What is Control?
The developments of this week had me wondering - is not economic influence a measure of control? Let me tell you how I got here. This week SEBI, in its policy on market infrastructure institutions (MIIs) said no single investor will hold more than 5% in a stock exchange, with some exceptions. And it said – ‘the shareholding limits prescribed for each category of investors shall be inclusive of all exposure (both on and off balance sheet) of a shareholder to the MII that facilitates or permits equity or rights over equity at any future date’. That means the 5% threshold includes convertibles such as warrants. But interestingly, when it come to the mother code on control – the Takeover Code, SEBI does not include convertibles either in the calculation of substantial ownership or in while determining control, until upon the conversion of the convertibles into shares. So why is it that SEBI, when determining ownership and hence control, includes converts in one policy but not in the Takeover Code? Aren’t converts a measure of economic influence and isn’t economic influence a constituent of control? Nischal Joshipura - head of M&A, Nishith Desai Associates and Vivek Gupta - Partner of BMR Advisors join me to pontificate.
Doshi: Nischal, why is it then that in the Takeover Code, which I keep referring to as the mother code, convertibles are not counted in when trying to determine control or influence but when it comes to the MII regulation by the very same regulator, when it comes to determining ownership and hence control, convertibles are counted in, what do you make of that?
Joshipura: It doesn’t surprise me because we have to look at the objective of each legislation. The objective of Takeover Code is different from the objective of MII regulations. The objective of Takeover Code is to protect the interest of the public shareholders in case there is a change in control or management of the listed company. How do you exercise control? Obviously through voting share- only if you can vote at the shareholders meeting you can exercise control and that’s the purpose for which the open offer gets triggered only in a situation where there is acquisition of voting shares beyond the threshold limits. The objective of MII regulations on the other hand is completely different. What MII regulation seeks to do is that it does not want any concentration of power in the hand of few persons which means that concentration of power could be voting or economic and if we read the Bimal Jalan committee report based on which SEBI has taken this decision on including the convertibles also in the threshold limits, it clearly states that its very important the stock exchanges being akin to national monopolies, its very important that there is no concentration of power in hands of few and hence diversification is crucial. So if one person is holding 5% equity shares today and lets say 70-80% warrants that person can keep on selling 5% every time and convert the warrants after the sale to again get back to 5% which even from takeover perspective may not be an issue but from an economic interest perspective; yes.
Gupta: Unfortunately I am also in Nischal’s camp. I think different sets of regulations have a different primary purpose. So the primary purpose of a Takeover Code is all about control. So the people who have drafted our Code have a general definition of control and then have a definition of substantial acquisition of shares which is also measured with respect to shares carrying present voting rights. Now if we see around us different sets of regulations have different primary purposes. You have the entire Foreign Investment Promotion Board (FIPB) regulations that proceed on the basis of counting total equity ownership. You have banking regulations that proceed on the basis that no one entity can hold more than 10% shares in a bank. So different sets of regulations have different primary purposes. As Nischal has vey articulately laid out the MII regulations have been framed in a way that no one single person should exercise undue control…(interrupted)
Doshi: But why is it that in measuring that undue control you include warrants in the case of one set of regulations but in the other case you don’t include convertibles?
Gupta: So no one person should exercise undue control at the same time, no one person should exercise undue economic benefit from holding of an asset. So its as simple as saying that – so here is an entity which functions in the financial system of the country…(interrupted)
Doshi: No where does it say that no one person should not get undue economic benefit. It may say it should not get undue economic influence but benefit? I don’t think they should have a problem with that?
Gupta: Like in a bank you are not allowed to own more than 10% equity, therefore similar in a stock exchange, what they are saying is you are not allowed to hold more than 5% ownership…(interrupted)
Doshi: I don’t have a problem with the 5% threshold in the case of RBI and banks it’s 10%; in the case of FDI policy its 49% or 74% depending on whatever sector you are and 26% sometimes. In the case of the MII regulations its 5%, in the case of the Takeover code its 25% of control. I am saying how you calculate that 25% or 5% - should it not be uniform because if you believe that warrants or convertibles of some form allow for economic influence, then don’t you think economic influence is a constituent of control and Vivek you brought up FIPB, we were talking about this earlier, doesn’t FIPB require you to go to it on a case by case basis in the case of warrants being part of the structure- that means FIPB believes that warrants allow you to exercise economic influence and that economic influence may in fact exceed the or add to the equity threshold that you may well be within but it may still give you additional control. So clearly they acknowledge economic influence.
Gupta: First let me answer on FIPB, the FIPB law is pretty simple. Anything which qualifies as preset equity which is equity shares as well as convertible debentures, compulsorily convertible debentures, compulsorily convertible preference shares are all accounted as equity today. So in terms of any economic rights rising there, they are captured. The FIPB policy treats warrants separately, ask for specific case by case approval even if you hold one warrant and you are otherwise looking sector wise limit… (interrupted)
Doshi: But why is that?
