This article is written by Raunak Sood, 4th Year BBA LLB (Hons.) at Bennett University, Greater Noida.

Introduction

The discussion paper released by SEBI seeks to get comments from the public on the issue of promoters being classified as public, the paper contains mooted policy, disclosure requirements, and conditions to which a promoter who wants to become public shall adhere therewith.

Defining a promoter and promoter group

A promoter is in control of the company, manages the company, named in offer document with a few exceptions as defined in Regulation 2(oo), ICDR whereas a promoter group consisting of promoter, his immediate family, body corporate, individually, and other conditions and exceptions as mentioned in Regulation 2(pp), ICDR. 

Objective 

A promoter has to comply with regulations in the interest of investor protection, hence the discussion paper seeks to give relief to such promoters by reclassifying them as public. 

Recommended Policy

A. Promoter or promoter group may reclassify by either giving out an open offer under Reg.3 SAST Regulations or sign a separation contract or holds less than 5% of share in the company. The promoter or promoter group shall follow the following conditions concerning the company-

1. Not holding previously executed SHA shall exist or any form of special rights.
2. Not holding any managerial position.
3. Not be debarred from the capital market.
4. Not exercise control.

B. Additionally, if promoter or promoter group wants to reclassify by signing a contract or holding less than 5% share- 

1. Shall give reasons, copy of contract and documents to the Stock Exchange.
2. Shall subscribe to minimum public shareholding norms thereby after 3years will become public shareholders. 

C. Furthermore, if the promoter or promoter group has less than 5% shareholding then –

1. Disclosure of promoter-ship should have been 3 fiscal years before reclassification.
2. Not fall within the legal definition of “promoter” or “promoter group”.

Disclosures

1. The promoter and promoter group shall disclose the percentage of their shareholding and the name of the company they are the promoter of to the respective stock exchange(“SE”). 
2. The SE is in charge to update the information given by the promoter on its website whereas on a case-by-case basis the SE has the right to ask for additional disclosures or relax a condition of disclosure with written reasons.

Based on the above-mentioned policy and disclosures, SEBI has sought an opinion from the public. 

Need to introduce law for reclassification of shareholders

Promoters are those entities or individuals who exert control over the company vide having a majority shareholding or having special contractual rights over the company or being in charge of daily management or named in the offer document through which securities are subscribed by the public or otherwise. The need to introduce a law for reclassification of promoters to public shareholders is because of the following reasons:

1. A promoter has to follow through series of regulatory compliances prescribed by SEBI in the form of promoter contribution of 20% of post-issue capital, disclosures of shareholding, voting rights, continuous disclosures, disclosure of pledged shares, declaration of non-encumbrance, and other compliances as prescribed by SEBI from time to time, but in 2013 when the discussion paper on promoter reclassification was due for public comments at that time, an individual could easily become a promoter of a company by making an open offer under Regulation 3, 4 and 5 of SAST but there was no law on the exit of promoters from the company.
2. There are many companies where the promoters are completely dormant because they have either sold out their majority shares, given up the control of the company and at the same time are not involved in the functioning of the company directly or indirectly, so to regulate the exit of such dormant promoters, SEBI proposed the said changes mentioned in the discussion paper.
3. If a promoter is allowed to exit the company then only the board of directors, shareholder and articles of association will be the ones guiding the future of the company, hence this will lead to good corporate governance within the company. 

Effect of the proposed changes on the investors

The changes surrounding a promoter reclassifying himself as a public shareholder will have the following consequences on the investors:

1. Whenever a promoter buys a stake in his own company it sends out a positive message to the investors because this means that the promoter is confident in the growth aspects of his own company, whereas, when a promoter sells his stake in his own company this sends a negative signal to the investors as it can be interpreted that the promoter is himself or herself not possessing enough confidence in the growth aspects of its own company. 
2. Investors are those people who have surplus money, they pump their surplus money to finance the operations of their company by buying equity shares and becoming members of the company or shareholders. The procedure and conditions proposed in point j, k, l, m, and n, in the discussion paper, give over the decisive powers to powers to the promoter for exiting the company and the stock exchange has to adjudicate on a case basis the exit of the promoter from the company, hence an investor who invested into the company seeing the persona of the promoter has been neglected because a promoter can exit the company without shareholder’s approval which causes prejudice to the interests of investors. 
3. There are scenarios in which a promoter who had once acquired the title of “promoter” within the company but subsequently the said promoter lost his shareholding and control over the management of the company, even though the shareholders of the company by majority approved to amend the articles of association to make the company professionally managed (a company without any promoters), still the tag of the promoter is stuck and the said promoter wants to stick to his post of “promoter” within the company, in such a situation the discussion paper does not give any power to the company or its shareholders to initiate the reclassification of a dormant promoter, hence this acts contrary to the interests of shareholders/investors who want to remove a dormant promoter. 
4. The whole policy framework as documented in the discussion paper is working under the assumption that promoters themselves want to exit the company because they do not have any say within the company, but no incentive is being given to a promoter to go through the tedious process of disclosures and related-procedures. A promoter who is barred from the capital market or a wilful defaulter, the company cannot get itself rid of its dormant promoter because point c. under the conditions mentioned in the discussion paper bars such promoter to exit the company, hence the company inclusive of its investors have to bear the brunt of a bad image of its promoters which goes against the interests of investors of the said company as shareholder approval is not necessary for reclassification. 
5. The proposed policy in the discussion paper framework allows reclassification of promoters by bypassing the investors who have invested their trust and money within the company, but reclassification can take place only as per the whims and fancies of the promoters of the company, such a law is contrary to the principles of equity and causes anxiety to the investors of the said companies. 

