SEBI introduces key changes to fundraising processes, disclosures and corporate governance – Shareholders


Background:

Securities and Exchange Board of India (SEBI) at its board meeting on September 29, 2022 (Board meeting) has among othersapproved an alternative mechanism for the pre-filing of offer documents in initial public offers (IPOs); additional information to support the IPO issue price; the follow-up of the proceeds raised thanks to the placement of qualified institutions (QIP) and preferential issues; and an alternative approval process for the appointment and removal of independent directors of listed companies.



Optional pre-filing of the offering document:

The current 4 (four) step filing process for an IPO on the main board includes: (i) filing a draft red herring prospectus (HDRD) with SEBI and the exchanges, making it available to the public for 21 (twenty-one) days and seeking comments from SEBI and approval in principle from the exchanges; (ii) confidential filing of the updated DRHP (UDRHP) with SEBI for confirmation; (iii) after the green light from SEBI, filing of a red herring prospectus (HPR) with the Registrar of Companies (Rock), SEBI and stock exchanges; and (iv) file a prospectus with SEBI, RoC and exchanges after pricing.

Consistent with various representations made by issuers and with the primary intent of maintaining the confidentiality of sensitive business information in the initial stages, SEBI has approved an alternate 5 (five) step filing mechanism whereby an issuer so willing may file DRHP confidentially with SEBI for comments, and with fellowships for approval in principle. Once SEBI observations have been incorporated, an updated HDRD (UDRHP-I) is available for public comment for 21 (twenty-one) days. This is followed by the confidential filing of a second updated DRHP (UDRHP-II) with SEBI. Upon approval of this UDRHP-II, the issuer may file the RHP with the RoC, SEBI and stock exchanges and launch the IPO.

The pre-filing facility addresses some of the concerns of potential issuers by allowing them to initiate the IPO process, while testing the waters to determine market sentiment and then deciding whether they wish to proceed with the IPO in stock Exchange. Accordingly, at this stage, the issuer’s sensitive business data and any competitive advantage of the issuer are protected from public/competitor disclosure. Speculation on the price and timing of the issue in the market during this interim period is also avoided.

The pre-filing will allow issuers to: (i) make more recent information available to the public and for the marketing of the issue (unlike the existing mechanism where marketing is usually done based on the information contained in the DRHP , which is updated only at the RHP stage, shortly before the opening of the IPO); (ii) resolve SEBI’s observations and comments on a confidential basis; and (iii) obtain more recent comments from institutional investors to gauge initial demand and pricing. It will also allow an updated document to be available to potential investors for an extended period. If the pre-filing mechanism is opted for by an issuer, it is likely to lengthen IPO times.



Disclosures of Key Performance Indicators in the Basis of Issue Price section:

SEBI, to strengthen disclosure requirements to substantiate the issue price in an IPO, has mandated certain additional disclosures in offering documents and price range announcements, including:

i) key performance indicators (KPIs);

ii) price per share of the issuer based on primary issues and secondary sales/acquisitions, during the 18 (eighteen) months preceding the IPO. In case there have been no such transactions in the previous 18 (eighteen) months, details of the last 5 (five) primary or secondary transactions with a look-back period of 3 (three) years from of the IPO must be disclosed; and

iii) weighted average acquisition cost (WACA) based on primary and secondary transactions, as well as the ratio against the floor price and the ceiling price of the IPO.

SEBI’s intention appears to be to bolster the rationale for IPO prices with additional information, which is essential to potential investors’ assessment of price levels. Issuers have historically disclosed company- or industry-specific KPIs in offering documents, particularly for marketing purposes. Issuers will now be required to disclose these KPIs in the “Basis of Issue Price” section of the offering documents, with the understanding that these KPIs affect the pricing of the IPO. This decision is likely to stem from SEBI’s assessment of the performance of recently listed new-age tech companies (NATC) which are largely supported by private investors and generally loss-making in the growth phase. Information on past transactions and past fundraisings by issuers aims to reduce information asymmetry between pre-IPO and IPO investors.

