.png)
Shareholder activism propelled by stewardship codes has gained traction, though often conflicting with regulations governing "persons acting in concert" (PAC). These concert party rules aim to prevent surreptitious changes in corporate control but can constrain legitimate investor engagement. This paper examines the tensions between activist shareholder initiatives and the regulatory PAC framework. It outlines the evolution of activism in India and introduction of stewardship codes, identifying key friction areas where concert party rules can dampen coordinated investor actions. To address this, the paper draws from Elinor Ostrom's work on governing shared "commons" resources. It explores extrapolating principles like defining clear boundaries, proportionate governance, fostering trust/reputational incentives, and safe harbors to the corporate context. This provides a nuanced framework balancing responsible stewardship against safeguarding regulatory integrity. Leveraging Ostrom's commons governance tenets, the paper proposes an approach enabling constructive activism while ensuring oversight against misuse of concert relationships. It advocates recognizing investor rights and regulatory aims through calibrated application of concert rules. Such a balanced framework can nurture long-term value creation via prudent stewardship over corporate franchises.
I.Introduction
Shareholder activism has become a buzzword in recent times. It aims to provide greater investor engagement, oversight, and responsible stewardship over the companies they have invested in. However, despite their well-intentioned goals, the realization of meaningful shareholder activism often finds itself in conflict with regulatory rules around "persons acting in concert" or PAC.
PAC rules are enshrined in regulations like SEBI’s Takeover Code, and designed for governing circumstances where investors coordinate their shareholding and objectives to acquire control over a company. While well intentioned to protect surreptitious change in control and protect minority shareholders, an overly broad application of these rules can potentially stifle legitimate investor engagement and collective activism efforts.
This paper explores the tension which lies at the heart of the same. First, in Part II, we provide an overview of shareholder activism in India and the subsequent introduction of the stewardship codes. In Part III, we delve into the key areas of conflict which arise here. In Part IV, we lay down the proposed framework and cornerstone principle. In Part V, we offer my conclusion.
II.Shareholder Activism and Stewardship Codes
A.Shareholder Activism in India
Life Insurance Corporation v Escorts was the first case where shareholder activism was recognised by the Supreme Court (“SC”). LIC, a major shareholder in Escorts Ltd., was opposing the company's decision to issue debentures linked with equity, since it would dilute LIC's shareholding. The central issue was whether LIC's rejection of this issuance was justified. SC, while overturning the judgement of the High Court, dismissed the allegations against LIC of mala fide conduct and clarified that rejection of issuance of debentures liked with equity was not barred merely because it would have diluted shareholding of LIC. Subsequently, various instances of shareholder activism in India have propped up. Few infamous ones would be the Tata Sons- Cyrus Mistry[1] case in 2016, Infosys- NR Narayana Murthy[2] case in 2017, L&T- Mindtree Acquisition[3] in 2019, and the more recent Zee- Invesco corporate case.
Shareholder Activism is particularly prevalent in jurisdictions like United Kingdom and Unites States of America. In UK, shareholders have statutory rights that allow them to influence company decisions and, by extension, affect corporate governance and strategy by meeting specific shareholding thresholds. For example, shareholders meeting the 5% shareholding threshold can force a company to put resolutions to a vote at an AGM or specially convened meeting, such as removing or appointing directors. At the 10% threshold, shareholders can prevent a bidder from exercising compulsory acquisition rights after a takeover. At 25%, shareholders can block special resolutions required for certain corporate actions, while at 50%, they can pass ordinary resolutions to remove or appoint directors. . Even in US after the changes made to universal proxy rules, excise tax on share repurchases, and proposed schedules 13D and 13 amendments, have entrenched the scope for shareholder activism. Crucially, a steering factor of shareholder activism are Environmental, Social and Governance (ESG) concerns at the heart of it. This globally rising trend has various strategic components to it, like boardroom diversity, short-term and SPAC activism, M&A related activism, proxy contests. This trend has also created ripples in India, with SEBI and stock market regulators have consistently attempted to stir investors to keep a keen eye in furtherance of corporate governance.
