Regulating unlisted firms

Streamlining existing system will aid corporate governance

The Union Ministry of Corporate Affairs (MCA) is reportedly willing to cede some of its regulatory powers to the Securities and Exchange Board of India (Sebi), specifically those that will allow the market regulator to have some level of oversight of unlisted companies. Such companies, which are not traded on the markets, are not normally subject to Sebi’s direct scrutiny. This is for a good reason — it is to reduce the regulatory burden. Listed companies, which are publicly traded, have higher disclosure, transparency and regulatory requirements in order to protect the interests of all market participants. This logic does not, of course, apply to unlisted companies.

However, in India concern has grown that this fact has allowed some large publicly traded companies to shift much of their business to unlisted subsidiaries in order to avoid scrutiny. This fact makes some regulatory and legal action much harder to conduct. For example, money can be diverted from the listed company to an unlisted subsidiary that is closely controlled by the promoters of the listed company, to the detriment of the minority shareholders in the listed company. This diversion is happening at scale in certain listed companies, where perhaps the majority of the overall business is being conducted at the unlisted level, below the regulatory radar. So minority investors have no clear idea of where the money may be going, how it is being spent, and so on.

There are also valid fears that some corporate groups use vast networks of unlisted subsidiaries as methods to evade or avoid the payment of their rightful share of the tax burden. Of course, outright money laundering, sometimes of the proceeds of criminal enterprises, is also possible, though no doubt that happens on a smaller scale than tax avoidance. There is also a lack of clarity on the definition of “insider trading” once unlisted companies are in the mix. Sebi recently set up a 25-member committee to examine corporate governance in India. The committee highlighted the problem of multiple regulators and multiple legal frameworks. There are implicit contradictions between the treatment of such acts as insider trading in current Sebi regulations and the Companies Act, implementation of which is the responsibility of the MCA.

Thus, there is a clear and persuasive argument for the streamlining of regulations. In spite of its protection of minority investors being extremely strong on paper, the actual fact is that Indian corporate governance with regard to controlling money being siphoned off has been weak. The current campaign against black money has also highlighted the problem of unlisted companies being misused. For that matter, there are too many listed companies themselves that are dormant and should be shut down. Clearly, the system needs to streamlined, and it is welcome news that the MCA intends to work with Sebi to this end. However, it should be kept in mind that the regulatory burden on unlisted companies should not be increased unduly, as that would go against the government’s stated aim of increasing the ease of doing business. International best practices in this respect should be studied carefully before any changes are made to the law. An additional point of concern is for Sebi to beef up its capability to handle the extra workload.