Selective Allotment And New Rights Issue Framework: A Double-Edged Reform

This article compares the changes made in the rights issue process with the previous framework. Additionally, this article evaluates the risk arising from increased flexibility, focusing on selective allotment and highlighting the risk involved for the retail investor.

Comparison: Old Framework vs. New Framework

To provide quicker access to capital, the new framework mandates that the rights issues be completed within 23 working days from the date of the issuer's board of directors approving the issue. In the former framework, the timeline prescribed for completion was 55-60 days from the date of the board's approval. Selective allotment has been allowed to specific investors in the new framework, whereas earlier the companies were required to follow a rigid structure without any strategic investor participation. Earlier, the subscription period was 15 days, which was insufficient. The new framework provides a flexible subscription period of 7 to 30 days, offering both issuers and investors greater adaptability.

In case of convertible debt instruments, the new framework provides a flexible system for the shareholder approval required under section 62(1)(c) of the Companies Act 2013. Under the previous framework, the rights issue got delayed because there was no fixed timeline to get the approval of the shareholders. The new framework maintains flexibility while complying with the regulations, as it specifies that the 23 working day timeline excludes shareholder approval.

Earlier, rights issue was a method to allot shares to the existing shareholders in proportion to their holdings. In the new framework, flexibility is given to the issuer to allot shares to strategic and anchor investors during the rights issue. While companies had the option to accommodate additional investors through other routes such as preferential allotments or private placements, these involved longer timelines, greater compliance requirements, and additional approvals.

Moreover, there were bid mismatches in the previous framework, leading to delays. An automated bid validation system has been mandated in the new framework. This system is expected to be operational in six months; the system is expected to reduce the mismatches that previously lead to delays. This would reduce errors in the application process and ensure the accurate processing of bids.

Selective Allotment & “Specific Investors”: New Flexibility, New Risks

The major shift is the introduction of the selective rights allotment. Under the amended framework the company can name one or more specific investors when a promoter renounces his entitlements. These investors (who may not be a current shareholder) must apply with payment on Day 1, and the issuer must announce to the exchange whether they applied or not. If undersubscribed, the remaining rights can also be allotted to the pre-identified/selective investors.

Intended to be a means to secure anchor participation but this change is bound to blur the line with preferential issue. As this allows promoters to allow on board specific investors who may not be shareholders in the guise of rights offer. Essentially, if a promoter does not wish to dilute to small shareholders, they can simply renounce in the favour of a selected party. This issuer driven allotment would lead to a loss of the shareholders rights in that particular portion as the old mechanism allocated the unsubscribed shares among all the applicants through pro rata waterfall mechanism.

The main concern in terms of the policy perspective is that the rights issue would lose its egalitarian spirit. In theory, rights issue is supposed to give all holders equal first call on new shares. However, in reality, with the new mechanism in place it would lead to receiving large chunks by anchors/insiders at the same discounted issue price and as a consequence of this the retail investors would find themselves to be frozen out. If rights issue is partially directed towards private equity fund or group company, there would be nothing left for smaller investors. Under the old regime only the existing holders could participate, whereas now the proposed selective allotment could go to selective investors including third parties/outsiders akin to preferential allotment. The intent of SEBI to make rights issue more attractive than preferential allotment would also bear the risk of unfair insider trades.

The major practical ambiguity with the specific investor allotment process is whether the same investor could take renounced entitlements and subscribe to the general unsubscribed pool? If so, they would be required to fill multiple applications, first on day one and again just before the allotment, which the regulations don't permit. SEBI requires the disclosure of all such investors but the same would have a very little effect with the absence of strict caps because the issuer can name multiple allied specific investors to absorb any shortfall, leaving no opportunity for smaller shareholders to over-subscribe.

Retail Participation and Inclusivity at Stake

Rights issues over the years have been advertised as being retail investor friendly because all the shareholder can buy or sell their entitlements. However, the new rules do not include any expanded retail reservation. In fact, the scrapping of the employee quota is a sign that the pre-existing protection to them has been reduced. Simultaneously, the process has been streamlined in a way that allows promoters to pre-arrange subscription, directly favouring the institutional and well-connected investors. This allows the major slices of an issue to be pre-committed to the insiders, placing the retail investor at a disadvantage as they already rely on selling their nil-paid rights if they don't subscribe.

This trend would shrink the effective allocation to retail investors. SEBI has set a wide time window (minimum subscription period of 7 days up to 30 days) for everyone to apply, but in practise the large “specific investors” bidders would grab majority of the shares early. In essence, the rights may resemble a wholesale placement than an inclusive offer.

Regulatory Arbitrage and Potential Misuse

The melding of rights issue with preferential allotment features may invite regulatory arbitrage in the following ways: -

· Sidestepping Takeover Regulation- As per the Regulation 3(3) when a promoter raises their stake above certain threshold the same can trigger open offer obligations. Rights issue consider issuer's existing shareholding as pre-offer capital. Hence, open offer is not triggered because rights issue is infusion of new share to existing stakeholder's holding. It has been observed over the years that promoters exploit rights issues to regain control, generally after losing their shares as rights issue bypasses the limits in the takeover regulations. The introduction of selective allotment would enhance the above as promoter could channel their renounced rights to a friendly institution which would quietly increase the group control.

· Bypassing preferential safeguards- Preferential issue has several safeguards including prior shareholder approval, pricing at a floor and prescribed lock-ins for beneficiaries. The faster and less regulated (no special meeting, just board resolution and 23-day timeline) rights issue would allow the insiders wanting to inject capital through outsiders at net market prices, without observing stricter conditions of a preferential issue, creating an arbitrage.

· Differential Treatment of the issue- smaller companies or those seeking to avoid rigorous review may prefer the new regime. Since draft offer reviews are no longer required and merchant bankers are optional, a company can carry out right issue with minimal external scrutiny. Especially, if the insiders are involved as sellers or buyers of the rights. No official review would increase the hidden related-party deals.

The companies would seek to game the new process and without strict regulatory oversight, the line between rights issue and private placement could blur easily.

Comparison to the International Norms

In the United States, rights issues are on pro-rata basis, every eligible shareholder gets tradable rights, and any unsubscribed shares are covered by a backstop investor (often an affiliate or bank) who agrees in advance to buy the balance. The backstops serve to stabilize the issue and not exclude the public. In United Kingdom and Europe rights issue (often called open offer) offer a 10-15 days open period to all shareholder in their proportional entitlement. Unsubscribed rights are either underwritten or placed to the banks, but there is no mechanism to allocate them only to pre-named parties.

Fairness, Transparency and Inclusivity: Mission vs. Reality

SEBI'S own charter emphasizes the fair, transparent market and equitable treatment of investors. Faster timelines, automated allotment to reduce uncertainty and the requiring monitoring of proceeds on all issues strengthen investor protection by ensuring use of funds. However, the new rules on the crucial point of fairness of allocation do not live up to ethos of the SEBI's charter. Permitting the pre-selection of shareholders, the framework permits the issuers to prioritise some investors over the others. This stands in conflict with the principle of equal opportunity which is embedded in rights issue. SEBI tried to mitigate this by requiring the disclosure of the specific investors in the offer documents and the ads. However, once the book is filled by approved buyers, having the names disclosed would do little help to the retail holders who missed out.

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