Investors have been seen to grow more aware of their rights and also willing to play a watchdog. The efficacy and long-term sustenance of the same remains to be seen. Prof Umakant, for instance, identifies key reasons for the rather mild adoption of the practice. To start with, there is limited applicability in companies with strong promoters’ stake. Further, there is a proclivity of misuse for the same, wherein some investors might employ it for personal gain rather than benefit of all shareholders. There are also interpretative and statutory legal hurdles for the same. It is unclear about what constitutes illegality when regulations are not followed, for instance, the case of missing MIB approval for Zee director appointments. Moreover, specifically after the SC ruling in Zee-Invesco case, it became evident that activist efforts can be blocked. Nonetheless, as Ajaz Ul Islam highlights, activist investors in India can improve a company’s overall governance practices; in fact, they seem to be particularly effective in reducing sales made to entities with close ties to the company. The chief problem however – which this paper focuses on, as clarified earlier, has been identified as Prof. Umakanth and Prof. Puchinak as the conflict with the in-concert rules. We tarry delving into this right away, and instead lay down the history concerning stewardship rules in India.
B.Stewardship Codes
Oxford Learner’s Dictionary defines stewardship as, “the act of taking care of or managing something.” Cambridge Dictionary says that, “someone’s stewardship pf something is the way in which that person control or organizes it.” These definitions give us some elementary understanding of stewardship. Simply, there is some care, organisation or ordering done by the owner. Crucially, the standard definition does not indicate that these are done out of duty or obligation; be it moral or legal. Instead, these are perhaps done out of one’s own will.
Loosely speaking, shareholder’s stewardship would thus conceptually include oversight over the investment, and some degree of ordering when things go astray. However, this was not the trend, at least in India. For the longest period of time, as Prof Umakant explains, investors showed little enthusiasm for company affairs and remained largely passive. However, in the last decade, this has changed due to regulatory interventions and market pressures. Regulatory measures such as SEBI's 2010 guidelines, which require mutual funds to actively engage in corporate governance, and the Companies Act, 2013, which facilitates e-voting and virtual attendance at meetings, have empowered investors. Additionally, the emergence of proxy advisory firms in India has further empowered investors by providing recommendations on corporate proposals, influencing decision-making processes. Market pressures have also contributed to this shift, as investors increasingly recognize the importance of engaging with companies to protect their interests and maximize returns. The rise of institutional investors, both domestic and foreign, has led to a more dispersed shareholding pattern, reducing the dominance of controlling shareholders and enabling greater influence by institutional shareholders. These factors, combined with global trends towards active engagement, have transformed investors from passive observers to active participants in corporate governance.[4]
The pillars of stewardship activity are the three codes notified between 2017 to 2019. The forerunner, IRDAI offered its stewardship guidelines in 2017 which was revised in 2020. This was immediately followed by PFRDA’s stewardship codes in 2018. In December, 2019, SEBI issued its own stewardship code directed at mutual funds and AIFs. In essence all of them have been inspired from the UK Stewardship Code of 2010, and have strikingly identical principles. However, at the same time, there is a varying degree of compulsion with respect to following and enforcement of these codes. A chart below illustrates a comparison between the two models.
Principle | IRDAI (Insurers) | PFRDA (Pension Funds) | SEBI (Mutual Funds & AIFs) |
Policy & Framework | Have a board-approved stewardship policy outlining responsible investment practices. | Detailed guidelines on voting in investee companies. | Have a stewardship policy outlining engagement strategy with investee companies. |
Engagement | Engage with investee companies on issues like environmental, social, and governance (ESG). | Flexibility to engage with investee companies but with a focus on maximizing shareholder value and pension scheme holder interests. | Engage with investee companies to promote good governance practices and long-term value creation. |
Voting | Mandatory participation and voting on certain resolutions/proposals based on insurer's AUM and shareholding. | Flexibility to decide on voting on a case-by-case basis. | Mandatory participation and voting on certain resolutions/proposals based on the nature of the proposal. |
Reporting | Submit an annual compliance certificate to IRDAI. | No specific reporting requirement mentioned. | Disclose voting records and rationale behind voting decisions. |
It should be noted, as Prof Umakant elucidates that this “trifurcated approach” is undesirable and must be considered and a transitory mechanism at best. His claim is incisive and illuminating. Firstly, it is not clear or justified why was the need of separate mechanisms felt for this, all the more because it has been regulated in the UK model in a single entity. Secondly, the fragmentation of the same creates more confusion, difficulty in implementation and increases noise in the market with the cost of communication shooting up. Nonetheless, even if such problems were to be resolved something more fundamental prevents stewardship codes from fully realising their potential – the in-concert rules. In the next section we delve into these considerations.
