[Ishaan is a student at Jindal Global Law School.]
On 24 June 2023, ICICI Securities (I-Sec) – the securities broking subsidiary of ICICI Bank – announced in a regulatory filing to the stock exchanges that its board had decided to delist its shares from the bourses and take the company private. The filing also contained a crucial detail that conveyed the novel and unprecedented nature of the proposed move. The delisting, it read, would involve a ‘share swap’: instead of receiving cash in lieu of their cancelled shares, public shareholders of the company would receive 67 shares of ICICI Bank in exchange for every 100 shares held in I-Sec.
The proposal promptly attracted the ire of investors and stirred controversy across the market. Public shareholders, which include LIC and Norway’s government pension fund, collectively hold a 25.2% stake in I-Sec; the remaining 74.8% is owned by ICICI Bank. Comprising a vulnerable minority, public shareholders of I-Sec have decried the move as an opportunistic ploy by ICICI Bank owing to the low valuation that the share swap offers them and, more importantly, because this novel delisting method (unlike the ordinarily used ‘reverse book-building’ process) erases any form of participation by shareholders in determining the value of their cancelled shares.
I-Sec’s delisting proposal merits a thorough analysis not merely for its inventive use of the SEBI (Delisting of Equity Shares) Regulations 2021 (Delisting Regulations) but also for the insight it offers into the corporate governance issues abound between promoters and minority shareholders when a company is taken private. This article examines the unconventionality of the proposed delisting and, thereafter, aims to dissect the tenuous legality underlying the proposal.
Understanding the Peculiarity of the ‘Share Swap’ Method
In India’s concentrated ownership landscape where ‘promoters’ hold an overwhelming majority of the shareholding in most firms, the delisting of a company poses inherent risks to its minority shareholders. A promoter with substantial control holds uninhibited authority to opportunistically announce a delisting when market prices of the company’s shares are lower than their intrinsic value, leaving minority shareholders unfairly compensated at such market price. Information asymmetries between the promoter and minority shareholders regarding the company’s true value and outlook further exacerbate the potential for opportunism. The Delisting Regulations thus aim to safeguard shareholders in a delisting and ensure the value they receive for their cancelled shares is fair and transparently determined.
As a crucial protection, the Delisting Regulations mandates promoters to provide shareholders an exit opportunity where they are compensated at a share price determined through a process called ‘reverse book-building’. In this process, each shareholder submits a price at which they are willing to sell their shares to the promoter through an online bidding system. Following the bidding, the price agreeable to as many shareholders as required to bring the promoter’s stake in the company to 90% is decided as the final exit price for all shareholders. Price discovery through reverse book-building therefore, revolves around shareholder participation and tends to provide shareholders a generous compensation.
I-Sec’s delisting, however, is proposed to occur entirely without a reverse book-building process. The exit opportunity provided to investors instead is in the form of a share swap which compensates them with 67 shares of ICICI Bank for every 100 shares of I-Sec. The 67:100 exchange ratio has been derived in a joint valuation report by the valuation firms PwC and EY at the behest of the boards of ICICI Bank and I-Sec. In stark contrast to a reverse book-building, this method of price discovery denies any voice to shareholders. This lack of involvement, coupled with the fact that the share swap values the company’s shares at nearly half the IPO price and the company’s growingly positive outlook, has led shareholders to staunchly oppose this unique delisting process.
Decoding the Contrived Legality of the Delisting
Special provision for delisting a subsidiary of a listed holding company through a scheme of arrangement
According to its stock exchange filing, I-Sec’s unique proposal is enabled by a special provision under the Delisting Regulations – Regulation 37 of Part C of Chapter VI – which allows the company to wholly bypass the legislation’s other provisions, including reverse book-building. This provision is available exclusively to the delisting of a subsidiary company through a scheme of arrangement with its listed parent company which must be engaged in the ‘same line of business’ and allows the subsidiary’s shareholders to be compensated with the parent company’s shares.
Meanwhile, a standard operating procedure circular issued by SEBI on 6 July 2021 (SOP) lays down the criteria to determine whether a parent and its subsidiary operate in the ‘same line of business’ under Regulation 37, namely: principal economic activities of both companies must fall under the same 3-digit code under the National Industrial Classification Code 2008 (NIC Code) and at least 50% of both companies’ revenue and net tangible assets must be attributable to the same line of business.
