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A Paper Tiger Rule

SEBI's new rule of promoters having to reveal their pledged shares may turn out to have little impact

SEBI has come out with a new set of rules governing shares pledged by promoters. Promoters will now have to reveal the extent of such pledging every quarter. If more than one per cent of shares of the company are involved, then this will have to revealed within seven days.

Since the ruling comes into effect with retrospective effect, all existing cases of pledged shares will have to be revealed this week. Pledged shares have become an issue since it came out that Ramalinga Raju had pledged almost all his Satyam shares. For all practical purposes, he was not the promoter of Satyam, a fact which was not known to other shareholders.

Tight liquidity and an exceptional fall in stock prices, coming on the heels of a period of exceptional business optimism have apparently put many promoters in a difficult situation. They have mortgaged their shares to raise money for various ventures. As share prices have fallen, lenders find the value of the mortgaged asset falling below the value of the outstanding loans. Since money is tight, promoters can't find more cash. Eventually, either the lenders sell the shares in the market or promoters sink deeper into the trap by pledging even more shares. As Mark Twain wrote, "A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain."

In the month since the Raju revelations, pledging of shares has received plenty of negative press. The logic is that a promoter who has staked his shares to raise money for other ventures is not committed to the business. In fact, he may be unwilling to redeem his stake because he knows that his business isn't worth what it's supposed to be.

In either case, it's only fair that other shareholders should know what is happening. However, I do believe that this issue is not as one-sided as it appears to be. A promoters' stake is his personal property and it's perfectly reasonable for him to use it to raise finance for other purposes. I expect that promoters of all kinds have regularly done so. Whether pledging is good or bad depends on the intentions of the promoter but that's something that the stock market may not bother about in its current mood.

Next week, I fully expect traders to approach all promoter revelations with the mentality of a lynch mob. Eventually, the investment community will get used to the idea that shares can be pledged for legitimate motives as well. Promoters too will learn to live in a more transparent world.

Or will they? I say that because based on what I've read so far, SEBI's new rule comes pre-installed with a most convenient loophole. It seems that promoters will not have to reveal pledging of shares in holding companies that may in turn have a stake in listed companies. I don't have ready numbers at this point, but my hunch is that a lot of the stakes in India are held through holding companies. If that is the case, then this new rule is little more than an eyewash.

Promoters who are unlucky enough to have currently pledged personal stake will get skewered. The big names who have convoluted holding structures and very little personal stake will basically be exempt from this rule. As time goes by, every single promoter will create convenient holding structures and this rule will quickly be reduced to a paper tiger.