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Securities Laws
SEBI recently made an innocuous appearing requirement for
mutual funds that has far-reaching implications on listed companies and on the
mutual funds. Simply stated, the SEBI Circular (SEBI/IMD/CIR No. 18/198647/2010,
dated March 15, 2010) now requires mutual funds to disclose in their annual
report as to how they voted at general meetings in respect of each of the shares
held by them in respect of specified matters. There are a few other connected
requirements.
As will be seen, these requirements have equal — if not more
— implications on the listed companies wherein shares are held. But let us first
outline the requirements. Incidentally, this article discusses only the
requirements relating to ‘corporate governance’ in the Circular and not other
requirements relating to ASBA, brokerage and commission, etc.
Firstly, it is required that the Asset Management Companies
(‘the AMCs’), i.e., the entities that manage the mutual funds, should disclose
‘their general policies and procedures for exercising the voting rights in
respect of shares held by them’. This disclosure is to be given on the website
of the AMC as well as in the annual report distributed to the unit-holders for
the financial year 2010-11 and onwards.
Secondly, disclosures in a similar manner and timing are to
be given of the ‘actual exercise’ of the proxy votes at general meetings of such
investee companies in respect of the following matters :
(a) Corporate governance matters, including changes in the
state of incorporation, merger and other corporate restructuring, and
anti-takeover provisions.
(b) Changes to capital structure, including increases and
decreases of capital and preferred stock issuances.
(c) Stock option plans and other management compensation
issues.
(d) Social and corporate responsibility issues.
(e) Appointment and removal of directors.
(f) Any other issue that may affect the interest of the
shareholders in general and interest of the unit-holders in particular.
The first annual report in which such disclosure is required
to be made is away more than a year from now and hence it may appear that the
implications would be realised/felt at that time. However, that may not be true
for at least two reasons.
(a) Firstly, since it is now mandated that such disclosures
have to be made, and since public disclosures often result in immediate public
scrutiny, the AMCs/mutual funds should today start considering as to how they
should vote.
(b) Secondly, while the schedule for disclosure in the annual
report is clear enough, the timing for disclosure on the website is not. Is such
disclosure required immediately, or as and when the vote is cast ?
(c) Thirdly, just as the mutual fund is now immediately
concerned with how it would vote, the investee company would also face the
implications of :
Having outlined the requirements, let us consider some issues
in some detail.
This requirement is not, unlike what has been incorrectly
reported in the press, a new or even ‘innovative’ one. In fact, it is a
requirement simply copied — a copy of a good, even if a little inappropriate,
requirement — from the west where this is a fairly standard requirement. This
requirement is extensively discussed in most corporate governance reports (see
for example the Hample Committee Report). What is more, many large institutional
shareholders in western countries publicly declare, in great detail, their
voting policies. Even, statutorily, in 2003 the SEC of USA has mandated a
similar requirement.
However, is this requirement appropriate to India — or, more
specifically, does it have such important consequences in India as it has in
western countries ? Indeed, any step towards making listed companies and their
Promoters more accountable to shareholders and otherwise raising the levels of
corporate governance are obviously welcome. However, this requirement continues
to reflect the approach in India of adopting western practices where the facts
are different. In the west, the mutual funds and other institutional
shareholders hold a significant stake in such companies and hence can easily bar
proposals of management as according to the Hample Committee report which is
almost two decades old, institutional shareholders held more than 60% of the
shares in listed companies. The shareholding of the Promoters/management in the
west was usually below 10%. The situation in India is different (almost
opposite) where the Promoters clearly dominate the shareholding, usually with a
clear majority holding. Even if mutual funds participate and even vote against,
the mutual fund vote cannot reject a proposal. The situation is similar to
wagging of its tail by the dog — the difference is that in the western
countries, the dog is the institutional shareholder who can wag the tail, i.e., the Promoters. In India, the mutual
funds are the tail and they can hardly wag the dog !
Interestingly, this is one of the first of ‘external’
corporate governance requirements in the sense that it applies to a person other
than the listed company itself. Clause 49 had this limitation of scope purely on
account of its placement in the listing agreement that applies only to the
listed company.
These requirements apply only to AMCs/mutual funds. But these
are not the only collective investment vehicles in India and others include
insurance companies, FIIs, NBFCs, etc. This limited scope is obviously because
SEBI does not have jurisdiction over other entities. One will have to see
whether the respective authority governing such other institutional investors
will also issue similar requirements.
The spirit behind such requirement is obviously to make
mutual funds active investors. As the SEBI Circular states — “It was felt that
mutual funds should play an active role in ensuring better corporate governance
of listed companies”. The disclosure requirement is an indirect pressure to
ensure that they are actively involved in important issues relating to the
company since their votes would now be disclosed.
However, at the cost of repetition, while this may make sense in a situation where such institutional shareholders dominate the holding, it is meaning-less in a Promoter-dominated company. True, there have been some cases where serious opposition by major shareholder has helped. However, there is a tendency to point out the finger-countable cases where exceptional interest taken in the rare public-shareholder dominated company and conclude that such exceptions prove the rule that there is a lot of scope for shareholder activism in India.
Also SEBI has not mandated that mutual funds should vote. It has just required such institutions using public money to disclose whether and how they are voting. But this transparency is sufficient to put them on guard.
One wonders whether this can have negative effect. Isn’t it likely that many mutual funds may want to play extra safe and oppose, at least by casting a vote against every resolution that could possibly be slightly or potentially controversial ? Their vote may not make a difference to the out-come, but such a step may help them avoid controversy later on. A vote cast may be viewed critically later by the media and others though with the benefit of hindsight. Of course, some mutual funds may want to remain objective and not act in this manner, but obviously there would be a subtle pressure to play safe. On the other side, companies who are at the receiving end may find it a little embarrassing to explain why certain mutual funds voted against their proposals.
Of course, it was not that mutual funds presently do not participate. Actually, often, many companies sound off institutional investors informally (though often the spirit, if not the letter, of insider trading regulations may be violated) what views they have in respect of major proposals, even where the Promoters command a significant stake. Thus, often, the mutual funds would have already given their views and hence may not bother to participate further or vote. This may now change.
In the end, in a little lighter vein, I wonder whether the requirements could and should end with mutual funds. After all, the technique of achieving the objective of entities that have public involvement through disclosure could apply to other persons too. For example, would it not make sense to require Independent Directors to also disclose the votes that they cast on important matters ? ! While one may argue that Board Meetings where they cast their vote are confidential events, this may also be a way in which there is pressure and accountability on these directors who are in a situation similar in some respects to mutual funds.
