This article is written by Jayant Saxena, pursuing a Certificate Course in Capital Markets, Securities Laws, Insider Trading and SEBI Litigation from LawSikho.

Introduction

Shares of investors can be locked-in, in pursuant to Initial Public Offering (“IPO”), scheme of arrangement, amalgamation, merger, reconstruction or reduction of capital undertaken by a listed entity.

A business typically brings in more revenue when the price and demand for the stock are up. If a private company becomes public, many core employees usually try to cash in their shares as soon as possible. In the case of the IPO lock-up phase, the key aim is to stop overwhelming the market with too many securities, thus reducing the price of the stock.^[1]

When an entity is under stress, protecting the rights of depositors and ensuring protection for an individual and the whole financial system is an essential aim of the reconstruction scheme. Lock-in of shares shall help to deal with this issue as the money invested for a significant period can come to a better and longer use. A reconstruction scheme of a Yes Bank was approved by the cabinet in March 2020, and many investors along with the State Bank of India (“SBI”) were invited to invest in the bank where a significant percentage of their investment was subject to lock-in requirements.^[2]

What is meant by locked-in shares

Lock-in indicates a restriction over the transfer of the shares. When the shares of an investor are under lock-in, the investor is unable to perform any action with respect to their locked-in shares. It restricts the trading subject to provision laid down under Issue of Capital and Disclosure Requirements (“ICDR”), Regulations, 2018 and SEBI (Disclosure and Investor Protection) (“DIP”) Guidelines. Under Prohibition of Insider Trading (“PIT”) Regulations, 2015, trading means subscribing, buying, selling, dealing, or agreeing to subscribe, buy, sell, deal in any securities.

As mentioned above shares can be locked-in in many instances. One of those is during the Public Issue. Issued shares are to be locked for any kind of trading by investors, promoters, or to whom the shares are issued. In most of the cases, it is the promoters whose shares are locked-in for a period of time which is mandatory to mention in the offer documents which get filed.

The lock-in shall commence on the date of the allotment in the proposed public issue and the final date of the lock-in shall be determined as three years from the date of the beginning of commercial production or the date of the allotment in the public issue, whichever is later.

Chapter 1 Part IV of Issue of Capital and Disclosure Requirements (“ICDR”), Regulations, 2018 deals with Lock-in Requirements and Restrictions of Transferability in case of a public issue.

Reason for lock-in of shares during reconstruction

A reconstruction scheme is a scheme wherein a stressed entity is revived instead of getting liquidated. A huge amount is pumped into the stressed company by the investors to deal with the degrading financial situation of that company. The consideration of pumping in money by investors can be shares of the company which will be subject to lock-in requirements.

During the reconstruction scheme of any company, there are many changes considered to revive the company back to normal by the Central Government or Reserve Bank of India (“RBI”). Those changes can be in the share capital of the company, memorandum of association, article of association, the constitution of the board, functioning of the stressed entity, or rights or liabilities of the entity including of employees.

Reason

The lock-up duration for a company’s newly listed public shares helps to maintain the stock price since hitting the market. When the price and quantity of the securities of the company are rising, the company brings in more money. If insiders of the company sell their securities in the market immediately after the listing of their securities, it might seem like the company is not worth investing in and there will be a decline in stock prices. Therefore, through the mechanism of “locked-in shares”, it is important for investors to stay invested for a specific period, so the securities they invested in remain listed on the stock exchange(s) to maintain the value of the business.

SEBI guidelines for lock-in of shares

Along with ICDR Regulations, 2018, SEBI (Disclosure and Investor Protection) (“DIP”) Guidelines governs the provisions related to Lock-in of shares. Chapter 4 deal with these guidelines with Promoter’s Contribution and Lock-in Requirements which is further divided into parts as illustrated below in a chart^[3]:

Parts	Sub-Parts
Lock-in Requirements	●       Lock-in on Minimum Promoter’s Contribution in Public Issues. (minimum 3 years) ●       Lock-in where Promoter’s Contribution exceeds minimum contribution which is not less than 20% of the post-issue capital. (1 year) ●       Lock-in of an unlisted company’s pre-issue share capital. (1 year) ●       Securities which are issued on firm allotment basis shall be subject to Lock-in. (1 year)
Other Requirements in respect of Lock-in	●       Promoter’s locked-in shares can be pledged only with banks/financial institutions as collateral for loans. ●       Inter-se Transfer of Securities amongst Promoters holding locked-in shares is permissible. ●       Locked-in securities must carry inscription ‘non-transferable’ along with the non-transferable period.

