Overhauling the Preferential Allotment Pricing Regime
3rd year law students at Maharashtra National Law University, Mumbai
In a recent move, the Securities Exchange Board of India (‘SEBI’) has decided to relax the pricing norms and the lock-in requirements for raising funds through preferential allotment of shares, pledge of securities, etc. making it easier for companies to raise funds. In its press release, released on December 28th 2021, SEBI has made changes in the Preferential Issue Guidelines contained in Chapter V of the SEBI (Issue of Capital and Disclosure), Regulations, 2018. This move comes after the scrapping of the deal between Punjab National Bank Housing Finance Ltd. (‘PNB’) and Carlyle Group in the midst of a controversial litigation battle between PNB and SEBI, due to regulatory objections to the deal by SEBI. The relaxations have been introduced by SEBI at a time when the Indian capital markets have witnessed several companies going public to take advantage of the current boom in India. It is therefore important to analyse if this move by SEBI will further encourage more companies to pursue the listing of its shares or if this reduction in corporate governance would prove to be detrimental for market security.
II. Background behind the amendment
In the PNB Housing Finance case, the board of directors approved the preferential allotment of equity shares and warrants to four companies on May 31, 2021: Carlyle Group, General Atlantic, Salisbury Investments, and Alpha Investments. Following this allotment, Carlyle Group, a US-based private equity firm, would have become the majority owner, and the original promoter, Punjab National Bank, would have reduced its stake from 32.64 percent to 20 percent. Unfortunately, before the transaction could be completed, it became embroiled in a number of controversies that drew attention to the specifics of the transaction. The proxy advisory firm - Stakeholders Empowerment Services claimed that the deal was unfair and it asked the PNB’s public shareholders to cast their votes against the resolution on preferential allotment. The proxy advisory firm claimed that the deal was unfair because the price determined for the shares did not reflect the true value of the shares. Making the matter further worse for PNB Housing Finance, SEBI ordered the company's Extraordinary General Meeting to be halted. SEBI claimed that the procedure used for determining the price of the shares failed to comply with the procedure specified in their Articles of Association (‘AoA’), that in turn violated the AoA.
The dispute reached the Securities Appellate Tribunal (‘SAT’), where PNB argued that SEBI lacked jurisdiction to issue such an order, had not given the firm a hearing, and had not previously pulled up listed firms in similar situations. Following a split verdict, the case was heard by the Supreme Court. However, citing pending legal issues, PNB cancelled the transaction and withdrew its appeal against the SEBI order.
Within a month of the controversial deal between PNB and Carlyle, the regulator took an important step waiving the inadequate system by recasting the preferential issue allotment regime and price monitoring in Mergers and Acquisitions related transactions. In order to facilitate fund raising by the issuers through preferential allotment of shares while at the same time ensuring that such issuance is not detrimental to the interest of shareholders, a comprehensive review of the entire guidelines for preferential issue was made so that the same may adequately reflect the present-day requirements of the market rather than the precursory markets on which the system was based.
Following this, SEBI made changes in the preferential issue allotment which required any change in allotment or control of not less than 5% of the issuer company, requiring a valuation report for pricing purposes, from a registered independent valuer. The objective of the amendment is to make it easier for issuers to raise funds through preferential allotment of shares while also guaranteeing that such issuance does not jeopardise the public shareholders' interests. SEBI believed that a full review of the whole preferential issuance guidelines was necessary to ensure that they effectively reflected the market's current needs.
III. The Amendments
Presently, the shares in compliance with the preferential issue norms are subject to the lock-in period, so the said shares can't be offloaded following the issue to profit from value exchange. SEBI has decreased the lock-in period from 3 years to year and a half (if there should arise an occurrence of promoters) and from 1 year to a half year (in the event of non-promoters) to blend the same with lock-in prerequisites in the event of public issue.
Further, previously, the price of the shares to be allotted pertaining to a preferential issue should be greater than the average of the weekly high and low of the Volume Weighted Average Price ('VWAP') of shares on the stock exchange during the previous 26 weeks or the VWAP during the two weeks preceding the relevant date. SEBI has shortened these periods to 90 days and 10 days, respectively, citing that the current norm of 26 weeks is too long for determining the price in light of market volatility.
SEBI has also made requiring a valuation report from a registered independent valuer mandatory, in the case of a preferential issue resulting in change of control or allotment of more than 5% of the issuer company's post-issue fully diluted share capital to an allottee or allottees acting in concert. Pricing will take into account the aforementioned valuation. Further, any such preferential issue be undertaken only on the basis of a reasoned recommendation from the committee of independent directors. Finally, SEBI has allowed pledging of shares allotted to promoters or promoters group under preferential issue during lock-in period in order to finance objects of the preferential issue.
IV. Analysis of the move
The goal of this move is to ensure that any changes to control transactions are properly assessed. In that sense, it is a significant shift rather than merely a procedural change. While this provides additional security to minority financial investors, it may not prevent the type of debate seen in PNB Housing. Assuming there was a discussion about the lack of valuation of pricing in PNB, there may be one about the methodology of valuation as well. In normal circumstances, the ruling price addresses a firm's worth. The ruling price is the price at which the last exchange on a security occurred, unless there was a higher or lower offer. But this may also lead to some problems which are uncalled for. Rather than introducing a new valuation metric, SEBI should consider making it easier for companies to raise capital. For example, if a company is unable to raise capital in accordance with the prescribed valuing standards, the company should be permitted to raise capital with the approval of its public shareholders rather than being prohibited from approaching its shareholders at all. And because they are level-headed, the current guidelines for evaluating preferential allotment work admirably. To prevent misuse, an equation is used to determine the floor cost. The use of a valuation method to determine control premium opens the door for anyone to scrutinise that in court. This will further give rise to future litigations.
Furthermore, SEBI has additionally put the onus on independent directors with regards to whetting such exchanges imagining the offer of a greater part stake. Any preferential issue allotment bringing about change in control might be done simply according to a contemplated recommendation from a panel of independent directors, which needs to be complied with. The recommendatory report shall consider all parts of preferential allotment including pricing. This could go against their intent and prove to be an overkill.
As indicated by the amendments, any allotment which brings a change in control must be backed by a valuation which considers control premium. Following that, the change assumes that verifiable market cost may not be an exact benchmark for a business bargain. The law seeks to make it easier for businesses to raise funds through preferential issuance while also ensuring that such issuance does not harm investors' interests.
Following the PNB and SEBI stalemate, a few consultants began investigating the AoA of listed firms due to preferential share allotment in order to avoid any similar administrative obstacles. However, as long as the controller specifies the valuing system, it is beneficial to all stakeholders. Regardless, the concept of control premium is unusual in that it rarely has a significant bearing and is dependent on a variety of factors such as the nature of the business, among others. All in all, it is a good move undertaken by the watchdog and its successful implementation will make the entire preferential share allotment regime simpler and more transparent to the investors.