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Introduction
In an ambitious move to improve the integrity and efficacy of corporate governance in India, the Securities and Exchange Board of India (SEBI) recently published a comprehensive set of proposals. These ideas seek to strengthen the ideals of transparency, accountability, and justice in the corporate sector, particularly for publicly traded companies. The primary objective of these recommendations is to strengthen disclosure standards to uncover and expose any secret agreements or arrangements that may hurt shareholder interests or market integrity. Furthermore, SEBI's programme aims to rebalance existing power dynamics inside firms by increasing shareholder control over critical corporate decisions such as special rights and board composition. The proposed reforms by SEBI demonstrate a distinct dedication not only to safeguarding the interests of investors but also to creating a corporate governance climate characterised by elevated ethical principles and equitable treatment for all parties involved.
Recently, the Securities and Exchange Board of India (SEBI) recommended revisions to governance requirements for listed businesses, giving shareholders additional rights and raising corporate disclosures on agreements that bind them.
SEBI stated in a consultation paper that a declaration is required for any agreement that creates a liability or significantly affects the management or control of a publicly traded company.
The regulator has identified instances of agreements that were not disclosed in the ordinary course of business, which could potentially affect the company's management or control or expose it to liability.
Given the circumstances, the repercussions could be substantial for the firm, even though the listed entity did not participate in the arrangement.
It further stated that shareholder agreements, despite not being incorporated into the Articles of Association (AoA), frequently fail to be submitted to the shareholders for approval, despite their binding nature and ability to establish limits. This denies them the ability to investigate such arrangements.
The regulator also proposes mandating listed businesses to make such disclosures in their annual reports beginning with the next fiscal year, and any agreement between shareholders and third parties to which the entity is not a party must be notified to the company within two days. The firm will then report this to exchanges. It intends to cover both existing and new agreements.
Simultaneously, it proposes granting the board the authority to reject such agreements and a voice in determining whether they are in the company's best interests. The market regulator has also requested feedback on a review of special shareholder rights. It states that other shareholders must agree to any special rights and privileges enjoyed by particular owners.
While such special rights must be evaluated after listing, it has been noticed that public institutional shareholders of freshly listed companies, particularly new-age startups, have consistently objected to special advantages granted to promoters or founders. As a result, it states that any unique rights granted must be reviewed before shareholders every five years.
Among other measures, the regulator wants to address board permanency by requiring periodic reviews. This applies to directors for whom the retirement by rotation' rule is not applicable.
Listed entities are advised to implement a policy requiring shareholders to examine all member directorships every five years, effective April 1, 2024.
To protect minority shareholders' interests in the event of the sale or lease of the entire company or all assets, it proposes amending clauses in the LODR rules to require disclosure of transaction data to all owners.
Increased Disclosures
SEBI is increasingly apprehensive about undisclosed agreements among listed entities due to the potential threats to market integrity, corporate governance standards, and minority shareholder interests that these hidden arrangements pose. The financial health, decision-making processes, and strategic orientations of a company can be substantially impacted by undisclosed agreements, which frequently keep critical information from other stakeholders and may jeopardise their investment and the entity's reputation on the market.
The Nature of Undisclosed Agreements
Undisclosed agreements can take various forms, including but not limited to side agreements, preferential deals, and arrangements between major shareholders and external parties that are not disclosed to the wider shareholder base or the public. These agreements may grant certain parties undue advantages, such as preferential access to information, assets, or decision-making powers, potentially at the expense of the company and its minority shareholders.
SEBI's Concerns
SEBI's apprehensions revolve around several key issues:
Transparency and Fairness: The absence of disclosure about these agreements impairs the transparency and impartiality that are essential to the operation of capital markets. It can result in an information imbalance in which just a few people have access to vital information, disadvantageously affecting the larger investment community.
Market Integrity: Undisclosed agreements can alter the market perception and valuation of the listed firm, resulting in poor investment decisions and perhaps influencing market prices.
Governance and Accountability: Such agreements can raise governance concerns, as decisions may not be made in the best interests of the firm or its shareholders as a whole, but rather to benefit a select few.
