New delisting norms should not shoo away investors
Nov 13, 2006
At a time when hundreds of companies are lining up to raise public money, the government has issued draft regulations for compulsory delisting of shares, which could drive retail investors further away from the capital market.
Essentially, the draft regulations seek to punish investors for corporate lapses and mis-management by throwing out companies and shutting exit opportunities. The draft rules say that stock exchanges can compulsorily delist companies that make losses for three consecutive years, if the management fails to inform the exchange about a change of address or even when they mop up shares and cause public holding to fall below the minimum prescription for listing.
In most of these situations, the rules ought to hold the management accountable and help investors effect a change in management; instead, the government seems set to create conditions for companies to raise public money, siphon it off to their private coffers and get a smooth and automatic exit after three years of losses. The government has invited public comment before the end of this month, after which the new rules will be part of the Securities Contracts (Regulation) Act (SCRA).
The irony is that everybody agrees with the need for a few thousand companies to be dropped from the Bombay Stock exchange’s (BSE) list and sympathises with its burden of surveillance and ensuring compliance with listing regulations for 7,500 companies. Many of these were historically listed with tiny capital requirement and low public shareholding of which barely 2,500 are traded regularly.
The draft rules only underline the need for policy making through proper discussion and a clear purpose. Funnily enough, at the inauguration of Sebi Bhavan in Mumbai, Finance Minister P.Chidambaram asked the regulator to "come out with measures to draw small investors to the capital market and ensure they felt safe about their investments". But these new regulations are likely to frighten investors because the absence of IPO ratings are allowing mutual funds and institutional investors to continue investing in a host of dubious and over priced issues.
As we noted last week, when a company gets a poor rating, those in charge of institutional investors would be forced to explain their investment in poorly rated issues. That is exactly how an issue that got a rating of 2 out of 5 failed to get any institutional subscription and was withdrawn. What better check could there be on dubious issuers? Yet, companies and market intermediaries are powerful enough to ensure that the demand of investor associations is consistently ignored and mandatory IPO rating is not being introduced.
So, companies can now take advantage of a 3-year bull run to pick up public funds through an over-priced and much hyped public offering and walk away with it in three years, so long as they meet one of these conditions: their shares are suspended for more than six months (this can be ensured by not paying listing fees, or not fulfilling corporate governance requirements or not complying with mandatory corporate filings) or infrequently traded in a three year period. Failure to furnish the correct address, unauthorised change of address, if the public shareholding sinks below the minimum listing requirement (usually because management mops up the shares) or violation of the SCRA which warrant a Rs one crore penalty or three month imprisonment could also trigger delisting.
But the most contentious regulation is that three consecutive years of losses are reason enough for companies to delist. Apparently, the government has forgotten the entire saga of India’s steel majors which made losses for several years until global commodity prices turned bullish and India’s economic growth boosted turnover and profitability. It may be recalled that institutional investors such as ICICI Bank made a lot of money by forcing companies to convert their debt to equity and then selling the shares when prices rallied substantially. Some companies involved with Ketan Parekh have also made a sharp recovery after floundering for several years in the aftermath of the scam.
A quick search shows that even companies like IFCI, Whirlpool and Tata Tele Maharashtra are among those reporting losses for the last three years. But are their shareholders desperate to get rid of these shares? Under the delisting regulations drafted by the SCRA, all of these companies would have been thrown out from the market.
What then is the solution to a problem, where everybody agrees that well over a thousand shares need to be delisted, but cannot agree on the delisting criteria? Plenty of suggestions have been made in the past, but most of them were discarded without a serious attempt at implementation.
One possibility is to eliminate companies with a tiny paid-up capital which are only being preserved as possible vehicles for reverse-mergers. Most of these have no public shareholding and can be compulsorily delisted almost immediately.
A second possibility is asking bourses to study companies which have less than 200 shareholders and meet all listing regulations. Given that stock exchanges have hefty investor protection funds, the money could be used to set up a committee and find appropriate solutions to each, so that shareholders get a reasonable exit, especially in infrequently traded shares.
A third strategy would be to take advantage of the booming Small and Medium Enterprises (SME) sector by making a serious effort to create a new exchange and transfer small and mid-cap companies to a new bourse, with different reporting and compliance rules.
Sebi seems to be uninterested in this market segment based on ill-conceived experiments such as the Indonext (a BSE trading platform) and the OTCEI. The Finance Ministry needs to initiate a serious discussion with banks, market intermediaries other experts to find solutions that would attract genuine issuers and build confidence among investors.