Related-party transaction norms: Protecting minority shareholders or stifling business?

The two core pillars of RPTs are that pricing be done at arm’s length and that the transactions happen in the ordinary course of business. At a basic level, the Companies Act takes care of these: boards are required to approve such transactions; in some cases, shareholder consent is also mandated with additional provisions that the concerned related party abstains from voting. Listed companies have additional rules to comply with, such as formulating a policy for RPTs and updating it periodically.

Sure, minority shareholders need to be protected, but the ever-tightening regulations have become extremely onerous. Moreover, the extent of regulatory oversight and the one-size-fits-all approach badly need reorientation.

Sebi’s latest circular is a lost opportunity to set things right. A unique feature of this circular is that an Industry Standards Forum comprising representatives from three industry associations—the Associated Chambers of Commerce and Industry of India (Assocham), Confederation of Indian Industry (CII), and Federation of Indian Chambers of Commerce and Industry (Ficci)— under the aegis of the stock exchanges has formulated these rules.

Also read | M. Damodaran: A letter to Sebi’s new chief

In short, Sebi has asked companies to make more disclosures such as standalone turnover, net worth and net profits of the related party for the last three years, which the audit committee then has to review. Not only does this burden the audit committee, but it also pressures the management to generate more information, a lot of which may not be that relevant.

It is important to distinguish between the intent of the requirements, the extent of which they are needed and the consequences. 

Also Read: Mint Explainer: What are related party transactions and why do they run into controversies

Clearly, business exigencies do require RPTs; however, it is not appropriate to approach such transactions with a mindset they are never in the interest of minority shareholders. Also, the aspect of arm’s length price is subjective, and a whole host of factors, such as quantum involved and credit terms, are important. While audit committees certainly do need to have oversight, it is unreasonable to expect them to examine RPTs in excruciating detail as if they are conducting an investigation.

In any case, many types of RPTs have built-in checks to prevent abuse of minority shareholders. For example, in an RPT between a company and an entity, where it is in a joint venture, the company cannot charge an excessive price because the joint venture partner would find that unacceptable.

Also Read: Shareholder nay to related party transactions may jeopardise Kalyani Group firm

When two listed companies with some common shareholdings engage in RPTs, the fact that there are different management teams with compensation often based on profitability is itself a strong deterrent to abuse. In practice, one has seen that two listed companies in a group with different management often have disagreements and negotiate hard on RPTs.

In the case of RPTs with a wholly owned subsidiary, there should be limited governance concerns since such units form part of the consolidated accounts. In any case, tax and other commercial aspects, such as measuring the standalone performance of subsidiaries, usually result in arm’s length prices being charged.

Only RPTs with promoters require the level of rigour that is currently mandatory across all categories of such transactions.

Overall, the latest dispensation only increases compliances, and costs and slows down decision-making. The problem with such regulations is that once they are introduced, it is very difficult to roll them back. The intent is laudable, but will such tighter rules really help minority shareholders? RPT regulations would be better off focusing on promoter transactions and not so much on the others.

Ketan Dalal is managing director at Katalyst Advisors. Views are personal.