While the delisting proposal does involve a scheme of arrangement between both companies, the use of Regulation 37 to delist I-Sec raises a puzzle considering I-Sec and ICICI Bank are not engaged in the ‘same line of business’ based on the SOP’s criteria or even intuitively. As stated in their latest annual disclosures, I-Sec’s business activities fall under the NIC codes 66120 (‘broking’) and 66190 (‘merchant banking and distribution of financial products’) while those of ICICI Bank fall under 64191 (‘monetary intermediation of commercial banks, saving banks. postal savings bank and discount houses’). The corresponding 3-digit NIC code for I-Sec is thus 661 while that of ICICI Bank is 641. Further, I-Sec’s latest annual report shows ‘broking and distribution’ and ‘issuer services and advisory’ accounting for 95.6% of its revenue while ICICI Bank’s annual report shows 64.8% of its revenue coming from ‘retail banking’, ‘wholesale banking’ and ‘other banking business’, erasing any possibility of the companies obtaining 50% of their revenue from a common business segment. At the same time, the tangible assets as described in the schedules to either company’s latest balance sheets show no indication of their investment in a common line of business. Simply put, I-Sec is a securities broking company while ICICI Bank is a bank.
The question, then, arises: How is I-Sec able to delist under Regulation 37 without being in the ‘same line of business’ as ICICI Bank?
Relaxation under Rule 19(7) of the Securities Contracts (Regulation) Rules 1957
As revealed in its draft scheme of arrangement and an audit committee report, I-Sec has obtained a letter from SEBI granting exemption from the strict enforcement of the 'same line of business' requirement. The letter has been granted under Rule 19(7) of the Securities Contracts (Regulation) Rules 1957 (SCRR) which allows SEBI to “waive or relax the strict enforcement of any or all of the requirements with respect to listing” at its own discretion.
At the outset, a fundamental question emerges yet again: why was relaxation sought under the SCRR when the Delisting Regulations provides a similar relaxation clause under Regulation 42? The answer lies in the fact that a subsidiary delisting through the share swap method under Regulation 37 of the Delisting Regulations, as mentioned before, is exempt from all its other provisions. With relaxation under Regulation 42 thus rendered unavailable, I-Sec was constrained to search for an alternate relaxation provision for delisting requirements which was apparently found under the SCRR.
The applicability of the SCRR’s relaxation clause to a delisting, however, stands on precarious legal ground. Rule 19(7) makes explicit in its text that it allows for the relaxation of 'requirements with respect to listing prescribed by these rules' and exists as a sub-rule of Rule 19 which solely contains requirements with respect to listing. The requirements for delisting under the SCRR are, meanwhile, found under Rule 21 which contains no provision for relaxation. Any mention of the use of a relaxation under Rule 19(7) for a delisting is also absent in the SEBI Master Circular on Scheme of Arrangement by Listed Entities and Relaxation under Sub-rule (7) of Rule 19 of the Securities Contract (Regulation) Rules 1957, dated 20 June 2023, which lays down a framework for schemes of arrangement by listed entities and only envisages such relaxation during a scheme involving a listing of securities. Evidently, Rule 19(4) is a tool intended for listings and its use to relax delisting norms remains uncorroborated. SEBI’s exemption order to I-Sec thus presents a curious and controversial application of the rule.
Conclusion
As SEBI contemplates replacing reverse book-building with a fixed-price method as the primary exit mechanism in a delisting, I-Sec’s proposal provides a preemptive glimpse into a world without reverse book-building. It highlights the importance attached by investors to the transparency and participation conferred by the process and raises the question of whether the safeguards in its absence would provide them an adequate sense of security. Further, I-Sec’s peculiar use of the delisting norms and the exemption by SEBI set a precedent that conspicuously deviates from previous applications of the law. Meanwhile, it remains to be seen whether I-Sec’s proposal will pass the pending approval of two-third of its public shareholders as required under the Delisting Regulations – an opportunity its investors presumably await with bated breath.