Listed companies find ways around profit-share disclosure

Include incentives in investment pacts with private-equity firms, and give stock options to the management

The Securities and Exchange Board of India's (Sebi)’s attempt to bring more transparency on profit-sharing deals between managements and private equity (PE) funds has not yielded results.

The regulator brought a rule last November, asking all listed companies to disclose such agreements for shareholder approval. Since then, not a single company has disclosed any.

Typically, these are side agreements between a PE fund and the management, linked to stock performance. For instance, a PE entity rewards the management if the stock of a company it has invested in exceeds the return expectation. Such profit sharing agreements are common in many countries.

Taking a view that such agreements give special treatment to top management and also create risk of misuse, Sebi asked all listed companies to seek shareholders' nod before enforcing such deals. Existing agreements, if any, were to be also made public for shareholder approval.

A senior Sebi official said: "We are surprised that no company has come forward with such disclosure." They would, he said, step up vigil on such deals.

Legal experts say management and PEs could have found a way around. Instead of a separate agreement with a promoter or a chief executive officer (CEO), these funds are now including such incentives in the investment agreements, which a company is not obliged to disclose in the public domain, they say. These agreements are usually made when a PE entity decides to invest in a company and could be updated from time to time.

“This has become an easy way to circumvent the Sebi regulation. Many companies feel such agreements are essential to keep the top managers motivated and don’t want to cancel these. Hence, they have taken refuge in Section 30 of the Listing Obligations and Disclosure Requirement (LODR) regulations,” said a source. Giving in to employees' demand, the Securities and Exchange Board of India (Sebi) tweaked the appointment rules for executive director (EDs). According to sources, the market regulator has decided to increase the number of ED posts to nine from eight. Six of them would be for staffers and the rest would be lateral or on deputation basis.

To carry out the decision, Sebi will appoint one external candidate and promote two internal employees to the posts of ED, said a source. Sebi staffers were lobbying for more internal promotions and had even moved Bombay High Court over this. However, the court had dismissed the petition, observing that Sebi has the power to make external appointment.

On April 11, Sebi Employees' Association (SEA) sought review of a rule that said the regulator has to recruit half of the EDs from outside Sebi.

An SEA letter sent to Sebi chairman, and seen by this newspaper, said, "The current regulation is akin to placing an artificial barrier on the natural progression of the internal talent pool to the post of EDs. The practice of bringing outsider as ED serves no purpose and is rather causing grave damage by devaluing internal expertise gained over years of hard work and experience. This creates a sense of frustration and resentment among employees."

The six EDs at present are: S V Murali Dhar Rao, market regulation, surveillance, and policy analysis; J Ranganayakulu, legal affairs; S Ravindran, investigation and

Section 30 specifies what developments a listed company should disclose to public shareholders. It entrusts the board of a company to decide a “material development” that needs to be conveyed to public shareholders and what could be kept away from disclosure.

Usually, all investment agreements are kept out of the definition of 'material development', citing confidentiality. However, according to the Companies Act, if a shareholder or an investigative agency demands the relevant documents, a company is obliged to provide these.

That apart, the total salary drawn by the top management of a company is intermediaries supervision; P K Nagpal, corporate finance; Anantha Baruah, investment management; and S K Mohanty, commodities.

Sources said there are two to three candidates within Sebi who are eligible for the post of ED. They include R S Srivastav, chief general manager and Amarjeet Singh, an executive assistant to the chairman. Both are seen as front runners for the posts of ED.

SEA wants appointment rules for ED disclosed in the annual report. However, any gains made through the agreements would be shown under incentives. In current law, only the salary of key managerial personnel (KMP) in a position of a wholetime director needs approval from the board. Any deals with people such as a chief executive officer or chief financial officer and the promoters who are not on the board don’t need shareholder approval. So, such agreements would not come to light unless a shareholder gets suspicious and asks for the documents or Sebi seeks these, on a tip.

Sources also say some companies could be substituting such side-way agreements with employee stock to be in line with the Reserve Bank of India policy, which directs RBI to choose all EDs from within the central bank. Also, a problem with lateral hiring is that the chairman fills posts with candidates of his choice, a source said, adding various instances in the past when chairmen have brought in their people.

Recently, the ED issue heated up when Sebi came up with vacancies for two ED posts in January. Then-chairman had put the appointments on hold. options plans (ESOPs), which are legitimate tools for incentivising the top management. Boards of more than a dozen companies are learnt to have revised their ESOP policy to accommodate such sops. In these cases, all the previous side agreements have either lapsed or been cancelled.

"Providing special performance incentives to the top managers of a company is common. It is also perfectly legitimate that a fund or investor allows reward to the management of a company for better performance. In fact, such incentives can be part of the employment agreements of the employee," said Lalit Kumar, partner, J Sagar Associates.