Corporate Securities Info

Control test vs grandfather rule

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Last week, the Supreme Court issued an entry of judgment on its ruling in June 2011 on the issue of foreign ownership in PLDT where it held that the 60-40 (percent) nationality requirement in public utility corporations, in favor of Filipinos, refers to common shares entitled to vote in the election of directors, not to the totality of the company’s capital stock.

With the denial of the motions for reconsideration, that decision, per the entry of judgment, became final and executory as of Oct. 18, 2012.

Unlike previous entries of judgment (which simply state the case number and names of the parties), the instant entry bore the note that the 40 percent foreign ownership cap relates “only to common shares and not to total outstanding capital stock (common and non-voting preferred shares).”

The special mention, in effect, sets aside the tribunal’s statement in its denial of the motions for reconsideration that “…the 60-40 ownership requirement in favor of Filipinos must apply separately to each class of shares, whether common, preferred non-voting, preferred voting or any other class of shares.”

This statement drew strong reaction from the business community. It said the inclusion of stocks, other than common, in determining compliance with the ownership rule would discourage foreign investments.

The clarification in the entry of judgment was a welcome relief to the business community.

Application

With this development, the SEC has gained more flexibility in crafting the rules and regulations that will govern the ownership of corporations engaged in nationalized businesses.

In this effort, it has to find a middle ground between complying with the tribunal’s instructions on the enforcement of the nationality rules and the need to make the country’s investment climate more attractive to foreign investors.

For one, the SEC has to take a close look at its approach in determining the nationality of corporations for purposes of verifying compliance with the ownership benchmark.

At present, it uses two methods in addressing this issue: the control test and grandfather rule.

Under the control test, if, on the basis of the documents submitted, it can be seen that at least 60 percent of a corporation’s capital is owned by Filipinos, the corporation will be considered of Philippine nationality.

Once the 60 percent Filipino ownership is established, no further inquiries will be made on the citizenship of the rest of the stockholders.

The grandfather rule, on the other hand, provides that the nationality of the stockholders is material or critical in determining the nationality of a corporation or its compliance with our laws on permissible foreign investments.

Criteria

Under this rule, the stocks owned by or registered in the name of foreigners are sorted out and added to determine if they meet the allowable maximum percentage of foreign ownership in nationalized businesses, e.g., 30 percent for advertising companies, 25 percent for recruitment agencies and 60 percent for financing companies.

The past rulings of the SEC show that it applies the control test in determining a corporation’s nationality, unless there are questions about the true character of such ownership.

If there are, the corporation is “grandfathered,” meaning, the nationality of the owners of the stocks under question is examined to determine if it meets the nationality requirements.

With the PLDT ruling already in force, the SEC may have to set aside the control test and apply the grandfather rule to corporations engaged in nationalized businesses.

For this purpose, it can require the key officials of the affected companies to submit sworn statements of their compliance with the minimum requirement on ownership of common shares by Filipino citizens.

But the problem is it is difficult to take affidavits at their face value. It is common knowledge that most Filipinos have little regard for written statements even if made under oath and notary publics will notarize any document for the right price.

Examination

If caught lying in a sworn statement (which is a big if), the person concerned can raise any of the following defenses: lack of knowledge of the significance of his statement, that he signed upon a lawyer’s advice, and that he acted in good faith in claiming compliance with the law.

The more worrisome part of the problem is, the record of conviction in our country for perjury or false affirmation in sworn statements is dismal. Hardly anybody goes to prison for that crime.

Unless the SEC wants to take a chance on the credibility of sworn statements, it has no recourse but apply the grandfather rule to all covered corporations.

It’s tough, but it has no choice. Otherwise, it runs the risk of being dressed down by the tribunal for not performing its duty to monitor compliance by corporations with the nationality rules.

If the examination involves only natural persons, the task is easy. The birth certificates or passports of the people will be the best proof of their nationality.

Unfortunately, it’s not going to be a walk in the park for corporations that are stockholders of corporations covered by the nationality rules.

When the corporations under review consist of two or more corporations with different areas of registration which, in turn, consist of corporations as stockholders, will the examination be limited to the first layer of stockholder-corporations or would also cover the second or third layer, if any?

Layering of corporations (or using corporations as stockholders of other corporations in different stages of organization) is a common practice in the business community. Unless used for unlawful purposes, it’s perfectly legal.

The SEC has to make sure that, in applying the grandfather rule in its monitoring activities, the business of business is not unduly hampered.

For comments, send your e-mail to rpalabrica@inquirer.com.ph.

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