SEBI Seeks Review Of Delisting Regulations

The body has issued a discussion paper on 9th May, 2014, seeking comments from stakeholders for a review of the regulations that were notified on 10th June, 2009

Delisting of equity shares of listed companies is regulated by SEBI (Delisting of Equity Shares) Regulations, 2009 ("Delisting Regulations"). The Delisting Regulations were notified on 10th June 2009 and replaced the erstwhile SEBI (Delisting of Securities) Guidelines, 2003. Unfortunately, the experience of various stakeholders with respect to delisting of shares under the regime prescribed under the Delisting Regulations has been less than satisfactory.

Responding to representations from various stakeholders including stock exchanges, industry bodies and investor associations, SEBI issued a discussion paper on 9th May 2014, seeking comments from stakeholders for review of the Delisting Regulations. As mentioned in the discussion paper, out of a total of 38 delisting offers made under the current regime, 10 offers were unsuccessful.

While the provisions of the Delisting Offers which are thought to have impeded successful completion of these delisting offers have been discussed in detail in the discussion paper, the real reasons for failure of the current regime need to be understood and appreciated.

Objectives of Delisting

At the outset, it is important to highlight the factors which motivate Indian companies to seek to delist their shares.

Firstly, there is a historical perspective which one needs to reflect on. Previously, the Foreign Exchange Regulation Act, 1973 capped foreign direct investment in Indian companies at 40% in most industry sectors which meant that multinational companies were left with no choice but to operate through listed companies if they could not find a trusted Indian joint venture partner. Similarly, several companies promoted by Indian businessmen were widely held owing to the promoters' inability to support the funding needs of these companies to the full extent.

These Indian promoters exercised control over day-to-day affairs of these companies via the instrument of managing agency system until it was abolished in April 1970. Keeping pace with the economic and regulatory liberalisation initiatives taken by the Government of India since 1991, these two classes of promoters have gradually increased shareholdings in their listed subsidiaries in order to retain control over them and continue to be the ideal candidates for delisting offers.

Promoters opt for delisting of shares for several other reasons too, including the following:

(i) Delisting is undertaken as a precursor to restructuring of a financially under-performing company or to diversify into newer & riskier business lines.

(ii) Indian foreign exchange laws now permit overseas listing of securities without a domestic listing, which allows promoters to raise funds in overseas markets at lower rates. This has encouraged promoters to seek to delist shares from domestic stock exchanges and opt for international listings in overseas jurisdictions where disclosure and corporate norms are lax.

(iii) Delisting enables companies to save on administrative and other costs associated with maintaining listing of the company's shares. This is a rational choice for promoters who have sufficient financial resources to support the company's needs for the foreseeable future.

The Other Side of the Story

Many of the companies who wish to delist their shares are wellrun organizations with a history of delivering good returns to shareholders and hence small shareholders are naturally reluctant to part with shares of these companies. This factor is even more pronounced in the case of Indian subsidiaries of multinational companies, owing to transparency in business dealings and superior corporate governance norms adopted by them in line with those followed by their parent companies.

Further, delisting of shares of well-run companies shrinks the capital market which runs contrary to SEBI's avowed objective of strengthening and deepening Indian capital markets. Availability of good quality stocks is a necessary requirement for a strong, deep and resilient capital market. SEBI's approach to regulation of delisting of shares appears to be biased, quite understandably, towards protecting interests of small shareholders. As is clear from the discussion paper, this approach does not appear to have yielded the desired results.

Issues at hand

The discussion paper highlights the following issues which have inhibited successful completion of delisting of shares in several deserving cases:-

• failure of Reverse Book Building Process ("RBBP") to achieve its intended objectives
• lack of sufficient demand for delisting offers
• the overall delisting process being found to be time consuming and inefficient

SEBI's attention has also been drawn to attempts by certain promoters to allegedly circumvent the Delisting Regulations through questionable arrangements with a set of investors. Even if these allegations are true, one would be excused for arguing that these promoters were perhaps left with no other choice, given the high rate of failure of delisting offers under the current regime.

Proposed Solutions

The central philosophy underlying a delisting regime in a developing but highly globalised market like India should be to enable the majority shareholder to gain the economic and administrative benefits of an unlisted company (via the delisting process), while ensuring a fair price for minority shareholders. Further, a delisting regime should discourage circumvention of its provisions and encourage compliance of its provisions in letter and spirit. The proposals outlined below, though perhaps not a panacea for all ills, would go a long way in achieving the philosophical objectives mentioned above.

1. Price Discovery Mechanism: The RBBP suffers from two key defects viz. (i) it does not assure certainty as regards acquisition of shares tendered by shareholders in a delisting offer, since the promoters are entitled to reject the offer if the price discovered through the RBBP is not acceptable to them; and (ii) it is biased in favour of institutional shareholders, since the delisting price is one at which the maximum number of shares are tendered. This impacts smaller shareholders who may have bid higher prices for their shares as their bids get rejected. It is logical for small shareholders to put in higher priced bids in a delisting offer, since entry price into a scrip for individual shareholders is usually more than that for institutional shareholders.

