An IPO has been a great leveller for the shareholders until recently as the Securities and Exchange Board of India ("SEBI") required that all shareholders in an IPO bound company should be treated at par (post IPO) irrespective of special rights that a shareholder may have held in the past. SEBI specifically prohibited issue of shares with 'superior voting rights' by listed companies, in order to avoid the possible misuse by the persons in control to the detriment of public shareholders. However, the position stands reversed now and for good reasons. SEBI in its board meeting dated June 27, 2019 approved the framework for issuance of shares with differential voting rights ("DVRs") and the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 ("SEBI ICDR Regulations") and the SEBI (Listing Obligation and Disclosure Requirements) Regulations, 2015 ("SEBI LODR Regulations") were both accordingly amended on July 29, 2019.
Desirability of DVRs has been a hotly contested issue. In theory, DVRs have been long criticised for violating the one share-one vote principle and destroying shareholder democracy. However, commercially, one share-one vote comes with costs as it deters entrepreneurs from taping public funds for the fear of compromising control. Countries such as Hong Kong and Singapore which did not allow DVRs till recently had lost out on some premium listings forcing them to relook at their listing laws. For example, companies such as Alibaba chose to list on the New York Stock Exchange, as opposed to Hong Kong Stock Exchange ("HKEX") and the London Stock Exchange as the latter two did not permit listing of companies that employ differential voting structures. Hong Kong and Singapore have since then changed their laws to permit differential voting structures along with detailed checks and balances. SEBI has had the benefit of comparing various formats of differential voting structures being followed in other jurisdiction and formulate a format for our country. As a result, SEBI ICDR Regulations now allow an IPO bound company having "superior right equity shares" (SRES). i.e., equity shares having superior voting rights compared to all other equity shares issued by the issuer, to list its ordinary shares.
Permission to list ordinary shares with a SRES framework is available only to those companies which have intensive use of technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition. Do note that there is no guidance provided on what will constitute "substantial value addition" and while the same terminology is used for listings on the institutional trading platform, not many listings have taken place on the institutional trading platform provided by the SEBI ICDR Regulations. Further, there are additional eligibility conditions for companies with SRES framework to list under the SEBI ICDR Regulations such as:
- the SRES shareholder should not be part of the promoter group whose collective net worth is more than Rs. 500 crores. Do note that while determining the collective net worth, the investment of SR shareholder in the shares of the issuer company shall not be considered;
- SRES can only be held by the promoters/founders who hold an executive position in the issuer company;
- The SRES should have been held for a period of at least 6 months prior to the filing of the red herring prospectus;
- The issue of SRES should have been authorised by a special resolution passed at the general meeting with the notice for the meeting containing certain mandated disclosures.
- The minimum and maximum voting rights of SRES is 2:1 and 10:1, respectively, compared to ordinary shares;
- SRES shall have the same face value as the ordinary shares and there shall be only one class of SRES.
As the purpose of the SRES framework is to provide enhanced voting rights to the promoter/founder, therefore, while the SRES will be listed on the stock exchange post the IPO, they will remain under lock-in until conversion into ordinary equity shares or mandatory lock-in provided under the SEBI ICDR Regulations, whichever is later. No pledge or lien can to be created on the SRES. Also, SRES are required to be converted into ordinary shares on the 5th anniversary of listing (unless extended by a shareholder resolution) or on occurrence of certain events such as demise or resignation of the SRES shareholder, merger or acquisition where the control would no longer be with the SRES shareholder etc. Further, the total voting rights of the SRES shareholders (including ordinary shares in the issuer upon listing, pursuant to the IPO), shall not exceed 74%.
Undoubtedly, these steps by SEBI to permit SRES in IPO bound companies is a huge positive for the new-age companies whose promoters/founders can now tap public money without fear of compromising control. As a cherry on top, Companies (Share Capital and Debentures) Rules, 2014 have also been amended to do away with the requirement of consistent track record of distributable profit for the last three years for issuing shares with differential rights. However, since with great power comes great responsibility, it is imperative that the corporate governance standards for the companies with SRES framework should be enhanced to ensure that the SRES framework is not misused. This is particularly important since in the recent times markets have seen a number of reputable companies coming under scanner for corporate governance lapses. A corporate governance lapse strikes at the base of investor confidence not just in the subject company but the entire legal regime of corporate governance in the country. Further, fear of corporate governance lapses is comparatively higher in companies which have concentration of control. Therefore, it is important to ensure that the corporate governance requirements in SRES companies are a lot more intense than other companies. To address this, SEBI requires that companies with SRES should have half of their board of directors and 2/3rd of the nomination and remuneration committee, stakeholder's relationship committee, risk management committee comprising of independent directors. The audit committee of such companies should comprise of only independent directors.
Further, there is a long of items in respect of which, the SRES shall be treated as ordinary shares. Do note that this list is only inclusive, and SEBI can add to it in future. Items in the current list are as below
- Appointment or removal of independent directors and/or auditors;
- Where a promoter is willingly transferring control to another entity;
- Related party transactions involving SRES shareholders;
- Voluntary winding up of the listed entity;
- Changes to the article of association or memorandum of association of the listed entity, except any changes affecting the SRES;
- Initiation of voluntary resolution process under the insolvency code;
- Utilization of funds for purposes other than business;
- Substantial value transaction based on materiality threshold under the SEBI LODR Regulations; and
- Passing of special resolution in respect of delisting or buy back of shares.
However, in comparison to the checks and balances provided in Hong Kong and Singapore for DVRs, the Indian corporate governance requirements for SRES companies seem less robust. For example, HKEX also requires an issuer with weighted voting rights ("WVR"), to establish a corporate governance committee comprising entirely of independent non-executive directors. The corporate governance committee is required inter alia, to review whether the listed issuer is operated and managed for the benefit of all its shareholders and whether the differential voting structure is being implemented in accordance with law. It also monitors all risks related to the issuer's WVR structure, including connected transactions between the issuer and/or a subsidiary of the issuer on one hand and any beneficiary of differential voting rights on the other and makes a recommendation to the board on any such transaction, etc.
HKEX also requires the issuer to appoint a compliance advisor on a permanent basis to consult with and if necessary seek advice on a timely and ongoing basis on matters related to the WVR structure, transactions in which any beneficiary of WVR in the issuer has an interest, and where there is a potential conflict of interest between the issuer, a subsidiary of the issuer and/or shareholders of the issuer on one hand and any beneficiary of WVR in the issuer on the other. Furthermore, an issuer with a differential voting structure is required to include the warning "A company controlled through WVR" on front page of all listing documents, reports, circulars, notifications etc. Similarly, Singapore Exchange also requires additional disclosures in the prospectus such as a statement on the cover page that the issuer is an issuer with a DVR structure, details of the DVR structure, the rationale for adopting DVR, key provisions in its constituent documents relating to DVR and matters that are subject to the enhanced voting process (in relation to a dual class share structure, a share that carries multiple votes but that otherwise has the same rights as an ordinary voting share).
There is a considerable merit in having a separate compliance committee or a compliance officer to monitor administration of DVRs. However, since India is yet to witness its first initial public listing under the new SRES framework, efficacy of the current corporate governance mechanism for the SRES framework is yet to be tested. However, we do hope that the SEBI will periodically re-evaluate the efficiency of the corporate governance standards for the SRES companies and improvise to make them more robust.
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