Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Siemens related party transaction

Two days after the Satyam fraud was announced, Siemens Limited, a
55% subsidiary of Siemens AG of Germany informed
the stock exchanges that “the Board of Directors of the Company
at its meeting held on January 09, 2009, has approved the divestment
of its 100% stake comprising of 6,815,000 Equity Shares of Rs 10 each
in its subsidiary Siemens Information Systems Ltd, Mumbai, to Siemens
Corporate Finance Pvt. Ltd., a 100% subsidiary of Siemens AG, subject
to receipt of all requisite consents, approvals.” In its press
release
, the company stated “This is pursuant to the change in
structure of the global software business, where SISL businesses have
also been aligned with the parent group. In the new model, SISL will
serve as an internal software factory supporting the R&D and product
development initiatives for business sectors globally. It will also
focus on increasing its presence in the domestic market and continue
to act as an offshore development centre for Siemens
worldwide.”

The response of the stock market has been brutal: the stock fell
almost 30% from Rs 298.00 to Rs 211.80 while the Nifty index fell by
only 6% from 2920.40 to 2744.95. The press release does not mention
anything about valuation or consideration, but clearly the market sees
this as a valuable business being transferred to the dominant
shareholder at a discount to its fair value. Investors are powerless
here because unlike in the Satyam-Maytas case, here the parent company
has a majority shareholding.

India should probably look at the UK model for dealing with such
situations. Rule 6.1.4(3) of the UK listing rules, requires that a
company that seeks listing of its equity shares in the UK should
demonstrate that “it will be carrying on an independent business
as its main activity.” In practice, rather than refusing to list
an issuer that fails to satisfy this requirement, the UK regulator
looks to see how a lack of independence will be managed. This means
satisfying itself that an issuer that has a controlling shareholder is
capable of carrying on its business independently of that
shareholder.

For example, when the promoters of the Sterlite group in India
listed their business in the UK as Vedanta Resources plc, the
restrictions that they agreed to as a condition for listing included
the following (Vedanta Resources plc, listing
particulars
, page 68-70):

  • The Board and the Nominations Committee and most other committees
    to which significant powers are delegated shall at all times comprise
    a majority of directors who are independent of the promoters
  • Neither the promoter-director nor any non-independent directors
    shall be permitted to vote on any resolutions of the Board to approve
    any arrangement or transaction with the promoters
  • The promoters may not exercise voting rights in the company in
    respect of any transactions or arrangements between the company and
    the promoters.
  • The promoters shall not invest in certain specified businesses
    directly or indirectly except through the company.
  • Transactions and relationships between the company and the
    promoters shall be conducted at arm’s length and on a normal
    commercial basis

Restrictions of this kind might have helped prevent the Siemens
transaction provided they were coupled with a requirement that a
related party transaction should be put to shareholder vote if say 10%
of the shareholders so demand. The institutional investors with 25%
shareholding would then have been able to demand a shareholder vote
and then vote it down with Siemens AG unable to vote its shares.

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