vote to enable companies to pass resolutions by requisite votes as required under the Companies Act, 1956, especially at a time when the AGM season is around the corner.

The order also prohibits the promoters/promoter group and directors from buying, selling or otherwise dealing in securities in any manner except to restore the minimum public shareholding; it also restrains the promoters/promoter group and directors of such companies from holding any new position as a director in any listed company. The order also states that SEBI can take further actions such as levying a monetary penalty, initiating criminal proceedings, moving the scrip to the trade-to-trade segment, excluding the scrip from F&O segment or any other action/direction so deemed appropriate.

Before this order was passed, all private sector listed companies were given three years to comply with the requirement of minimum public shareholding and SEBI had from time to time prescribed various methods to be used to reduce the excess promoters’ shareholding. SEBI had also advised companies to comply with the minimum public shareholding and warned that it would take appropriate proceedings if the companies fail to do so.

After considering all these facts, SEBI has now passed its order which also emphasises the importance of availability of shares with public to ensure reasonable depth in the capital market and that prices of the securities are not susceptible to manipulation.

The reason given in the order to freeze the various benefits on promoters’ shares is to ensure equitable participation of the promoter/promoter group and the directors qua the public shareholders in the affairs of the listed company and also provide a level playing field for the promoter/promoter group of the non-compliant companies with the

promoter/promoter group of the companies that have already complied with the minimum public shareholding and to ensure balance by not permitting disproportionate advantage arising out of non-compliance of the minimum public shareholding.

This order may be challenged. One of the grounds for challenging it can be this: voting rights and other corporate benefits are the basic rights under the Companies Act, 1956 and therefore these cannot be taken away unless there are grounds to take them away as provided in the Companies Act, 1956. If such a ground is taken, will it succeed in challenging the order?

The Companies Act, 1956 gives certain basic rights to a shareholder such as voting rights in proportion to his share of the paid-up equity capital, rights to receive dividend, proportionate entitlement to rights and bonus issue, proportionate right to tender shares in a buy-back offer, return of capital (surplus left) on winding up of the company, etc. Now these rights are basic rights and cannot be taken away from a shareholder unless provided in the Companies Act, 1956. For example, as provided in Section 206A, rights and bonus issue can be kept in abeyance for those shares whose request for transfer has been delivered to the company but the transfer has not been registered by the company.

Therefore, the question now is whether SEBI has the jurisdiction to override and pass orders to take away the basic rights of a shareholder on grounds other than as provided in the Companies Act, 1956.

The preamble to SEBI Act, 1992 provides that SEBI has been established to protect the interest of the investors in securities and to promote the development of and to regulate the securities market and for the matters connect therewith or incidental thereto. Section 11 and 11B of SEBI, Act, 1992 give wide powers to SEBI to issue directions. In fact, Section 11(1) repeats the preamble and states that it shall be the duty of SEBI to protect the interests of investors in securities and to promote the development of and to regulate the securities market by such measures as it thinks fit. The use of words ‘such measures as it thinks fit’ shows the intent of the legislature to give SEBI wide powers to issue orders and directions for the objective for which it has been established. Further, Section 11B also provides that if SEBI is satisfied that it is necessary in the interest of investors or orderly development of securities market it may issue directions to any person as may be appropriate in the interest of investors in securities and the securities market. In fact, it has been observed that Section 11 and 11B are the soul and heart of the SEBI Act, 1992. Further, Section 12A of Securities Contracts (Regulations) Act, 1956 also provides for similar provisions as provided in Section 11B.

Then, Section 11 (4) of SEBI Act, 1992 also reiterates the objective that in the interest of investors or securities market, SEBI may by order restrain persons from accessing the securities market and prohibit any person associated with securities market to buy, sell or deal in securities.

Therefore, SEBI, after due observance of principles of natural justice, has enough powers and provisions in its armoury to pass orders, of the kind it has passed in this case. In fact, SEBI has in the past issued directions prohibiting alteration of capital structure, not to issue further securities, instructions to depositories to freeze the beneficial owner’s account, etc. and all of them are pursuant to powers vested under Section 11 and 11B.

Interestingly, there are enough judicial precedents (even from the apex court) to support the power of SEBI to issue directions and choose appropriate measures to its satisfaction befitting the needs of the circumstances.

Therefore, it is very unlikely that a challenge on the ground that the SEBI order in this case takes away the basic rights of a shareholder under the Companies Act, 1956 will succeed. 

(Lalit Kumar is a partner with J. Sagar Associates. Views are personal.) 

Disclosure: The author’s firm represents some companies affected by the SEBI order.

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