III.Conflicts
C. A. Persons Acting Inconcert Rules
The concept of Persons acting in Concert (“PAC”) is cornerstone principle under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 ("Takeover Code"). It is aimed at collectively regulating investors that have a common objective of acquiring shares or control of a target company, regardless of their individual shareholdings. Once, an entity is deemed as a PAC, significant implications emerge out of the Takeover Code. To start with, whether the acquiring process is direct or indirect, they are considered “acquirer” with joint obligations. Their aggregate shareholding is considered for thresholds like open offer triggers. And the indirect or direct holding is combined in a composite when evaluating “control”. Furthermore, cooling off periods and pricing rules apply collectively after an open offer and public disclosures are mandated to identify all PACs involved.
Rule 2(q) of the Takeover Code gives a two-part definition of PAC – General Definition and Deemed Categories. General Definition covers persons with a common objective of acquiring shares or control, pursuant to an agreement (formal or informal). The tests designed for the general category include: a) requiring evidence of a shared substantial objective to acquire shares; b) separately, a close business association alone is insufficient; c) only circumstantial evidence of agreement can be relied upon when direct proof is absent. Deemed Categories exist when certain relationships trigger a rebuttable presumption of acting in concert. The present rebuttal is hinged on, a) requirement of an underlying intention to actually acquire the target’s shares; b) unless evidence exists to corroborate to the same.
B. The Site of Conflict
Prof. Umakant et al. explain that conceptually there are two key sites where conflict between in concert rules and shareholder activism arises – a. disclosure requirement; b. mandatory offers. Effectively regulators are unable to identify a balance between activism and backdoor changes in control. Additionally, they point out how the PRI guidance elevates a certain binary of what constitutes activism and not. It focuses on soft measures and disassociates with board changes or other aggressive demands. Further, as they illuminate without the threat of board change, or board change being used as a bargaining chip there is little reason why board would at all pay heed to demands of activist shareholders. This renders shareholder activism depleted, devoid of substance and merely facial. While these observations were made with respect to the general global regulatory landscapes, it is not untrue for India. In fact, as highlighted earlier, the pulse is more prominent in India. The chief reasons already highlighted in the section II of this paper are, historic conservative approach to activism, and judicial decisions which impose heavy costs. All of this aggravate the pre-existing difficulty of shareholder activism which exists.
IV.Balancing the Scales: Ostrom’s Governing the Commons
The imperative to foster a system which can balance activism by shareholders and at the anti-abuse of the company is well understood and accepted. This part of the paper takes a shot at it by trying to regulate it based on Elinor Ostrom’s works on governing the commons. In part A, we explain critical aspects of the theory. And next, in Part B, we elucidate how regulation based on these principles can be created.
D.A. Trust, Reciprocity and Reputation
A common refers to a shared asset or resource that is jointly owned and managed by a number of people. These individuals have access to its benefits and are responsible for maintaining and protecting it. To ensure that these markets remain optimal, several principles for regulating commons have been established. Key principles are, having clear group boundaries, ensuring that all stakeholders are identified and included in the process of rulemaking. It is also crucial to recognize the rights of the community within the broader regulatory framework, which should be established and enforced by external authorities. Additionally, a system of proportional penalties for violators should be developed, and mechanisms for low-cost dispute resolution should be put in place.
In her work on managing commons, Elinor emphasizes the importance of "second-order rationality," which involves considering not just individual interests, but also the interests of the group as a whole. To achieve this, she suggests relying on three key principles: trust, reciprocity, and reputation.
