Revised norms: a step in the right direction

Revised norms: a step in the right direction

Sebi yesterday at its board meeting decided to extend the compulsory tender offer requirements in the takeover regulations to ADRs/GDRs. While this is a step in the right direction, it does not go far enough in correcting the deeply flawed view Sebi had taken in its regulations.

The issue in brief is that acquisition of a large number of shares or control of a listed company obliges the acquirer to make a compulsory offer to shareholders to acquire another 20% of the shares of the company. This is to enable such shareholders to have an exit opportunity. The regulations exempted acquisition of ADR/GDRs from this compulsory offer under the deeply flawed view that ADRs/GDRs do not carry voting rights ’till converted into shares’. In fact, ADRs and GDRs do carry voting rights. They are as much shares as are Indian shares held in Indian depositories.

Also Read Sebi ammends takeover code: may affect Bharti-MTN

Read Sandeep Parekh’s blog Initial Private Opinion

ADR/GDRs are convenient means of holding equity of another country without worrying about the logistics of buying those shares overseas using an overseas broker, converting dividends into local currency etc. For this purpose two sets of ‘depositories’ are used (to take the example of an Indian company with listed ADRs) in India which effectively holds say 10 million shares of that company and thus taking them out of circulation from the Indian market. Simultaneously, the foreign depository issues ADR/GDR securities for the same number (though often they are issued in a ratio — say 1 ADR to represent 2 shares) to depository receipt holders in the US market. These DR holder have all of the same rights as an Indian shareholder, for example, right to receive dividend, right to vote and right to residual value on liquidation of the company.

As far as the right to vote is concerned, it is governed by the contract between the DR holder and the depository. There are four types of contract terms which could govern this contract a) the depository will take instruction from the DR holder and vote according to that wish b) the depository will vote according to what is in the best interest of the shareholders c) the depository will vote in favour of existing management d) the depository will not vote the shares. Only in the last case are votes not exercised. However, even then, the shareholder has the power to vote the shares – it is just that he has contracted away the power to someone else who will abstain from voting. If the shareholders had collectively negotiated, they could have got these rights and can always claim these by amending their agreement. This is similar to an Indian shareholder who agrees with another person (whether an individual, company or institution) by way of a shareholder agreement that he will not vote the shares.The law cannot be influenced by the terms of a private agreement on voting arrangements particularly as there is no need for votes not to be exercised by the depository. The key to understanding takeover regulations is the power to exercise rather than its actual exercise.

The regulations treated ADR/GDRs as securities without voting rights and thus exempt them from the applicability of the tender offer requirements on substantial acquisition. Sebi’s treatment of ADRs/GDRs as not having voting rights particularly where it gives exemptions from the applicability of the takeover regulations was wrong in principle. This is particularly perverse where the ADR/GDRs are held by the promoter group itself and they get all the rights without the obligation to make a tender offer to shareholders on large acquisitions. It mixes up the power of voting rights with its actual exercise. The amendment means that where voting rights are in fact exercised, the exemption will be removed. However, the exemption is still retained for cases where the DR holder gives up his rights to the depository. Having corrected three forths of the inappropriate law, we now need to move forward and correct this perversity as well.

Sandeep Parekh is faculty at IIM,A and a WEF Young Global Leader