By S Sivakumar
The article presents an analysis of how promoters of listed entities use ‘Rights Issue’ to circumvent the regulatory mechanisms under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2011(herein after referred to as the SAST Regulations). Rights Issue increases the shareholding of the promoters without attracting the mandatory open offer obligations and disclosure requirements under the SAST Regulations. This is much to the detriment and disservice to the objective of the Takeover Code which is to protect the interest of the minority shareholders and provide them with an exit opportunity at a competitive price. It is imperative to understand the concepts of ‘Mandatory Open Offer’ and ‘Creeping Acquisition’ under the SAST Regulations along with ‘Rights Issue’ to comprehend the issues raised in this article.
The trigger for the mandatory open offer obligations is attracted when either the Acquirer or the Persons Acting in Concert acquire shares which along with its existing stake allows it to exercise control of 25% or more voting rights. Any such additional purchase can only be undertaken by making a public announcement of acquiring a minimum of 26% of the stake in the target company and giving an exit opportunity to the minority shareholders. Creeping Acquisition refers to the acquiring of stake in the company by either the Acquirer or Persons Acting in Concert (who usually have significant holdings) in multiple small transactions that does not result in attracting the trigger for mandatory open offer obligations and disclosure requirements under the SAST Regulations. When the promoter shareholding is already in excess of 25% of the voting power but less than the maximum non-public shareholding, the maximum percentage by which the promoters can raise their equity stake is capped at 5% of the voting power. This cap on creeping acquisition is confined to a financial year and only increase in equity stake resulting from the secondary market is considered for ascertaining whether such acquisition attracts the mandatory open offer obligations. To avoid the applicability of the SAST Regulations, the promotors have subscribed to the option of Rights Issue to raise their holdings effectively. Rights Issue are a type of equity offering wherein the company raises additional capital through Further Public Offer and gives first preference to the existing shareholders before opening up the entire issue for subscription to the general public.
Circumvention of SAST Regulations: In Perspective
The logic and reasoning behind employing ‘Rights Issue’ as a mechanism to increase the promoter shareholding requires an in-depth analysis. This is because a similar increase in the equity stake otherwise from that of Rights Issue would have triggered the mandatory open offer obligations under the SAST Regulations. SEBI does not consider the increase in equity stake arising by virtue of Rights Issue as a part of the Creeping Acquisition limit. Hence, any attempt by the promoter to raise equity stake through Rights Issue would go unnoticed without attracting mandatory open offer obligation and public announcement. It is very likely that the promoter uses this route to increase the stakes and circumvent the rules governing the creeping acquisition under the SAST Regulations.
Promoters raising their equity stake through the Rights Issue grants them a number of incentives. Firstly, the promoters get the shares at a substantially discounted price as the objective of Rights Issue is to confer the benefit of a discounted share price to the existing shareholders. This is a matter of concern for the policy makers and the regulatory bodies as the ability of the promoters to acquire shares below the market price would be antithetical to the interest of the minority shareholders who are supposed to be the beneficiaries of the Rights Issue. This is because more consolidation of power at the hands of the promoters would dilute the voting rights of the minority shareholders. Secondly, in almost all cases the underwriters of the Rights Issue are the promoters themselves instead of merchant bankers or the investment banks, making them eligible to subscribe to the remaining unsubscribed shares. Thirdly, it is not necessary that the company mandatorily provides for the ‘specific objective’ for the funds raised through Rights Issue, the necessary implication of which could be use of Rights Issue for nothing more than gaining control in the company. Fourthly, the process of initiating a Rights Issue is fairly simple as the procedure only requires the approval of the board, the issue size to remain within the authorized capital, disclosure to the designated stock exchange amongst the others as compared to the procedures under mandatory open offer under the SAST Regulations which both protects the interest of the minority shareholders and keeps a check on the hostile acquisition and takeovers.
It is also imperative to note that the SEBI has relaxed many norms in relation to the Rights Issue such as the profitability and capitalization thresholds which are mandatory in cases of an Initial Public Offer and diluted the disclosure requirements for the Rights Issue. In fact, there is no eligibility criteria for a listed company to opt for the Rights Issue as a mode of raising the capital unlike the barriers imposed in other avenues. This is simply a case where the loopholes in the law have compromised the protection of the minority shareholders which is the basic premise on which the SAST Regulations have been formulated.
SEBI as the regulatory body of the securities market has taken multitude of initiatives to protect the interest of the investors and improve corporate governance. The SAST Regulations are indeed an attempt by the regulator to govern the substantial acquisition of shares and takeover to protect the interest of the minority shareholders and provide them a safe exit opportunity and prevent any hostile bids. But the implications necessitated by the loopholes and the grey areas in the regulation needs swift resolution so that there is no alternative way in which promoters raise the equity stake beyond the creeping acquisition limit without adhering to the open offer obligations under the SAST Regulations. To prevent the promoters from using the Rights Issue as a tool to increase their equity stake and escaping the SAST Regulations, it is necessary that all or any part of increase in equity stake arising out of the Rights Issue must be included while considering the trigger point for open offer obligations under the SAST Regulations. Also, increased measures to prevent the abuse of minority shareholders should be taken along with possible eligibility criterion to regulate the companies who opt for Rights Issue. It is fundamental for the policy makers and the regulatory bodies to pay immediate attention towards the Rights Issue, essentially those with non-specific objectives and bring necessary changes in the SAST Regulations. In addition, from a policy perspective it is sine qua non to find out what are the driving factors of the alternate forms of raising equity and its nexus with SAST Regulations to comprehensively address the negation of the interest of minority shareholders arising from the circumvention of the SAST Regulations.
The author is currently in their third year, pursuing their B.Com LLB from the Tamil Nadu National Law University.
 SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2011.
 SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2011, Reg 3(1).
 SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 2011, Reg 3(2).
 The Companies Act, 2013, S 62.
 Y.H Malegam, Report of the Malegam Committee on Disclosure Requirements in Offer Documents, (July 16, 2004).
 SEBI, Discussion Paper on Rationalisation of Disclosure Norms for Rights Issue, 2009.