Gupta: That is a completely different debate. We have had a debate on put and call options. We have a situation where the FIPB (Foreign Investment Promotion Board) wants to control rights to future equity at a certain price.
Doshi: Why is that? Because they believe rights to future equity amount to economic influence and maybe a constituent of control. So you could be well within the equity threshold of 26%, 49% or 74% but you could, by virtue of warrants, exercise a higher degree of influence?
Gupta: I don't entirely agree. I think that's also being slightly presumptuous for the simple reason that today they are capturing all instruments which can be converted to a later date except for warrants. So convertible debentures are captured today in our equity calculation. Convertible preference shares from an FIPB angle are calculated today. The basic point that I want to make is every regulation has its own basic purpose, has its own basic objective and the calculation is tailored to that objective. Now that said, I think there is an additional point to make here. So the fundamental problem that I have, specifically in the context of this and in the context of a few other things happening around us, though is that this government needs to evolve a system of checks and balances in terms of what kind of regulation it brings out in response to judicial pronouncements.
Doshi: I know what you are saying which you are not articulating. You are saying these regulations are a response to the Bombay High Court judgment in the MCX case.
Joshipura: Also the other way, to take Vivek's point forward on the objective of the legislation, if we take Competition Law also, the way the definition of shares has been defined it includes any security which entitles the holder to receive shares…
Doshi: I was going to come to CCI. I was going to come to the Competition Act which is ‘any security which entitles the holder to receive shares with voting rights.’ That means that even the Competition Commission believes that economic influence is a constituent of control and therefore they want to count it in when they are determining their threshold. They also aligned to 25% recently when in the amendment - they changed the Schedule on exemption from 15% to 25% to align it with the Takeover Code and yet in that 25% calculation they are going to include security which entitles the holder to receive shares with voting rights, whereas the Takeover Code will not do that when they calculate 25%. Clearly two different regulators are talking two different languages there and principally or not whether you agree with what they are doing, doesn't it create operational issues for you?
Joshipura: But I think the objectives are also very different. The Competition Law is an economic law. You are looking at the market share which an acquirer is getting through acquisition. That market share just by measuring the voting rights is not sufficient. You have to look at the economic rights also and that's how it is different from the Takeover Code where the only…
Doshi: But this is not regarding the market share of an entity, this is regarding the ownership of the entity and the ownership of the entity they are saying is at 25%. If it's an acquisition of up to 25% we will exempt it but that 25% is calculated including convertibles, isn't it?
Gupta: Let me try and articulate it little differently. For example in the case of the Competition Law, concentration of economic power or concentration of power is an important consideration. A concentration of power happens in two ways. Concentration of power happens if you economically have a certain right over a certain stream of incomes and assets. Concentration of power happens if you have control over a certain stream of incomes and assets. So I think in the case of the Competition Law they are very clear that either form of concentration of power is something…
Doshi: But if that economic power does not result in control, it wouldn't matter, right? I am saying at the end of it all of these regulations are trying to determine control.
Joshipura: I think one thing which is also important to note is Competition Act is applicable to all types of companies-listed and unlisted. If you are acquiring a stake in a private company which is not a subsidiary of a public company where even the preference shares can carry voting rights equivalent to equity shares, where do you capture those type of securities and that's why you need such broader definitions for legislations like Competition Law where there is a possibility of equating the preference share voting right equivalent to the equity shares.
Doshi: Both of you deal with these situations on a daily basis. What do you do in a transaction where in one case warrants or convertibles are not counted in and therefore you do not come under the scrutiny of the Takeover Code but you still come under the scrutiny of the CCI's Merger Control Guidelines because they will choose to count in convertibles maybe only compulsorily convertible convertibles because that's how it seems to be worded. But nonetheless they will choose to count in convertibles?
Gupta: That's fine. So I will go and comply with both laws and if Takeover Code does not require me to make an offer I don't have to make an offer and if Competition Law forces me to go to the Competition Commission, I will go to the Competition Commission.
Doshi: A last word to you and in this question I will bring in the UK Takeover Code as well. Under that code, ‘control’ means an interest, or interests, in shares carrying in aggregate 30% or more of the voting rights. Many people believe that the UK Takeover Code includes all kinds of converts when it goes to calculate that 30% trigger. I am just confused. We seemed to be having several different ways of calculating what constitutes control. In some cases convertibles are included. In others they are not included. But as a lawyer you seem fine with that situation.
Joshipura: Absolutely fine. I think these are all well thought out legislations. Each regulator has to ensure that the purpose for which that law has been made serves the interest of the stakeholders. Just to give you one more example, even under ICDR Regulations for calculating the 20% promoter shareholding which is to be locked in, SEBI has mandated that 20% shareholding has to be calculated after considering the convertibles. So I think each law is well thought out.
Doshi: All right. If the lawyers both agree then why should I complain!