Why are shares of Yes Bank locked

Yes Bank Ltd., is a registered banking company under the Companies Act, 1956 having its Office at Yes Bank Tower, Mumbai, Maharashtra. Under Section 45 of Banking Regulation act, 1949, through an application made by RBI to Central Government, an order of moratorium was passed on March 5, 2020, for staying the commencement or continuance of all actions and proceedings against the Yes bank for a fixed period of time for the sake of public interest and the interest of the depositors. Pursuant to that, a restriction on withdrawal up to Rs 50,000 per depositor was imposed due to the bad financial health of the bank. The moratorium lasted for 13 days and was lifted on March 18, 2020.

During this moratorium, a Draft scheme of Reconstruction was circulated by RBI which was approved and thereafter notified on March 13, 2020^[4]. Let us look at the reasons behind the deteriorating condition of Yes bank in past years.

Deteriorating economic condition

After the inspection into the books and records of Yes bank by RBI, it was found that the bank needed more than Rs. 10,000 crore capital for growth^[5]. Their market capitalization value plunged below Rs. 10,000 crores and the Gross Non Performing Asset (“NPA”) was already around 7.4% in September 2019 against other private banks having NPA around 0.5% (“HDFC”) or 1.1% (“Kotak Mahindra”)^[6]. Shares of Yes bank hit a record low of Rs 5.55 in March.

Misguided Assurance

Yes, by making a declaration that the management of the bank is in constant touch with the investors who would spend and bring the kind of capital that the banks need to survive, the Bank has provided false assurance. But there weren’t any such plans in fact. In addition, the Reserve Bank of India reports that they have been in regular contact with the Yes Bank management to find ways to create liquidity and a stable financial position.^[7]

No substantial investors

In November 2019, the bank revealed that it had interest from a consortium of investors amounting to $2 billion (Rs 14,60,00,00,000). However, despite communication to investors, nothing else emerged^[8]. One capital-raising adventure took Yes Bank to a Canadian investor, Erwin Singh  Braich, who was said to have agreed to infuse the bank with $1.2 billion. After critics raised questions about the investor’s due diligence, the board of Yes Bank ended up not receiving the offer^[9].

Liquidity outflow

In the 2019 December quarter, the Liquidity Coverage Ratio (“LCR”) had fallen to 74.6 percent due to a significant outflow of deposits amounting to around Rs 44,000 crore. Yes bank had violated vital liquidity and regulatory requirements. Post-December withdrawal of deposits amounting to Rs 28,000 crore (until March 5 when the deposit moratorium was placed) had led to a drop in LCR of 20.9 percent (against 100 percent regulatory requirement)^[10].

Impact of lock-in of shares on shareholders

Many investors came forward to help the sinking boat of a Yes bank, SBI being the biggest of all. Apart from SBI, ICICI Bank, Housing Development Finance Corporation Limited, Axis Bank, Federal Bank, Bandhan Bank Limited, etc. too invested a significant amount^[11] in the bank. In a disclosure under Regulation 30 of Listing Obligations and Disclosure Requirements (“LODR”), a part of the reconstruction scheme, SBI who invested Rs 60,50,00,00,000 (Rupees six thousand and fifty crores only) amounting up to 48.21% of the shareholding in Yes bank, shall not be allowed to decrease its holdings below 26% before 3 years starting from March 14, 2020, and the remaining shareholding shall be freely transferable and will not be subject to lock-in requirements.^[12] SBI later on infused more capital into the bank bringing the aggregate percentage up to 49%.