Based on these above-mentioned reasons and the lacunae covered, it can be concluded that the proposed changes are hurting the investor because the proposed regulations bypass the need for shareholder approval. 

Effects of the proposed changes on the company

The changes proposed in the discussion paper has a positive impact on the dynamics of the company, such an impact has been considered in the discussion paper and the proposed policy framework has had both positive and negative effects on a company because of the following reasons:

Negative Effect

1. The discussion paper does not take into account the scenario wherein the articles of association of the company are amended to change the company into a company without any promoters for the purpose of good governance, but the dormant promoter becomes uncooperative and blatantly refuses to reclassify himself as a public shareholder, since no power has been given to the company and its shareholders to reclassify the said dormant promoter, this lack of power on part of the company and its shareholders will be a negative impediment for the company and its good governance. 
2. The proposed changes do not give any power to the company inclusive of the board of directors and respective shareholders to pass a resolution to reclassify a dormant promoter who does not exert any form of control over the company, the process of reclassification can begin only at the request of the promoter and during the reclassification process as it is mentioned in point g. of the discussion paper, there is a 1-year period after which the promoter may be reclassified, this 1-year period is quite large period of time to reclassify a promoter who is having no relationship with the company, this will have adverse effects on the company because it will moreover disincentivize a dormant promoter who will want to exit the company which itself defeats the objective of the discussion paper. 
3. Under the common conditions mentioned in the discussion paper, the lacunae being that there is no express clause in the discussion paper iterating a condition that bars the promoter turned public shareholder to return back to the company on the board of directors after the said promoter has exited the company (in the position of non-executive nominee director), this is causing a negative effect on the company because such former promoter sharing the same pedestal as another public shareholder will be able to have some influence on the management of the company. 
4. A major problem with the policy laid down in the policy framework as mentioned in the discussion paper is that the exit of a promoter shall be done on a case by case basis by the stock exchanges whereas there is no condition mentioned in the procedure that the said stock exchange after receiving a request for reclassification should dispose of the case on merits within a specified period of time, since there is no time frame mentioned in the procedure, case by case adjudication will take a long period of time to dispose of reclassification cases, this will disincentivise companies/ promoters to reclassify themselves which will go against the best interests of the company which wishes to get themselves rid of dormant promoters.

Positive Effects

1. A positive effect of the proposed changes that the said policy framework which allows all the promoters to exit will allow the company to function with only the board of directors, articles of association and the shareholders who will be the ones to guide the company, this is a part of good corporate governance. 
2. Another positive effect on the company can be seen in the form of point f. of the discussion paper which mandates that the exiting promoter shall furnish reasons for his reclassification, this will have a positive effect on the company and its future prospects because generally when a promoter decreases his shareholding within the company it raises a red flag for the investors and show that the promoter is himself not confident in his own company, thereby if the promoter is furnishing reasons for exiting the company vide the reclassification process, this will have a positive impact on the company since the said company will not be viewed in a negative light by prospective investors of the said company.

Suggestions

The following points under para 11 should be amended, substituted, or added to: 

1. Point c. should be deleted completely as it goes against the interest of the investors because a promoter with a bad image is like a black mark on the future of the company hence such promoters should be allowed to exit in the larger interest of the company.
2. An additional point that can be added under “Conditions with respect to disclosure and procedures” that it should be mandatory for the promoter to get a shareholder approval before the stock exchange can reclassify him or her as public shareholder. 
3. An additional condition under “Common conditions with respect to scenario I, II and III” should be added that the promoter who has successfully classified himself as public shareholder shall not have any sort of representation on the board of directors, not even a nominee director. 
4. Point g. should be amended, wherein the 1-year time period should be deleted at the same time, this amended point g. read with point k. should mandatorily fix a period within which the stock exchange has to dispose on merit, a request for reclassification. 
5. The conditions under point a. should be expanded to explain as to what will happen if the company is not left with any promoters and who will be the main face of the company after a promoter exits the company. 

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