It may therefore be advisable to replace RBBP with a fixed price mechanism on the lines of that existing under the SEBI Takeover Code, where the acquirer quotes a price which he is willing to pay for the shares tendered in the offer, subject to a statutorily prescribed floor. This may be coupled with an obligation on the part of the promoter to acquire all shares validly tendered under the delisting offer. This would ensure that the delisting price reflects "willing buyer willing seller" arrangement and the delisting process guarantees certainty of exit for public shareholders participating in the delisting offer.

2. Voting Threshold for Shareholder Approval: Currently, the Delisting Regulations require approval by way of a special resolution, with at least 2/3rd of the public shareholders voting in favour, for undertaking a delisting offer. Requirement of shareholders' approval does not serve any useful purpose, since approval of shareholders would anyway be reflected via participation in the delisting offer. However, if this requirement is to be retained, then the requirement to seek approval of 2/3rd of public shareholders ought to be diluted by prescribing approval of a majority of the public shareholders, consistent with SEBI's circular dated February 4, 2013 with respect to schemes of arrangement.

3. Minimum Acceptance Threshold: The minimum acceptance threshold of higher of (i) 90% of share capital or (ii) 50% of offer size, as currently prescribed in the Delisting Regulations, enables large shareholders to hold the delisting process to ransom, since small shareholders adopt a dormant and non-participative approach, partly in view of the provision requiring the promoters to accept shares tendered by public shareholders even after closure of the delisting offer, for a period of one year.

This situation is further compounded by Regulation 3(2) of the SEBI Takeover Code, which prohibits promoters from undertaking market purchases of shares beyond 75% of share capital. It is suggested that either the minimum acceptance threshold be reduced from 90% to 75% or the promoters be permitted to undertake market purchases of shares during the currency of the delisting offer beyond the 75% threshold, so long as the benefit of any higher price (visà- vis the price offer discovered via RBBP under the delisting offer) is made available to shareholders participating in the delisting offer.

This will increase the probability of delisting offers being successful, while at the same time assuring a fair price to public shareholders. If the delisting offer still fails, the promoter may be required to dilute his shareholding to 75% within 12 months from announcement of the delisting offer, akin to SEBI Takeover Code provisions.

4. Provision for Exemptions: Unlike SEBI Takeover Code, the delisting regulations do not empower SEBI to exempt any specific class or company from the rigors of delisting regulations. It is generally observed that institutional investors do not have significant holdings in companies which are financially under-performing and a significant part of the shareholding of such companies is held by individual inactive shareholders. With regard to such companies, delisting offers cannot be successful under the current dispensation, given the indifference and nonparticipative approach of small shareholders.

The situation gets compounded due to the inability of promoters to infuse equity into the company in view of the minimum public shareholding requirement of 25%. It would, therefore, make sense to include an enabling provision empowering SEBI to exempt financially weak companies and any other deserving class of companies from the rigors of Delisting Regulations, especially shareholder approval and minimum acceptance thresholds. It would be better to allow such companies to be delisted rather than expose public shareholders to the consequences of winding up proceedings.

5. Takeover-cum-Delisting Offer: Currently, SEBI Takeover Code does not permit takeover-cum-delisting offers. This results in the acquirer being required to make two offers for acquiring shares of public shareholders at different points in time, even if the acquirer's original intent is to acquire the entire shareholding of the company. Consistent with regulations in developed jurisdictions, it would be advisable to allow takeover-cum-delisting offers, subject to upfront disclosures about the acquirer's intention to delist the company.

6. Taxation: The sale of shares in a delisting offer may result in accrual of capital gains. In this regard, unlike in the case of capital gains arising from sale of shares on the floor of the stock exchange which are exempt from capital gains tax u/s 10(38) of the Income Tax Act, 1961, the sale of shares in a delisting offer attracts capital gains tax, which makes it financially unattractive for a shareholder to tender his shares in a delisting offer vis-à-vis selling them on the floor of the stock exchange. It may be advisable for SEBI to request the Ministry of Finance to provide a level-playing field by exempting from capital gain tax, any capital gains accruing via sale of shares in a delisting offer. Securities transaction tax could be levied & collected on sale of shares in a delisting offer as per a special mechanism to be jointly devised by SEBI & CBDT.

Conclusion

It is encouraging to note that SEBI continues with its practice of reviewing various regulations framed by it on a regular basis, by adopting a consultative approach. In this respect, the discussion paper on review of the Delisting Regulations is a welcome step and one hopes that the consultation process culminates in adoption of a majority, if not all, of the proposals outlined above, thereby ushering in a progressive delisting regime.

Disclaimer - Views expressed in this article are personal and do not constitute views of the Tata group.