In addition to SBI, as of March 13, 2020, other investors’ shareholdings will be subject to lock-in for a term of 3 years. The remaining 25% of the shareholding allocated to other investors shall be freely transferable and will not be subject to any lock-in requirements. So, if Ms. Riya holds 200 shares in Yes Bank, 150 of them will be locked for 3 years, and the rest 50 will be freely transferable by her. This requirement is not valid for investors who are holding shares below 100. Also, if  Ms. Riya buy shares after March 13 i.e. March 14 or 15, her shares will not be subject to a lock-in period^[13]. The lock-in period will ensure stability in the bank’s core capital^[14].

The impact has been negative for the shareholders holding Additional Tier -1 Bonds (“AT-1”) of Yes Bank. These bonds are unsecured, perpetual bonds with no maturity date. Interest rates on these are usually higher than secured bonds and fixed deposits. Many investors suffered a huge loss when RBI decided to write-off these AT-1 Bonds worth Rs  8,415 Crores^[15]. Basil 3 are the norms that govern these AT- 1 Bonds. As per the norms, the risk associated with these bonds was that the issuing bank has the discretion to skip the interest rate and maintain a Common equity tier 1 ratio of 5.5%, failing which the bonds can be written off. The bank was unable to do so which eventually led to these bonds being written off. Many investors were anguished on such a move as they contended that they were not told about the risks associated with these bonds during the time of issuance.

Conclusion

The lock-in requirement imposed by SEBI Regulations plays a vital role in the stressed entities as well as for the minority shareholders of the company. It helps in developing the stressed entity growing back to their full potential where they can establish their reputation back among the other banks and companies. The infused capital by investors must stay invested in the entity so it can be used for a longer period of time to meet the financial obligations which were deemed detrimental in the growth of the entity. Once the lock-in period is lifted, investors thereafter can freely transfer their shares. Lock-in requirements serve the purpose of stopping the new shareholders from liquidating the assets of the company as soon as their shares hit the secondary market. A Similar situation was witnessed way back in 2004. where many investors and borrowers got angry when RBI imposed a moratorium of 3 months on Global Trust Bank due to its bad governance issue. Later on, the bank was merged with Oriental Bank of Commerce.

References

^[1] https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/lock-up-period/

^[2] https://english.jagran.com/business/crisishit-yes-bank-gets-a-lifeline-as-govt-approves-reconstruction-plan-icici-sbi-among-investors-10009628

^[3] https://www.sebi.gov.in/legal/guidelines/aug-2009/sebi-dip-guidelines-updated-upto-august-20-2009_4161.html

^[4] https://www.rbi.org.in/scripts/bs_pressreleasedisplay.aspx?prid=49479

^[5] https://www.businesstoday.in/sectors/banks/rbi-board-superseding-points-to-graver-issues-at-yes-bank/story/397654.html

^[6] https://economictimes.indiatimes.com/wealth/save/check-the-financial-health-of-your-bank-with-these-8-ratios/gross-non-performing-assets-npas/slideshow/74927100.cms

^[7] https://corpbiz.io/learning/steps-taken-by-rbi-and-sbi-against-yes-bank-crisis/#unsound_and_erroneous_assurance

^[8] https://www.businesstoday.in/sectors/banks/rbi-board-superseding-points-to-graver-issues-at-yes-bank/story/397654.html

^[9] https://www.livemint.com/

^[10] https://www.thehindubusinessline.com/money-and-banking/yes-bank-q4-continual-deposit-outflowscapital-ratios-breaching-regulatory-requirement/article31523202.ece

^[11] https://www.yesbank.in/pdf/sebi_lodr_regulations30_pdf

^[12] https://www.yesbank.in/pdf/sebi_lodr_regulations30_pdf

^[13] https://www.financialexpress.com/industry/banking-finance/lock-in-free-fpo-signals-yes-banks-return-to-business-as-usual/2024076/

^[14] https://www.goodreturns.in/news/lock-in-for-yes-bank-shares-what-it-means-for-yes-bank-shar-1144360.html

^[15] https://www.bloombergquint.com/business/rbi-on-challenge-to-yes-bank-at-1-bond-write-off-at-best-an-investment-decision-gone-wrong

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