The legality of assisting in IPO subscription by issuer through negotiation of cheap loans

The disinvestment of PSUs has not been successful particularly in the retail and employee reservation category and this is a matter of concern for the government if one is to go by the number of articles in business papers on this issue. Hence is it not surprising that Coal India, the country’s largest coal miner, is negotiating with some of the state-owned banks such as SBI to seek cheap loans for its employees so as to enable them to subscribe to the shares reserved for the employees in its upcoming initial public offering. (See link). While these efforts on the part of Coal India carry good intentions since its employees will become equity holders, the method might require adherence to certain specific provisions of the Companies Act and, pursuant to which, specific disclosure in the prospectus will have to made.

As per section 76 of the Companies Act, a company may pay commission to any person in consideration of, inter alia, his procuring or agreeing to procure subscription for any shares in the company subject to fulfillment of certain conditions such as the payment of the commission must be authorized by the Articles, the commission paid should not exceed a certain specified amount, the amount of commission and the number of shares must be disclosed in the prospectus and a copy of the contract for the payment of the commission is delivered to the Registrar at the time of delivery of the prospectus. Underwriting agreements are a classic example whereby the company pays commission to the underwriter for it to agree to subscribe or procure subscription of shares being offered in the public offer. As a result section 76 is complied with and necessary disclosures are made in the prospectus.

In this backdrop, the efforts on the part of Coal India may trigger section 76 since if a big company like Coal India is negotiating access to cheap loans from big banks like SBI, it is unlikely that no monetary consideration would flow from Coal India to SBI in the shape of commissions. And for cheap loans to be made available, SBI would have to come up with a new loan product meant for prospective employee investors of Coal India and market it. This may amount to ‘procuring subscription’.

In the alternative, negotiating of cheap loans for IPO subscription by employees could also come within the ambit of section 77 of the Companies Act, which, inter alia, permits the provision by a company, in accordance with any scheme for the time being in force, of money for the subscription of shares in the company for the benefit of the employees of the company. This is one of the exceptions to the general rule which prohibits public companies to give any financial assistance in connection with subscription of shares in the company.

Thus the act of Coal India might fall under section 76 or 77 and this will depend on the modality that is adopted by Coal India such as the size of the loan, whether Coal India has a scheme in place or not etc. However if it falls under section 76, it will require additional compliances as indicated earlier.

Misstatement in prospectus and the role of SEBI

A recent judgment by the Delhi High Court in Kimsuk Krishna Sinha v. SEBI (MANU/DE/0743/2010) throws interesting light on the role of SEBI in ensuring correct disclosure in offer documents and actions that SEBI can or should take in case there is misstatement in prospectus.

The case pertains to the IPO of DLF Limited in mid 2007. The case of the appellant was that a criminal case filed by him against one of the group companies was not disclosed in the red herring prospectus and the reply that the concerned company was not a group company was not satisfactory since the promoters of DLF Limited continued to be associated with the concerned company.

High Court disposed the matter by directing SEBI to undertake an investigation into the complaints filed by the appellant, and on its way to passing the final order made some interesting observations.

High Court observed that “the purpose of inserting Section 55A in the Companies Act was to empower the SEBI to take both corrective and preventive action. This is perhaps because as a regulatory body SEBI gets to see the draft prospectus preceding a public issue by a company even before the public gets to see the RHP. SEBI is enabled and empowered to examine the DRHP and insist on complete and truthful disclosure of all relevant facts therein. The very purpose of having an independent regulatory authority like SEBI, and vesting it with statutory powers of inquiry, is to enable it to take prompt action in matters relating to issue and transfer of shares. Particularly, SEBI is expected to be the sentinel, read the fine print of prospectuses keeping the investors' interests in view. It has both a preventive and corrective role to perform. Therefore, it is not possible to place a narrow interpretation on the words "issue and transfer of securities" occurring in Section 55-A of the Companies Act. Given the object and purpose of the provision, it should be broadly construed”. It also held that “…merely because the public issue was closed, SEBI could not be relieved of its statutory duty to conduct an enquiry into the complaint and into the veracity of the statements made in the prospectus (RHP). There are enough powers vested in it under the SEBI Act for this purpose” and that “SEBI Act expects SEBI to act as an institution accountable to the investor public and be both accessible and responsive to complaints.”

These observations make it compelling for one to analyse in greater detail as to what exactly is the nature and role of SEBI as a regulator. Should it just play a facilitative role by allowing issuers and investors to weed out the informational asymmetry that exists, and in case of any wrongdoing, leave the matter to be governed by sections 62 and 63 of the Companies Act in case of misstatements? Or should SEBI assume a much higher responsibility and “read the fine print of prospectuses”? To what extent is SEBI justified in relying on the due diligence carried on by the merchant bankers?

