Cases disclose penalties for common business practices

The Securities and Exchange Board of India (SEBI) has levied penalties in two recent cases concerning common business practices. In both cases the penalties could have been avoided had the (inadverdent) acquirer/pledgor been aware of the requirements of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (takeover code), and the SEBI (Prohibition of Insider Trading) Regulations, 1992. However, even seasoned practitioners at times can overlook the finer nuances of the compliance requirements.

Invocation of pledged shares

In a recent order, the adjudicating officer (AO) levied a penalty of ₹1 million (US$16,600) on the promoter shareholders/pledgors (noticees) for delay in making disclosures relating to a change in their shareholding as required by the takeover code and the insider trading regulations. The change in the noticees’ shareholding was as a result of invocation of pledge by the pledgee.

The AO did not accept the noticees’ argument that the pledgee invoked the pledged shares without any intimation to the pledgor.

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The noticees contended that: (a) they learned of the invocation on 25 February 2012, two days after it was effected; and (b) the change in shareholding was disclosed in the shareholding pattern of the target company for the quarter ended 31 March 2012.

The AO held that the noticees failed to make the disclosures within the stipulated time and directed the noticees to pay the penalty, jointly and severally. The delay in making the disclosures was 39 to 44 days.

Analysis: Where a pledgee invokes the pledge and transfers the shares through change in beneficial ownership of the shares in accordance with the SEBI (Depositories and Participants) Regulations, 1996, the pledgor and the pledgee must make the required disclosures even if: (a) the pledgee invokes shares without any intimation to the pledgor; or (b) the parties have agreed to allow a subsequent redemption of the transaction through repayment of the loan by the borrower/pledgor.

For shares in demat (electronic) mode a pledge is created merely by the concerned depository marking a lien in favour of the pledgee. It is only on invocation of pledge that the shares in the pledgor’s demat account, with a lien already marked, are debited and credited to the demat account of the pledgee.

There have been instances where the pledgor and pledgee have stated in security documents their intention to create a pledge of shares, and the shares were transferred from the demat account of the pledgor to the demat account of the pledgee at the time of creation of pledge. By the time the parties realize this, it is too late, since the transfer has already led to them violating not only the depositories and participants regulations but also the takeover code and insider trading regulations by not making the prescribed disclosures. In such a situation, a pledgee may even trigger an open offer under the takeover code, if the invocation does not fall within the exemption from making an open offer and crosses the triggering threshold.

Lax attitude to compliance

In another case, an AO levied a penalty of ₹700,000 on a noticee that had demonstrated a casual and unbecoming attitude by not making the disclosure required by regulation 13(2A) of the insider trading regulations.

Under regulation 13(2A), the noticee was obliged to disclose its shareholding within two working days of becoming a promoter or part of the promoter group. In this case the noticee became a promoter of the listed company after reclassification from the “public” category to the “promoter and promoter group” category in the shareholding pattern for the quarter ended 30 June 2012. This led to an increase in the promoters’ shareholding from 49.17% to 53.93%.

Analysis: Reclassification of a shareholder from the “public” category to the “promoter and promoter group” category can have implications on the shareholding of the existing promoters of a listed company, and may result in unintended consequences under the takeover code, for example: (a) promoters breaching the creeping acquisition limit of 5% (individually or in aggregate) in a financial year; (b) the aggregate promoter shareholding exceeding the maximum permissible non-public shareholding; (c) change in control from “sole” to “joint”. These consequences would lead to further complications whereby the promoters would also trigger an open offer under the takeover code.

To conclude, public shareholders seeking reclassification to the “promoter” category need to be mindful of the implications discussed above and the existing promoters can’t afford to be impulsive in entertaining such requests from public shareholders, notwithstanding the commercial compulsions. In terms of the takeover code, the obligations of the acquirer and persons acting in concert with the acquirer are joint and several and so they are responsible for fulfilment of the applicable obligations prescribed under the takeover code.

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Suhail Nathani is a partner and Yogesh Chande is an associate partner at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.