Proposals for Mandatory Disclosure
In response to these concerns, SEBI has proposed a framework for the mandatory disclosure of all material agreements affecting listed businesses, whether directly or indirectly. The essence of these proposals is:
Disclosure Norms: SEBI recommends creating strong disclosure standards that compel listed businesses to report any agreement or arrangement that could have a major impact on their governance, operations, or financial performance. This applies to both existing and new agreements.
Periodic Review: The recommendations call for a periodic assessment of these disclosures to ensure their continuous relevance and significance, resulting in an up-to-date repository of information available to all stakeholders.
Enhanced Scrutiny: For agreements assessed to have a major impact, SEBI suggests an enhanced scrutiny system, which may include third-party audits or regulatory review, to analyse the consequences for the listed firm and its stakeholders.
Penalties for Non-Compliance: To enforce these norms, SEBI intends to impose fines on listed businesses that fail to meet the required disclosure requirements, to discourage non-disclosure and promote an open and transparent culture.
SEBI's proposals aim to address the issues caused by secret agreements head-on, ensuring that all important information is made public. This action is designed to level the playing field for all investors, improve corporate governance standards, and strengthen the integrity of India's capital markets by cultivating a culture of trust, transparency, and accountability.
Shareholder Rights
An additional fundamental aspect of SEBI's governance reform is the enhancement of shareholders' influence, specifically about critical corporate decisions, to empower them. Proposed measures include approaches to reassessing the special privileges granted to specific shareholders and the makeup of corporate committees. The aforementioned suggestions are based on the premise that a board composition that is more diverse in its interests and a more equitable distribution of decision-making authority will result in corporate governance practices that are more impartial and just. By deconstructing the established power structures that have traditionally marginalised the opinions of shareholders, the overarching objective is to cultivate an environment of governance that is more democratic and inclusive.
Reviewing Special Rights
An essential element of the proposals put forth by SEBI entails a thorough examination of the special rights that are bestowed upon specific shareholders. These rights frequently encompass voting rights, the ability to nominate directors for the board, and privileges that grant specific shareholders an unbalanced impact on corporate determinations. The apprehension in this situation is that the broader shareholder base might be marginalised as a result of these privileges, which could lead to decisions that do not necessarily serve the company's or investors' best interests.
The implementation of mechanisms to periodically review these special rights and ensure they continue to serve the best interests of the company and all its shareholders is recommended in SEBI's proposals. This may entail establishing minimum requirements for the activation of specific rights, guaranteeing that they do not sustain an inequitable distribution in the decision-making process, and potentially subjecting these rights to a shareholder vote to ratify or modify them by present business goals and market conditions.
Board Composition
Another critical area SEBI is focusing on is the composition of the board of directors. The board plays a pivotal role in shaping the strategic direction and governance of a company, and its composition significantly impacts how shareholder interests are represented and safeguarded. SEBI’s suggestions aim at making the board more reflective of the company’s shareholder base, thereby enhancing its diversity and the range of perspectives considered in the boardroom.
Proposals in this area include mechanisms to ensure more transparent and democratic processes for the nomination and election of directors. This might involve setting criteria for the independence of directors, ensuring they can act in the best interests of the company without undue influence from dominant shareholders. Additionally, SEBI suggests enhancing the role of minority shareholders in the election process, potentially through measures such as cumulative voting, which could give them a stronger voice in determining the composition of the board.
Empowering Shareholders in Decision-Making
SEBI's proposals propose more extensive measures to capacitate shareholders in the corporate decision-making process, extending beyond the examination of special rights and board composition. This includes facilitating their participation in critical strategic moves, mergers, acquisitions, and other significant decisions and providing them with adequate information and opportunities to do so. To promote a corporate governance atmosphere characterised by greater transparency, equity, and democracy, SEBI endeavours to facilitate participation that is more inclusive and well-informed.
In essence, the Statement of Economic Affairs (SEBI) demonstrates a paradigm shift in corporate governance in India by prioritising the improvement of shareholder rights via the examination of special rights and board composition and by expanding shareholder engagement in corporate decision-making. By seeking to achieve a balance of power within publicly traded companies, these measures not only contribute to the stability and well-being of the corporate ecosystem in India but also safeguard the interests of minority shareholders.