Trust is especially valuable in situations like the prisoner's dilemma, where there is incomplete information and players must make decisions without knowing the intentions of others. By placing trust in one another, firms competing under a self-regulatory framework can avoid a "defect-defect" outcome and reach a Nash equilibrium. Reciprocity is also important, as research has shown that in iterated prisoner's dilemma scenarios, the "Tit for Tat" strategy proposed by the likes of Anatol Rapoport is optimal. This involves not defecting first and then reciprocating the other player's move from the previous round. By following this strategy, players can build a cooperative relationship over time. Finally, reputation plays a key role in maintaining compliance with norms and ensuring that those who violate the rules are excluded from using the common resource.
These three principles, derived from behavioural analysis of markets, provide the normative backbone for designing and gauging legal framework.
E.B. Identifying Key-Principles
Drawing from Elinor Ostrom's seminal work on governing shared resources or "commons", principles can be extrapolated to help reform the regulatory framework around "persons acting in concert" (PAC) under Indian securities laws. This could allow balancing shareholder activism against potential abuses, akin to collective action problems that arise in managing common pool resources.
1.Defining Boundaries
To start with, defining clear boundaries is necessary. What constitutes a “group” acting in concert must be defined with well-defined boundaries. Further, all relevant stakeholders in stakeholder activism in the process of updating the PAC rules. Analogously, it is crucial to recognise rights within a regulatory framework, it should set out the nature of abuse which are prevented and enshrine the legitimate rights of shareholders to coordinate efforts in these circumstances. As Ostrom highlighted, successful governance of a commons involves ensuring the rights of the community are enshrined and protected by formal external authorities. Securities regulators through proper rulemaking can still provide the overarching enforcement framework.
2.Proportionate governance
Firstly, passive and active forms of activism can be differentiated. For example, passive might include voting against proposals, while active could involve board challenges. This can enable and form the bedrock of tiered system of regulation based on the level of activism and potential impact on control. Secondly, Penalties instituted should be scales to the extent and egregiousness of the violation. Aligning with Ostrom’s guidance on proportional sanctions this allows for measured deterrence. Furthermore, providing healthy and accessible dispute resolution mechanisms for disagreement between shareholders and companies.
3.Fostering Trust and Reputation
Ostrom's core principles of trust, reciprocity and reputational incentives provide behavioral guidelines. For the PAC rule, this could involve requirements and safe harbors that foster transparency and information sharing between companies and cooperating investors. Reputation-based incentives can be created by mandating public disclosure around any substantiated PAC violations. This allows market forces to discipline mis-conduct, beyond just regulatory sanctions. Further, a system should for circumstances where companies with a history of good governance and responsible engagement with activists benefit from a lighter regulatory touch.
4. Safe Harbours for Approval of Coordinated Actions
Building on the theme of reciprocity, the revised regulations could establish formal "safe harbor" approval procedures. Subject to full disclosures, certain forms of investor cooperation and coordinated engagement with companies could be prospectively sanctioned by regulators as permissible. This would legitimize identified forms of value-additive shareholder activism and collective action, while preventing unintended over-regulation of such activities.
V.Conclusion
In conclusion, this paper has highlighted the inherent tensions that exist between promoting shareholder activism and stewardship on one side, and regulating against potential abuses of concert party relationships on the other. By drawing from Elinor Ostrom's work on governing the commons, we have attempted to humbly propose a solution. we advocate for a framework which clearly defined boundaries, instituting proportionate governance mechanisms, leveraging trust and reputational incentives, and establishing safe harbors for approval of coordinated actions. Such an approach allows recognizing the legitimate rights of investors to actively engage, while providing regulators with the oversight required to maintain market integrity. Ultimately, this nuanced architecture can unlock an ecosystem where responsible shareholder stewardship and long-term value creation for all stakeholders is facilitated without compromising on regulatory safeguards.
[1] Cyrus Investments Pvt Ltd & Anr. v. Tata Sons Ltd. & Ors
[2] Vishal Sikka vs NR Narayana Murthy
[3] Larsen & Toubro Limited v. Mindtree Limited
[4] Id.
コメント