Shedding light on the LinkedIn Order – SBO Analysis

• The Companies Act, 2013 necessitates SBO disclosure to prevent misuse through illicit activities, aligning with FATF Recommendations.

• RoC penalized LinkedIn India for SBO non-disclosure, extending to CEOs of Microsoft Corporation and LinkedIn USA

• Contrary to SBO Rules, RoC’s reliance on subjective tests extends beyond defined parameters, potentially setting erroneous precedents.

Introduction

The Companies Act, 2013 (‘CA 2013’) mandates companies to disclose and maintain a register of their Significant Beneficial Owners (‘SBOs’)¹. The concept of SBOs is derived from the 2012 Recommendations of the Financial Action Task Force (‘FATF Recommendations’) which prescribed every member country to ensure that there is up-to-date information on beneficial ownership and control of legal persons so as to assess the risks of misuse of legal persons for money laundering or terrorist financing.² In this way, the disclosures pertaining to a SBO help to uncover the individuals who ultimately own or control a company. It is important to know this information to prevent the misuse of corporate structures for illicit purposes such as tax evasion, money laundering, and other fraudulent activities.

SBO identification becomes important because legal ownership of shares in a company does not always equate to beneficial ownership of such shares. Legal title or controlling shareholding may be in the name of an individual or entity who is not the actual beneficial owner, exercising control in the entity, directly or indirectly. The FATF explains that control can also be exercised by informal means (such as through close personal connections or relatives).³

Subsequently, in 2016, the Company Law Committee recommended that companies may be mandated to obtain information on beneficial ownership and maintain a register of beneficial owners⁴. In 2017, the Companies (Amendment) Act was passed to give effect to these recommendations⁵. The underlying rationale behind disclosing SBOs is to gauge the identity of individuals who exercise control over legal persons, but who may not be easy to track due to their names not being mentioned in the companies’ register of members.

Furthermore, identifying SBOs helps ensure transparency and good governance and by requiring the reporting of individuals who hold significant control, either directly or indirectly, the CA 2013 aims to pierce the corporate veil to reveal the actual beneficiaries of corporate actions and profits. This is important for maintaining the financial integrity of the company by having a clear picture of the ownership and control structure of the said company.

In this hotline, we discuss the recent order of the Registrar of Companies (‘RoC’) penalizing LinkedIn India for failing to identify its SBOs and not making the necessary disclosures as required by the CA 2013 (‘LinkedIn Order’)⁶. We examine the legal framework governing SBOs to shed light on the RoC’s approach in the aforesaid order.

Legal Framework

In India, SBOs are governed by Section 90 of CA 2013, read with the Companies (Significant Beneficial Owners) Rules, 2018 as amended from time to time (‘SBO Rules’)⁷. An SBO is every individual who, acting alone or together, holds beneficial interests of not less than twenty-five percent or such other percentage as may be prescribed (however, the SBO Rules prescribe ten percent)⁸in shares of a company, or voting rights in such shares or rights to participate in the dividends arising from such shares, or holds the right to exercise, or actually exercises significant influence or control over the company⁹.

It is pertinent to note that a right or entitlement for the purposes of SBO analysis may also be held indirectly, for instance, where the member of the reporting company is a body corporate and the individual holds a majority stake in the body corporate (or its ultimate holding company)¹⁰. Further, a twin-test is laid out under the law, taking into account both objective and subjective analysis of SBO. Under the objective test, the RoC looks at the shareholding of the individual in question and whether he/she indirectly (or together with direct holdings) holds not less than ten percent of the shares.¹¹ Under the subjective test, the RoC looks at whether the individual in question has the right to exercise, or actually exercises significant influence or control in any manner, other than through direct holdings.¹²

Primary Responsibility: Under the CA 2013 read with the SBO rules, the primary responsibility lies on the individual who holds or acquires significant beneficial interest to make the declaration to the company.¹³ The CA 2013 also prescribes that the company must maintain a register of such individuals who have made declarations in this regard with the company.¹⁴ Further, every company maintaining such a register is also required to file details of SBOs with the registrar.¹⁵

Secondary Responsibility: The CA 2013 also imposes a secondary responsibility on the company to take necessary steps to identify an SBO and require him/her to comply with the above requirements.¹⁶ A company shall give notice to any such individual whom the company knows or has reason to believe is an SBO, has or is likely to have knowledge of an SBO or has been an SBO in the preceding three years.¹⁷ Such an individual must reply to the notice within 30 days, and if they fail to do so or provide unsatisfactory information, the company is required to approach the NCLT with a request to restrict the right of transfer of the SBO’s shares or even suspend all rights attached to such shares.¹⁸

Recently, the Ministry of Corporate Affairs, Government of India (‘MCA’) also notified the Limited Liability Partnership (Significant Beneficial Ownership) Rules, 2023 (‘LLP Rules’)¹⁹ which provide for similar obligations to disclose SBOs in relation to LLPs.

