Making Inter-corporate Financing Transparent

The Securities and Exchange Commission of Pakistan (SECP) has decided to streamline investments made by listed companies in associated firms, much of which is made without proper disclosures to the shareholders.

“The idea is to bring transparency and fair practices in investments funded from shareholders’ money and formulate guidelines to promote inter-corporate financing,” says Chairman SECP Muhammad Ali.

For this to happen, the draft of the ‘Companies (Investment in Associated Companies or Associated Undertakings) Regulations, 2011,’ is expected to be approved by the end of December 2011.

At present, Section 208 of the SECP Ordinance provides that a company should obtain approval through a special resolution by the firm’s general body for such investments.

The companies have been indulging in inter-corporate financing without observing the relevant legal provisions. SECP has passed around 280 orders against improper financing of company associates with low returns or to establish a non- listed private company at the expense of shareholders.

“Currently, the practice is that companies provide loan or finance their subsidiaries without informing the minority shareholders and making proper disclosures,” an official of the SECP’s Companies Law Division said. Such practices provide undue benefit to private companies whereas the shareholders do not get the desired returns.

“Besides, it is always easy to hide the profits made in the private company in which investments have been made,” the official added.

To ensure disclosures and strictly monitor directors from making investments in their own companies, the draft regulation has tried to cover every possible loophole. Most of the large groups prefer equity investments where returns are not
guranteed. The name, amount of loans, their purpose and the expected benefits to the investing company has to be clearly spelt out in the company reports.

The financial position, including main items of balance sheet and profit and loss account of the associated company on the basis of its audited financial statements for the last year, has to be placed before the shareholders. “Currently, the companies do not disclose the details of investments,” the SECP official said.

The new rules would also require the investing company to disclose the technical details of investments like rate of return, mark-up etc. to be charged, detail of guarantees/assets pledged for obtaining such funds and repayment schedules. The companies will have to obtain permission, and disclose the maximum price and the maximum number of securities to be acquired.

Under the proposed new regime, the name of the associated company or undertaking has to be disclosed, while the board of directors has to inform about purpose, benefits and period of investment in the company reports. Besides the volume of maximum amount of investment has also to be approved by shareholders in a general body meeting.

“In case of investee being a listed company, average of the preceding 12 weekly average and price of the security intended to be acquired,” for the proposed investment, the regulation says. Similarly, companies would be required to disclose the earning per share for last three years of the associated company or associated undertaking.

The board will be required to inform the minority shareholders about the salient features of agreements between the company making investment and the firm where the investment would be made. The draft regulation has also defined the pre-requisites in case of investment in securities of a project of an associated company that has not commenced operation.

Over the years, the mode and means of inter-corporate finance has become complex and needs to be monitored more intensely by the regulator while promoting this type of funding A balance has to be struck between rights of shareholders and the need to facilitate access to finance for weaker firms on soft terms, made easier through inter-corporate financing.

Article originally published in the Daily Dawn. Republished with permission.