The SEBI has also decided to impose an additional responsibility on the independent directors for the determination of the issue price by requiring that a committee of independent directors recommend that the price range is justified on the basis of quantitative factors / KPIs compared to the WACA of primary issues and secondary transactions. Considering that the issue price must be approved by the board independently, it is unclear to what extent independent directors can bring additional value to the process.



Product monitoring of issues raised through QIPs and preferred issues:

Under Securities and Exchange Board of India (Registration and Disclosure Requirements) 2015 (LODR regulations), while listed companies are required to disclose the use of funds raised through QIPs or preferential issuances and to explain any variation in their annual report each year until these funds are fully utilized, there was no obligation to monitor the use of the proceeds by an external agency (except in the case of preferential issues of companies with stressed assets which required monitoring of the proceeds of the issue by a public financial institution or a scheduled commercial bank). SEBI has now mandated the monitoring of the use of the proceeds of the issue for all preferential issues and QIPs of 100 (one hundred) crore INR, by credit rating agencies (BOW), in the same way as public and rights issues, thus aligning the regulatory framework.

The obligation for a company to communicate quarterly to the exchanges the deviations and variations in the use of the product compared to what is disclosed in the offer documents or indicated in the statement of reasons for the convening of general meetings, and the audit committee’s obligation to review such statements remains the same. However, the appointment of an independent CRA will add an additional level of checks and balances. Potentially, the current requirement under Regulations 32(6) and 32(7) of the LODR regulations applicable to public issues and rights issues will also be extended to preferential issues and QIPs, thereby requiring companies to submit comments or a report from the oversight agency to be placed before the audit committee and submitted to the exchanges on a quarterly basis.



Alternative Approval Process for the Appointment and Removal of Independent Directors:

To strengthen the corporate governance framework of listed companies, SEBI had, through an amendment to the LODR Regulation on August 3, 2021, introduced Regulation 25 (2A) which requires that the appointment, renewal and removal independent directors by a listed entity be subject to shareholder approval by special resolution. Prior to this amendment, in accordance with the Companies Act 2013, the appointment and removal of an independent director required shareholder approval by ordinary resolution and only reappointment required a special resolution. To provide companies with flexibility in appointing independent directors, SEBI approved an amendment to Regulation 25(2A) of the LODR Regulation that, in the event that the majority required for such a special resolution is not obtained , the independent director may still be appointed if approved by: (i) a majority of shareholders; and (ii) the majority of minority shareholders. This flexibility will facilitate the otherwise arduous process of identifying suitable candidates and onboarding independent directors for companies. SEBI seems to suggest a similar objective approval structure to jurisdictions like Israel, which provides for the appointment of independent directors through minority shareholders, and the UK, where a dual voting structure exists for listed companies. blue-chip companies that have a majority shareholder, i.e. the approval of both – shareholders as a whole and independent shareholders, in addition, if either fails, a second vote of all shareholders (including the controlling shareholder) can be arranged.

Another significant change brought about by SEBI is greater flexibility in the existing framework for offering for sale (FSO) of shares via the mechanism of the stock exchange by among others, (i) remove the threshold for holding a minimum of 10% of the capital – so that non-promoting shareholders can participate in the OFS, thus opening up this mechanism to other non-promoting shareholders; (ii) reduce the cooling-off period for the seller to buy/sell shares before or after the SFO, from 12 (twelve) weeks to a range of 2 (two) weeks to 12 (twelve) weeks depending on the liquidity of these securities; (iii) allow retail investors to bid for the unsubscribed portion of the non-retail segment; and (iv) extension of the SFO through the exchange mechanism to listed real estate investment funds/infrastructure investment funds.

The contents of this document do not necessarily reflect the views/positions of Khaitan & Co but remain solely those of the authors. For any other questions or follow-up, please contact Khaitan & Co at [email protected]

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