The Securities Contracts (Regulation) Rules, 1957

The Securities Contracts (Regulation) Rules, 1957 prescribe, amongst other things, the thresholds for minimum offer and allotment of each class of shares to public as part of public offerings. In terms of the extant provisions^[7], for a company with different classes of shares, an initial public offering has to be undertaken for each class of shares, complying with the prescribed thresholds for each class. As part of the recent revisions relating to SVR Shares, SEBI has approved initial public offerings of ‘only ordinary shares’ by technology companies, while providing that SVR Shares shall also be listed after the issuer company makes a public issue.

There seems to be a disconnect between the two positions and necessary regulatory clarity in this regard may be required.

DVR Shares in Foreign Jurisdictions

In the United States, issuers with pre-existing DVR Shares are permitted to list on NYSE and NASDAQ, subject to higher levels of disclosure requirements and safeguarding measures. Major companies like Facebook, Google, Snapchat and Alibaba have adopted structures with DVR Shares in the United States. Canada also permits dual-class structures subject to approval from shareholders other than promoters, directors, insiders, officers and proposed recipients of the issue.

In Hong Kong, DVR Share structures are permitted subject to certain prescribed eligibility norms. Singapore also permits listing of companies with DVR Share structures only if such structures exist prior to listing.

Analysis and Challenges

Investor Protection

From a policy and regulatory perspective, there seems to be an attempt to encourage and explore DVR Share structures in India, going forward. However, from a market standpoint, the primary challenge for Indian companies and promoters will be to make DVR Share structures appealing to investors by addressing common concerns and providing adequate safeguards.

In fact, the underlying rationale for the initial prohibition on SVR Shares in 2009 was the potential detrimental impact on minority shareholders. Based on the proposed revisions, the turnaround in SEBI’s position seems to be based on two broad factors:

• introduction of a higher level of governance and protective measures for companies with SVR Share structures, conceptually similar to the requirements in the United States. Companies with SVR Shares are required to have a minimum of two-thirds of independent directors on all committees except the audit committee, which must consist of only independent directors. Further, after the initial public offer, SVR Shares will have voting rights similar to that of ordinary shares for a set of identified matters including: (i) appointment or removal of independent directors and auditors; (ii) voluntary transfer of control by promoters; (iii) related party transactions involving shareholders holding SVR Shares; (iv) voluntary liquidation; and (v) revisions to the articles of association other than those affecting the SVR Shares, etc. Sunset provisions have also been introduced, based on both validity (with SVR Shares having a five year validity period, which can be extended by a resolution on which holders of SVR Shares are not entitled to vote) and specific events (death of the shareholder, resignation from office, relinquishing of control, etc.); and
• the decision to limit the permission to technology companies, given the sector’s potential for fast growth and the requirement to raise capital at the right time while enabling founders and innovators to retain control of their businesses.

In an Indian context, where businesses continue to be largely promoter driven and closely held, investors are apprehensive of undue and disproportionate promoter influence. Companies with DVR Share structures are more likely to witness oppression of minority shareholders and mismanagement by the promoters, who may exercise a disproportionate amount of power and control, making it difficult for investors to step in if their rights are infringed or if the company is not performing well.

Pricing, Taxation and Related Issues

While SEBI has presently not elaborated on pricing and valuation related aspects of DVR Shares, this will be a key issue for investors going forward. The optimum price for each transaction will vary based on the various factors unique to the company, including the track record of the business and the promoters, the stage of growth that the company is at, prospects of such company and the sector, as well as the voting ratios, dividend payout etc., which are proposed. For transactions involving non-residents, pricing requirements under foreign exchange regulations will also need to be complied with. Given the increased risk involved, it is natural to expect that investors will adopt a conservative approach to pricing DVR Shares.

Given that it may be difficult to objectively quantify the additional value attributable to superior voting rights, the amount of premium payable by the investors for SVR Shares will need to be determined on a case to case basis and this may, potentially, give rise to “fair market value” based pricing and taxation issues. Historically, the Indian tax authorities have taken conservative positions on investment related matters, especially while dealing with new structures, and the principles are often settled only after significant and protracted litigation. Further, authorities may also invoke the wider powers available under the General Anti Avoidance Rules regime, if they are of the view that a transaction involving DVR Shares has been structured fundamentally for tax “efficiency”. The approach adopted by the Indian tax authorities, therefore, will be critical going forward. To address investor concerns, continuity in tax policies will also need to demonstrated, with the recent developments on taxation of foreign portfolio investors being a case in point.

While SEBI has opened up the capital market again for companies with SVR Share structures, the approach seems to be a measured one, and a staggered implementation strategy has been adopted, prioritizing technology companies. However, the response of the market to the regulatory changes can only be assessed in time, and a great deal will depend on how the above issues are addressed as well as how promoters are able to provide adequate safeguards and convince investors to participate while trying to retain voting control.

Footnotes

[1]       Companies designated as technology companies under SEBI’s innovator’s growth platform, i.e., companies which intensively use technology, information technology, intellectual property, data analytics, bio-technology or nano-technology to provide products, services or business platforms with substantial value addition.

[2]       Please see SEBI Circular SEBI/CFD/DIL/LA/2/2009/21/7 dated July 21, 2009.

[3]       2010(1) Comp LJ 509.

[4]       Please see Paragraph 6, Issuance of shares with Differential Voting Rights, SEBI Consultation Paper dated March 21, 2019.

[5]       Please see Section 47 of the Companies Act, 2013.

[6]       Please see Section 47 of the Companies Act, 2013 read with Rule 4 of the Companies (Share Capital and Debenture) Rules, 2014.

[7]       Please see Rule 19(2)(b) of the Securities Contracts (Regulation) Rules, 1957.

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