SEBI Consultation Paper On Strengthening Corporate Governance

There has been a flurry of Consultation Papers (‘CP’) issued by SEBI on a variety of aspects, including on REITs and InvITs, ESG disclosures, alternate investment funds and many others in the last few months.  One of the CP is on “strengthening corporate governance at listed entities by empowering shareholders dated February 21, 2023 and it deals with 4 separate issues, including in relation to ‘agreements binding listed entities’.

Overview of the issue

The CP mentions that Listing Obligation and Disclosure Requirements (LODR) requires disclosure of material events or information to the Stock Exchange by listed entity and in terms of that requirement, agreements which are binding and not in the normal course of business have to be disclosed by listed entity.  This includes “disclosure of shareholders agreements, joint venture agreements and family settlement agreements to the extent they impact management and control of the listed entity, agreement with media companies etc.  The CP further provides that shareholder agreements are one of the common types of agreements entered into by listed entities; it is an arrangement that regulates the relationship between the shareholders, the management of the company, ownership of the shares, rights, obligations and protection of the shareholders; it may be entered into between shareholders (without the involvement of the company) or between the shareholder(s) and the company.

Proposals in the CP and some issues

The CP mentions that if the listed entity is not party to the agreement, nevertheless an obligation must be placed on the parties entering into such agreements to disclose it to the companies; the issue seems to have been “that there have been instances wherein promoters have entered into binding agreements with third parties having an impact on the management or control of a listed entity or such agreements have placed certain restrictions on the listed entity, however, these facts were not disclosed to the listed entity and its shareholders.   Non-disclosure of material information creates information asymmetry and results in significant market reaction when it is known to the public at large at a later stage”.

Whilst the underlying logic of the proposals in the CP is laudable, there are some aspects that need to be addressed before proposals become part of the LODR formally and some of these are as under:

1. The aspect of family settlement agreement is particularly sensitive, both in terms of the content and in terms of the timing of disclosure.  This is because a family settlement agreement may be dealing with many things which may not have relevance to the company; of course, the CP does mention that it should be disclosed to the extent that it impacts management and control of the listed entity.  However, the agreement maybe an integrated one and one would presume that only relevant extracts are proposed to require disclosure.
2. As an extension of the above point, what if the family settlement involves transfer of shares between the promoters, but the promoter to whom shares have been transferred as part of the family settlement was anyway running the company in such a situation, it may not actually impact the management of the company and it may not impact the day to day control, but it may impact the legal ownership.  One would assume that regardless of change of legal ownership, if the management and control is not impacted, that should not require disclosure.
3. There is a reference in Para 2.2 of the CP regarding “agreement with media companies”.  This requires elaboration, because it is not clear what is intended.
4. There is also a reference in the draft para which is intended to be added in the LODR that an agreement directly or indirectly seeks to ‘impose any restriction or create any liability upon listed entity shall be disclosed’ whether or not the listed entity is a party to such agreement; the issue of creating any liability is not very clear and needs clarity.
5. The draft para talks about agreements entered into by the “shareholders, promoters, promoter group, related parties, KMP, directors or other officers of a listed entity, subsidiary, associate company to be disclosed; whilst this is in the proviso and the main clause seeks to restrict the disclosure where the agreements purpose and effect is to impact management and control of the listed entity, the references in the proviso are very wide and may need a relook; for example, related parties of promoters entering into an agreement to impact the management and control of the listed entity appears farfetched, in any case.
6. There is also a requirement for Board of directors of the listed entity to provide its opinion along with a detailed rationale as to whether such an agreement is in the economic interest of the listed entity.   One would submit that this requirement casts a very onerous responsibility on the board; independent board members are getting particularly concerned about huge exposure being on Boards, and these kinds of clauses can be a deterrent to accepting board membership.

Summing up

The objective of disclosure is laudable, but on a broader note, the extent of the disclosure required is casting enormous obligations on listed companies.  Perhaps there is a need to look at disclosure requirements vis-à-vis the size of the company, given that a very significant percentage of market cap is represented by the Top 500 companies which account for 96 per cent of market cap.