By Jayant M. Thakur
Chartered Accountant
BACKGROUND
A listed company is subject to dual regulation. First, by the Companies Act, 2013 which is the parent act under which it is incorporated and which lays down the basic rules about how companies should be governed. And second, the multiple regulations notified under the SEBI Act. The regulator under each of these sets of laws is also different.
It is not as if the objectives of the two laws are clearly distinct and non-overlapping. Unfortunately, however, neither regulator would like to cede to the other and agree that some areas are best regulated exclusively by the other. Thus, several areas are regulated by both the regulators. And these areas actually keep increasing. Whether the concept and requirements relating to Independent Directors, whether the issue of shares and debentures, whether the setting up of various committees, their constitution and scope, etc., each regulator makes its own set of provisions.
This article attempts to look at this overlap and the resultant consequences. It also highlights the attempts made periodically to harmonise and even cede control. It also differentiates the nature of enforcement by the two regulators.
But this article arises primarily out of a recent informal guidance issued by SEBI. In this case, not only is there dual regulation, but owing to what appears to be poor drafting, certain harsh consequences have arisen which SEBI has merely reinforced without accepting.
AREAS OF DUAL GOVERNANCE
The objectives of the Companies Act, 2013 (‘the Act’) / Rules notified therein and the Securities Laws (consisting of the SEBI Act and several regulations notified by it) do have common areas. Both have as one of their objectives the governance of companies, even if SEBI primarily regulates companies that have listed, or propose to list, their securities. Both regulate the issue of securities, even if SEBI basically regulates the issue of securities to the public.
Thus, for example, the whole area of corporate governance is regulated minutely by both the laws. The definition of ‘Independent Directors’ is enunciated elaborately and separately by each of the two regulators. The constitution of committees such as the Audit Committee and the Nomination and Remuneration Committee is similarly laid down independently by the two laws. And the manner of issue of securities is also regulated independently by each of the two sets of laws.
Both sets of laws also regulate related party transactions. However, the definition of related parties, the nature of related party transactions governed, the manner of their approval, the quantum limits beyond which special approvals are required, etc., are all framed with differences, some major and some minor.
The result obviously is many differences, big and small, which companies have to carefully navigate through.
CONSEQUENCES OF DIFFERENT PROVISIONS
What happens when the same issue has differently-worded provisions under the Act / Rules and the Securities Laws? For example, the minimum number of Independent Directors required. The Act has made a simple rule which may result in a lower number of minimum Independent Directors, while the Securities Laws (the LODR Regulations) would require more. Or, say, the definition of related party transactions. The definition of related parties under the SEBI LODR Regulations is wider and covers groups of persons who are not covered as related parties under the Act. Similarly, the definition of related party transactions under the SEBI LODR Regulations is wider. So, again, the question is how will the differences be reconciled?
Primarily, the answer is that (i) both the sets of provisions have to be complied with, and (ii) in case of overlap / difference, the narrower or stricter provision will apply. If the LODR Regulations require more Independent Directors while the Act prescribes a lower number, the LODR Regulations will apply. Similarly, the wider definition of related party transactions under the SEBI LODR Regulations will apply.
But while this may be a good basic principle, the provisions of each set of laws should be carefully examined.
ATTEMPTS TO HARMONISE AND CEDE CONTROL
It is not as if the two regulators are always deliberately confrontational and engaged in a turf war. There is actually a tendency to carefully review what the other regulator has already provided in its corresponding provisions. Indeed, from time to time reviews are carried out and attempts are made to harmonise wherever possible. However, often a fresh set of amendments is made which widens the gap further. Since the provisions governed by SEBI are generally in the Regulations which can be easily amended, SEBI is able to update the provisions to current requirements and also take care of the difficulties faced. The amendments to the Act require approval of Parliament, although, interestingly, we have also seen a series of amending acts over the years.
DUAL ENFORCEMENT ACTION
Each of the two sets of laws has differing consequences in case of violation. Even the process of enforcement can be different. A violation of the provisions in the Act may result in fine and / or prosecution and, at times, other action. SEBI, however, generally has a wider arsenal of actions. It may be in the form of levying a penalty, directing persons not to deal in securities, barring persons from accessing securities markets, disgorgement, etc.
Companies and other persons in default alleged to have violated the provisions may face dual proceedings, one by each regulator, even for substantially the same violation!