Listing of securities of small and medium enterprises in India

What is the legal framework for public offering of securities by SMEs?
The legal framework for the public offering of securities by SMEs is primarily contained in the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”), SEBI press release dated November 9, 2009 and SEBI circulars dated April 26, May 17 and May 18, 2010.

Who can issue securities under the legal framework for public offering of securities by SMEs?
An issuer whose post-issue face value capital does not exceed ten crore rupees can issue securities in accordance with Chapter XA of the ICDR Regulations. An issuer whose post issue face value capital is more than ten crore rupees and upto twenty five crore rupees can also issue securities in accordance with Chapter XA of the ICDR Regulations. The second category of issuer may migrate its securities from the SME exchange to the ‘Main Board' (a recognized stock exchange having nationwide trading terminals, other than SME exchange) if its shareholders approve such migration by passing a special resolution through postal ballot to this effect and if such issuer fulfils the eligibility criteria for listing as laid down by the ‘Main Board’.

Further, an issuer listed on a recognized stock exchange other than a SME exchange and whose post-issue face value capital pursuant to further issue of securities of the same class does not exceed ten crore rupees will have option to make further issue of specified securities of same class in accordance with Chapter XA of the ICDR Regulations provided that its entire specified securities of the same class shall be listed on the SME exchange.

Where are securities, issued by SMEs pursuant to ICDR Regulations, listed?
Securities issued by SMEs pursuant to the ICDR Regulations are required to be listed on a SME exchange.

What is a SME exchange?
Regulation 106B (1) (c) of the ICDR Regulations defines SME exchange to mean a trading platform of a recognised stock exchange having nationwide trading terminals permitted by the SEBI to list the specified securities issued in accordance with chapter XA of the ICDR Regulation and includes a stock exchange granted recognition for this purpose but does not include the ‘Main Board’.

What is the legal framework for setting up of a SME exchange?
SEBI, through a circular issued in May 18, 2010 superseding a guideline issued earlier in November 5, 2008, laid down the framework for recognition and supervision of stock exchanges or platforms for SMEs. For the listing of securities issued by SMEs, either a dedicated stock exchange for SMEs can be set up or an existing stock exchange can set up platform for the SME sector. A new stock exchange or a platform can be set up after applying to Market Regulation Department, SEBI in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 and Securities Contracts (Regulation) Rules, 1956 subject to the applicant fulfilling certain conditions such as corporatisation of the stock exchange, minimum balance sheet networth of Rs. 100 crores, nationwide trading terminals and an online screen based trading system etc.

What are the important differences in the process of offering of securities under the SME legal framework as opposed to offering of securities under the non-SME legal framework of the ICDR Regulations?
· The SMEs issuers, making a public issue or a rights issue, are not required to file the draft offer document with SEBI.
· While filing the prospectus with the SME exchange, they are required to file a copy with the SEBI on which SEBI will not issue any observation.
· The underwriting shall be for the entire hundred percent of the offer through the offer document and shall not be restricted upto the minimum subscription level
· The merchant banker shall underwrite at least fifteen percent of the issue size on his or their own account.
· The minimum application size in terms of the specified securities shall not be less than one lakh specified securities.

· Further no allotment shall be made pursuant to any initial public offer if the number of prospective allottees is less than fifty.

Further, SEBI has made the process of market making mandatory in a SME public offerings and the responsibility is on the merchant banker to ensure compulsory market making through the stock brokers of the SME exchange for a minimum period of three years from the date of listing of the specified securities. Pursuant to a SEBI circular dated April 26, 2010, SEBI has laid down the norms for the market makers involved in the process of market making such as registration of the market makers, the obligations and responsibilities of the market makers, risk containment measures and monitoring of market makers etc.

Is migration from a SME exchange to the Main Board and vice versa permitted?
The ICDR Regulations permits migration of companies to SME exchange or migration to the Main Board.

Is there a listing agreement in place for listing of securities on a SME exchange?
Pursuant to a circular dated May 17, 2010, SEBI specified the model SME equity listing agreement containing of listing for issuers seeking listing on SME exchange.

What are the differences in the model listing agreement for listing on a SME exchange upon comparison to the listing requirements in Main Board?
Some relaxations are provided to the issuers whose securities are listed on SME exchange in comparison to the listing requirements in Main Board, which inter-alia include the following:

· Companies listed on the SME exchange may send to their shareholders, a statement containing the salient features of all the documents, as prescribed in sub-clause (iv) of clause (b) of proviso to section 219 of the Companies Act, 1956, instead of sending a full annual report;
· Periodical financial results may be submitted on “half yearly basis”, instead of “quarterly basis” and
· SMEs need not publish their financial results, as required in the Main Board and can make it available on their website.