Role and obligations of promoters in the capital market

The logic behind making the promoters bear the brunt for what was evident as the failures of the management and the issuer of a “newly made public” company is typical to the Indian capital market scenario.

From evergreening promoter-tag imposed continuous obligations and disclosure requirements to liabilities disproportionate to economic interests, promoters have always been the scapegoat when the actual controllers of the company have faulted in the majestic voyage.

Against this background, the Securities Market Regulator SEBI recently introduced a consultation paper proposing to replace the concept of “promoters” with “persons who are in control.”

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Evolution

Corporate structure in India has always been promoter-centric. While there are alternate theoretical perspectives on why such a system was followed, the most common justification is founded along with corporate paternal logic.

In layman’s terms, the promoters are the company’s parents. Such a position has been sanctimonious, especially in a traditional kin-oriented society like India-where the parents are answerable for the child’s doings.

However, recent studies have shown that the corporate structure in India is undergoing a radical shift from Promoter oriented to investor-oriented. With the increase in the number of private equity and institutional investors having a substantial stake in unlisted companies and continuing their shareholding post listing, most of the non-promoters have become some of the largest public shareholders and at often with special rights like appointing directors.

While this trend is seen mainly in new-age tech companies that do not have a family-owned or distinctly identifiable promoter group, the number of financial companies with zero to low promoter shareholding is also increasing every day

Rules for promoters

It is interesting to note that India does not have a law that specifically governs a promoter’s rights, obligations, and duties. Nonetheless, the compliance requirement that a promoter has under the wide maze-like phenomena of the Indian corporate law is nothing less to make separate legislation in itself.

As far as the capital markets are concerned, being a promoter subjects the person to multitudes of obligations, including disclosure obligations, lock-in restrictions, providing exit opportunities, and ensuring compliance with the applicable law.

In cases where the issuer has been found in contravention of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015, the Regulator can even freeze the Promoter’s shareholding in the company. This often shifts the focus from the issuer’s board, which controls and governs the issue.

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The West

Like every other jurisdiction that endeavor for a strong capital market, the legal obligations and liabilities of promoters in US listed companies are nothing short of their counterparts. However, unlike the followed system in India, in the U.S., the promoter’s role is mainly active only in the initial phase of incorporation and early-stage liquidity.

By the time the company is about to list, the law provides the issuer an option to list as a “professionally managed company” if the promoter stake is diluted substantially. In such cases, the board is answerable for securities compliance.

Very recently, in the case of Houghton v. Saunders & Ors (alleged prospectus misselling case), the Supreme court of Newzealand, in its ruling, accepted the argument that the “promoters” could not be held liable, especially when they lacked sufficient control and decision-making power over the offer.

It is not like SEBI has not considered exploring these new frontiers of “actual control” before.

For example, In 2016, SEBI had issued a consultation paper for setting out bright-line tests for what constitutes control under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, but sadly stopped further to pursue the same.

Therefore, it may be helpful for both the investors and the Regulator if SEBI re-examines the definition of ‘control’ and introduces specific objective criteria for determining what constitutes “control.” This will clear the ambiguities existing under the current laws and shift the Promoters’ burden to controlling shareholders. And in cases where there is no identifiable controlling shareholder, the board and the management may be held liable for compliance failures.

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Conclusion

In the Indian corporate structure, the designated persons selected for the role of scapegoat for securities compliance requirements are the promoter entities.

The selection process has become more than overt for historical reasons tied to the Indian kin-oriented corporate framework.

However, there is no denying that the Indian capital market is evolving.

It has become imperative for the regulators to re-look at the laws and bridge the regulatory gaps to ensure that Indian companies are at par with global standards and have the edge over their foreign counterparts.

In this context, the consultation paper SEBI has proposed is crucial for the growth and development of the Indian securities market.

Nevertheless, given the far-reaching impact of the changes proposed in the Consultation Paper, it will be interesting to see how SEBI, in consultation with other regulators, will consider the details and nuances of this new proposal and transition process while implementing it.

(The writer is a B.A.LLB (Hons.) student at the National University of Advanced Legal Studies, Kerala, India)