Latest Share-pledging Regulations from SEBI - Atasi Das

Introduction 
The Securities and Exchange Board of India (SEBI) is India’s national regulatory body in the securities market. It seeks to protect the financial interests of the common stock market investors as well as to ensure efficient functioning of the capital markets. SEBI’s recent amendment, via a circular dated 28th January, 2009 regarding the mandatory disclosure of pledged shares by promoters, came in the wake of the Satyam fiasco (wherein promoter Ramalinga Raju pledged almost his entire shares, after intentionally inflating the share prices via profit falsification). 

What is Share pledging?
Company promoters normally pledge shares as collateral for raising capital from financial institutions, for purposes such as: 

• Meeting working capital requirements
• Raising personal loans
• Funding an acquisition

In case the value of the pledged shares (being used as collateral) declines, the financiers ask the concerned promoters to shell out an additional margin, failing which the financier is free to sell these shares in the market in a bid to minimize his loss. Often promoters make use of share-pledging to dilute their equity participation in the company. The sheer volume of these shares being dumped in the market has a deflating effect on stock price.

Financing personal loans via share pledging on part of promoters is an investment risk from the point of view of investors whose money is at stake. Until now, such transactions were often conducted on the sly, even making use of ‘hawala’ (illegal system of money transfer).

Share pledging is also often said to be linked with insider trading – that is, trading in stocks by persons who have access to such information about the company as the general public may not have – which is deemed illegal (but is difficult to prove) and leads to price distortion of securities via asymmetric information flow.

The Amendments
SEBI has instructed promoters, involved in share pledging to inform the company about the said transaction, within seven working days of its occurrence.  Companies in turn have been asked to submit the transaction details to the stock exchanges. Promoters are to disclose particulars of pledged shares if they exceed 25,000 shares (on a quarterly basis) or one percent of shareholding rights, whichever is less.

These recent SEBI amendments involve the following clauses.

• Clause 35 and
• Clause 41, pertaining to the Equity Listing Agreement

While the aforesaid Clause 35 is concerned with the reporting format of a company’s shareholding pattern, Clause 41 deals with a company’s submission format for its quarterly financial results. The revised reporting formats will incorporate even the minutest of details regarding a company’s pledged shares. The amendments will come into force from the quarter ending on 31st March 2009 and will apply to publicly traded companies.

SEBI has announced the beginning of both event-based and periodic-share pledging disclosures by companies.  Event-based disclosures are to be made at the point of time when a promoter pledges shares as loan collateral, while periodic disclosures regarding pledged shares are to made by companies on a quarterly basis.

Proposed Benefits of the Amendment
A proper disclosure framework involving share pledging will give the general public access to important and relevant information like the following:

• Time of initiation of pledge
• An approximate idea about the volume of the debt undertaken
• Stock price volatility, if any, will provide an indication of the borrower’s financial distress

Thus, the SEBI amendments are set to boost investor confidence and promote transparency in the system and could be a step in the right direction towards the incidence of further Satyam-like fraud.

[Footnote: Promoter of a company refers to a person(s) who has either initiated the company or is involved in its directorial activity.]