INVESTOR ACTIVISM & CLASS ACTION SUITS

DEVENDRA BHANDARIDIRECTOR, STAKEHOLDERS EMPOWERMENT SERVICES

Investor Activism vs Active Investors

Investor Activism

► Definition of Activism: “direct vigorous action” or “use of direct, often confrontational action”

► Activism involves vigorous action (including demonstrations/protests) or involvement to achieve goals

► Often results in disruptions

Active Investors

► An investor who is not passive and participates constructively in corporate affairs

► An investor who knows his role, rights and limitations, the remedies available and how to play the role

Having active investors is more conducive to growth of companies and capital markets than investor activism as it creates a collaborative environment instead of a disruptive one.

Activism may lead to mistrust, reduce collaboration and impede value generation at firms

Active investors collaborate with boards/managements to generate value for the firm

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Active investors and the Legal framework

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Aim: Allow orderly operations and protect investors against fraud, cheating, oppression etc.

Legal FrameworkThe Companies Act 2013 and related RulesThe SEBI Act and regulations framed by SEBIGuidelines of Statutory bodies like ICSI, ICAI, ICWA

Key challenge for regulators Enforcement (detection, reporting and punishment)

Is the idea behind giving an active role to investors just to help regulators in enforcement?

NO

Detection, reporting and punishment of frauds erodes value as the fraud would have already occurred. To prevent value erosion, proactive action to prevent fraud is required.

Role of investors should be to actively participate in company’s affairs to prevent mismanagement / fraud through vigilance and due-diligence

If a fraud has occurred, investors should also help regulators in detection and reporting

Legal framework in India has been created to protect stakeholders and company value. Active investors play an important role in the same.

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Role of Active Investors

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Passive Investor

► Concerned with portfolio performance

► Performance targets achieved through trading

► Limited participation in Corporate Governance

Empowered Active Investor

► Active role in Corporate Governance for improved long-term portfolio performance

► Active engagement with management to align interests

Role of Investors – a changing landscape

Analysis of DVR pricing indicates that investors assign considerable premium to voting rights. However, low voting levels at AGMs indicates that investors do not exercise their voting right, even though they pay a

premium for it. Therefore, while the value of active participation is known, it is wasted by the investor body.

Very few investors in India are aware of their rights, roles and responsibilities and even fewer exercise their rights. To enable investors to be active in corporate affairs, investor education is of

paramount importance

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Investor education – a case study

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To ensure that companies operate within the legal framework, ensure good governance and avoid value erosion, investors need to play their role and participate actively within their limited role

Institutional investors - Educated investors who may or may not be active

Retail investors - May be educated or uneducated and active or passive

Education is required for uneducated investors as well as for educated investors who are passive

Fact: Management, directors and shareholders are separate. Further, promoters of the Company have the same rights as other shareholders of the Company.

Case: SES had released a report on the unfair remuneration practices followed by a Company where the remuneration of promoter director was more than 25 times the remuneration of other executive directors.

Issue: The promoter was exercising undue influence and extracting premium of ownership.

Investor response: The report was published on Economic Times. Educated reader of the publication responded with comments to the effect that “he is the owner of the Company and deserves to get returns”.

Conclusion: Even an educated investor was unable to make the distinction between the return of an investor for ownership (through dividends) and that of a director for executive role (through remuneration).

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Investor Participation

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Factors inhibiting investor participation

► Lack of knowledge and education► Inefficient/ insufficient infrastructure and cumbersome processes► Cost deterrents: time and money► False sense of helplessness: belief that investors cant influence decision making

Solution

• Companies Act 2013 – new corporate governance provisions

• SEBI Governance Code – robust disclosure requirementsImproved Regulatory

Framework

• E-voting, postal ballots• Class Action SuitsImproved infrastructure

• Proxy Advisory Firms like SES• Initiatives by MCA, SEBI, Stock Exchanges, Depositories

etcEducational Services

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Example of active investors making an impact

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Maruti Suzuki

announces deal with

Suzuki (parent

company)

Negative market

reaction. SES releases

recommendations

Institutional investors

collaborate to raise

concerns

Company accepts most recommendations made

by SESJSPL

proposes resolution to

allow promoter to

set remuneration

SES releases advisory

report and asks investors

to oppose move

Most institutional

investors oppose the proposal in the AGM

JSPL forms an independent Remuneration Committee

Jet Airways announces deal with

Etihad

SES releases report

highlighting change in

control and need for

open offer

Regulators take

cognizance of the issues

raised

Deal modified to

reduce control of

Etihad over Jet

eClerx proposes enabling

resolution to issue

securities

SES highlights that

Company recently did a buy-back and

can’t issue shares

SES raises concerns to

the Company

Company withdraws

the proposal

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Key issues active investors must take up