The proposals from SEBI stand out because they place a strong emphasis on protecting the interests of minority shareholders, particularly when it comes to asset sales.
Minority Shareholder Protection
The proposals from SEBI stand out because they place a strong emphasis on protecting the interests of minority shareholders, particularly when it comes to asset sales. The primary objective of the regulator's initiatives is to safeguard the interests of minority shareholders during the implementation of substantial corporate activities, preventing their neglect or compromise. SEBI is establishing a precedent for a governance framework that places the interests of all stakeholders first by mandating that such decisions undergo more rigorous examination and, in specific instances, majority shareholder approval. By implementing this strategy, the risk of exploitative practices is substantially mitigated, thereby fostering a more stable and predictable market environment and bolstering the rights of minority shareholders.
Understanding that asset transactions can have significant effects on a company's financial health, strategic direction, and shareholder value motivates the regulator to concentrate on this area. Insufficient protective measures may result in these transactions favouring majority shareholders to the detriment of minority shareholders, thus compromising the integrity of the market and eroding investor trust.
Concerns in Asset Sales
Asset sales have the potential to materially affect a company's financial position, revenue, debt levels, and growth prospects. This is especially true for transactions that involve substantial portions of the company's operations or critical assets. Concerning such matters, minority shareholders are primarily apprehensive that majority-controlled decisions may not consistently reflect their interests or the company's long-term sustainability. A disadvantage may result for minority shareholders and the company if assets are sold under unfavourable conditions, are undervalued, or are structured in a way that favours a select business group.
SEBI's Proposals for Enhanced Protection
SEBI has put forth several measures aimed at enhancing transparency, impartiality, and minority shareholder participation in the decision-making process concerning asset sales to mitigate these risks and safeguard the interests of its holdings.
Mandatory Disclosure: SEBI suggests that organisations ought to be obligated to provide comprehensive disclosure regarding their intended asset sales. This disclosure should encompass the reasoning behind the sale, the terms relevant to the transaction, the valuation techniques utilised, and the anticipated ramifications for both the organisation and its shareholders. Using this transparency, every stakeholder is adequately apprised and able to evaluate the ramifications of the transaction.
Independent Valuation: SEBI recommends mandating an independent valuation of the assets involved to ensure that asset transactions are conducted at fair market value and to prevent undervaluation or preferential treatment. The purpose of this stage is to offer an impartial evaluation of the asset's value, thereby facilitating a more fair and just process of decision-making.
Minority Shareholder Approval: One of the most consequential suggestions entails mandating minority shareholder approval before the divestiture of substantial assets. This measure ensures that a wider range of shareholders participate in decisions of this kind, which have the potential to be revolutionary, rather than just those who hold the majority stake.
Enhanced Oversight: SEBI is contemplating the implementation of more stringent oversight mechanisms about asset sales, which may encompass regulatory authority or independent committee examination. By imposing this additional level of scrutiny, the company and all of its shareholders can be certain that the transaction is conducted in their best interest.
Impact of SEBI's Proposals
By implementing these suggested measures, substantial progress can be made in protecting the rights and interests of minority shareholders throughout critical corporate transactions, such as asset sales. SEBI endeavours to cultivate a corporate governance environment that is more inclusive, equitable, and transparent through the implementation of mechanisms that promote transparency, ensure fair valuation, and involve minority shareholders in the decision-making process. These initiatives serve the dual purpose of safeguarding the interests of minority shareholders and improving the reputation and appeal of India's capital markets through the advocacy of equitable, transparent, and stakeholder-centric practices.
Conclusion
The entire package of ideas put forth by SEBI marks a significant turning point in the evolution of corporate governance in India. The purpose of these ideas is to rebalance the governance landscape in favour of more openness, equity, and accountability. This will be accomplished by addressing crucial concerns such as hidden agreements, shareholder rights, and the protection of minority interests. As the deadline for public comments approaches closer, stakeholders from all walks of life have the opportunity to make contributions to the formation of a governance structure that is reflective of the expectations of the market participants as a whole. If the suggested modifications are put into effect, they have the potential to not only improve India's attractiveness as an investment destination but also to strengthen the principles of fairness and honesty that are the foundation of the functioning of its capital markets.
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