Interestingly, under section 24 of the Act, certain specified provisions of the Act relating to listed / to be listed companies are to be ‘administered’ by SEBI. Ideally, such a provision would have ensured not only that dual provisions are either eliminated or harmonised, but even the action is by a single regulator. However, the provisions of this section have a narrow scope.
MANAGERIAL REMUNERATION – DUAL PROVISIONS AND CONSEQUENCE OF POOR DRAFTING
Let us take up a specific case that provides a good example of overlapping provisions with certain anomalous results owing to poor drafting. This case relates to payment of ‘managerial remuneration’, i.e., remuneration paid to directors. Traditionally, the Act has regulated payment of managerial remuneration in fair detail. The persons who can be appointed as Managing / Wholetime Directors, the manner of their appointment, the upper limits of their remuneration, etc., are all regulated in detail. Earlier, payment of remuneration beyond the specified limits required approval of the Central Government. However, now the Act requires approval of the shareholders instead. But even the shareholders cannot grant approval for remuneration that exceeds certain limits. The Act places limits on managerial remuneration in terms of percentage of net profits (as calculated in a prescribed manner) and, in case where profits are inadequate, or there are losses, in absolute terms.
SEBI had, till recently, not provided for limits on managerial remuneration but dealt with the subject by requiring the Nomination and Remuneration Committee to recommend managerial remuneration. However, with effect from 1st April, 2019 it made several requirements relating to certain managerial remuneration. One such requirement related to Promoter Executive Directors and became an area of confusion and a company approached SEBI for an ‘informal guidance’. It may be recalled that SEBI grants ‘informal guidance’ on provisions (for a relatively small charge) which, although it has limited binding effect, often helps know the view that SEBI may generally take.
The relevant provision is Regulation 17(6)(e) of the SEBI LODR Regulations which reads as under:
(e) The fees or compensation payable to executive directors who are promoters or members of the promoter group, shall be subject to the approval of the shareholders by special resolution in general meeting, if –
(i) the annual remuneration payable to such executive director exceeds rupees 5 crore or 2.5 per cent of the net profits of the listed entity, whichever is higher; or
(ii) where there is more than one such director, the aggregate annual remuneration to such directors exceeds 5 per cent of the net profits of the listed entity:
Provided that the approval of the shareholders under this provision shall be valid only till the expiry of the term of such director.
Explanation. – For the purposes of this clause, net profits shall be calculated as per section 198 of the Companies Act, 2013.
As can be seen, the provision states that the upper limit on annual remuneration in case of one such Promoter Executive Director is Rs. 5 crores or 2.50% of the net profits, whichever is higher. In case there is more than one such director, the corresponding limit on the aggregate remuneration to all such directors is 5% of the net profits.
The anomaly is apparent. The limit on remuneration in case of one director is given in an absolute amount as well as in a percentage. However, in case of more than one such director, the limit is given only in percentage terms. To take an example, if the net profit is Rs. 50 crores, then the company may pay Rs. 5 crores as managerial remuneration to one such director, being the higher of Rs. 5 crores and Rs. 1.25 crores (2.50% of Rs. 50 crores). If there are two or more such directors, however, the company can pay only Rs. 2.50 crores, since in such a case the company cannot pay more than 5% of its net profits as aggregate remuneration to all such directors. Thus, even the single director, who could have otherwise received up to Rs. 5 crores, would now get a far lesser remuneration since the aggregate limit for all the directors put together is Rs. 2.50 crores! Of course, if the net profits are very large (say, beyond Rs. 100 crores), the difficulty arising out of such an anomaly would be diluted. But if the profits are less, the anomaly becomes even more glaring.
For a company that needs more than one such director, the provision creates difficulties. When SEBI was approached for an informal guidance on this, it confirmed the above view and said that the remuneration would be limited to 5% of net profits (see informal guidance dated 18th November, 2020 to Manaksia Aluminium Company Limited). Thus, the company would be required to approach the shareholders for a special resolution.
To be fair, SEBI could not have resolved a drafting anomaly through an informal guidance since this would generally require an amendment.
CONCLUSION
A careful consideration is needed whether at all there is a need for dual sets of provisions on the same subject which result in overlap, conflict and even confusion, apart from double proceedings and double punishment. A fleet-footed SEBI could be given exclusive jurisdiction over listed / to be listed companies in several areas. This will ensure that companies have a single set of provisions to apply and that there is a single regulator who will take action in case of violation and the regulator is one who has several different enforcement actions that it can take that are suited to the violation/s.