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Lack of woman directors

Excessive control exerted by promoters

Repricing of ESOPs

Preferential allotments to promoters

Excessive remuneration to promoter directors

Lack of independence on boards of PSUs and PSBs

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Class Action Suits

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Class Action Suit (CAS) is a lawsuit that allows a large number of people with a common interest in a matter to sue or be sued as a group. Concept of CAS is quite common in developed countries like USA, UK and Singapore but did not exist in India until recently, when it was incorporated under Section 245 of the Companies Act, 2013 .

What led to incorporation of Class Action Suits in the Companies Act, 2013

In 2009, Mr. Raju, Chairman of the

Satyam, confessed to have falsified and

exaggerated accounts

Auditors of Satyam (PwC)

were also found to be in breach

of their obligations

Satyam and PwC agreed to pay $125M and $25.5M to settle claims filed by ADR

holders by way of CAS in US

Share price nose dived

causing huge losses to

shareholders

No similar action could be initiated in India due to absence of statutory provision for Class Action Suits in the Companies Act, 1956. This led to huge losses to Indian shareholders and underlined the

need for change in the corporate law.

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Who can file a Class Action Suit

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Under the provisions of Section 245 of Companies Act, 2013, Members/Depositors may proceed for CAS if they are of the opinion that the management or affairs of the Company are being conducted in manner that is prejudicial to the interests of the company or its members or depositors

Type of Company Requisite Share holders Requisite Depositors

Company with Share Capital

100 Members or 10% of total number of Members

100 Depositors or 10% of total number of Depositors OR Depositors to whom the company owes 10% of total deposits of the companyCompany without

Share Capital1/5th of total number of Members

Who can sue under Section 245

Rights Provided under Section 245 are additional to Section 241 (Oppression & Mismanagement). Members can proceed under section 241 & 245 separately and distinctly. (However against the principle of res judicata)

Food for thought: As per Section 245, CAS can be filed before Tribunal on behalf of members or depositors. Does it imply that it is for all members? If yes, damages to be awarded to all members or to only those who brought the action?

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Who can be sued under a Class Action Suit - Section 245(1)(g)

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Company

Directors of the Company

Auditors for any false and misleading statement in the Audit Report or for wrongful conduct

Any expert or advisor etc. for misleading statement made to the company or any wrongful conduct

Food for thought: The provision may be construed as being against the principle of common law i.e. there is no privity of contract

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Procedures related to Class Action Suits

Institution of Class Action Suits

» Section 245(4) and 245(5) provide for procedure while instituting a Class Action Suit

» The Tribunal, while considering a CAS, shall take the following into account

» Whether the applicant is acting in good faith

» Whether the cause of the action is one which the member/ depositor could pursue in his own right

» Where cause of action is yet to occur

Admission of Class Action Suits

» Procedure to be followed is laid down in Section 245(5)

» A public notice to be served to all members or depositor

» Similar application in any jurisdiction to be consolidated and lead applicant to be appointed

» No two CAS for the same cause of action shall be allowed

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National Company

Law Tribunal

Appellate Tribunal

Supreme Court

Appeal Appeal

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Relief available through a Class Action Suit

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Restrain the company from committing an act which is ultra vires the MOA/AOA or in breach of AOA/MOA

Declare resolution altering MOA/AOA as void if it was passed by suppression of material facts or obtained by misstatement. Restrain company from acting on such resolutions

Restrain the company from doing any act which is contrary to the provisions of this act or any other law for the time being in force

Restrain the company from doing an act which is contrary to any resolution passed by the members

Claim damages and compensations against company or its directors, auditors, experts, advisors, consultants for any fraudulent, unlawful or wrongful act

Power has also been given to members and depositors to make applications for future actions, by the company

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Benefits and Challenges

AdvantagesNumber of people

with a common

interest in a matter to sue or

be sued as a group

Reduction in number

of law suits, time and cost

Enhanced security

for deposit

holders (in place of civil suit)

NGOs or activists can take

up causes for

affected people

Companies will be

more careful while

appointing directors, experts, advisors, auditors

Directors, auditors &

advisors will select companie

s and carry out

their roles with due diligence

Key Challenges

Delays in legal system

Absence of plaintiff law

firms in India

misuse by unscrupulous

minority shareholders to pursue vested

interest

Available only to members and

depositors. Other

stakeholders excluded

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