RoC's Observations

In a radical move, the RoC recently penalized LinkedIn Technology Information Private Limited (‘LinkedIn India’) and its directors for failing to disclose their SBOs as required under the CA 2013 read with the SBO Rules. The RoC also went a step further and imposed penalties on the CEO of Microsoft Corporation (ultimate holding company of LinkedIn India) (‘Microsoft’), Mr. Satya Nadella and CEO of LinkedIn Corporation USA (‘LinkedIn USA’), Mr. Ryan Rolansky.

The order is of substantial importance to companies operating in India whose ultimate holding companies are based abroad. Here, the RoC based its findings primarily on sub-clause (iv) of clause (h) of Rule 2(1) of the SBO Rules, which provides that an SBO includes an individual who has the right to exercise, or actually exercises, significant influence or control, in any manner other than through direct holdings alone.

The RoC relied on 3 main factors to identify SBOs; the nature of the relationship between LinkedIn India and holding companies (‘holding-subsidiary test’)²⁰, the nature of the reporting channels (‘reporting channel test’)²¹ and the nature of financial control (‘financial control test’)²² exercised over LinkedIn India.

LinkedIn India had disclosed LinkedIn USA as its holding company in its financial statements, despite LinkedIn USA not having any upstream shareholding in the shareholding pattern of LinkedIn India. LinkedIn USA and LinkedIn India are both subsidiaries of the Microsoft Corporation. Upon noting this, the RoC concluded that the only way LinkedIn USA could be regarded as the holding company of LinkedIn India, without any direct or indirect shareholding, is if it exercised control over the Board of Directors (‘BoD’) of LinkedIn India.

Accordingly, under this holding-subsidiary test, it concluded that Mr. Ryan Rolansky, being the CEO of LinkedIn USA, holds the right to exercise this control over the BoD of LinkedIn India and is therefore liable to be disclosed as an SBO. It further relied on annual filings of Microsoft with the US SEC to find that Mr. Ryan Rolansky is a part of the senior leadership of Microsoft and ultimately reports to Mr. Satya Nadella, CEO of Microsoft Corporation. On this basis, the RoC concluded that Mr. Satya Nadella is also liable to be disclosed as an SBO of LinkedIn India.

Second, under the reporting-channel test, the RoC examined the executive structure of LinkedIn India and that of its holding and group companies. It found that the BoD of LinkedIn India were appointed from a pool of Microsoft employees worldwide. It concluded that the individuals appointed were Microsoft’s ‘nominees’ on the board of LinkedIn India, despite LinkedIn India vehemently contesting the same.

Thereafter, the RoC examined the Bye-Laws of Microsoft and found that Mr. Satya Nadella, as CEO and Chairman, had general charge and was responsible for the supervision of the business. Accordingly, the RoC found that majority of directors of LinkedIn India are employees of the Microsoft or LinkedIn Group who ultimately reported to Mr. Ryan Rolansky and Mr. Satya Nadella.

Lastly, under the financial control test, the RoC noted that related party transactions were being carried out by the LinkedIn India on behalf of some other group entities and vice versa. Further, the board resolutions of LinkedIn India provided that “this resolution does not supersede any prior resolution adopted by the BoD of the Microsoft Corporation related to the authorities of the Chief Financial Officer or Treasurer of Microsoft Corporation to bind Microsoft Corporation which shall remain in full force and effect.” Accordingly, the RoC concluded that the ultimate control over the financial transactions of LinkedIn India vested with the employees of the Microsoft Corporation, who are subject to the supervision of its CEO, Mr. Satya Nadella.

In view of the above facts, the RoC imposed a cumulative penalty of INR 27 Lakhs on LinkedIn India, its directors and Mr. Ryan Rolansky and Mr. Satya Nadella.

Our Analysis

A careful look at the SBO Rules indicates that the CEO is to be disclosed in relation to a member of a reporting company only in case where such member is a pooled investment vehicle (‘PIV’) or an entity controlled by the PIV or where the investment manager of the PIV is a body corporate.²³ However, the RoC’s approach in LinkedIn Order appears to overextend the subjective test (as discussed above) in identifying an SBO through the identification of ‘control or significant influence’ and holds CEOs of LinkedIn USA and Microsoft Corporation as SBOs despite both these entities not being a PIV.

Explanation I to clause (h) of Rule 2(1) of SBO Rules makes it clear that if an individual does not hold any right or entitlement indirectly under sub-clauses (i), (ii) or (iii) of clause (h), Rule 2(1) of SBO Rules, he shall not be considered to be a significant beneficial owner. Since in the instant case, neither Mr. Satya Nadella nor Mr. Ryan Rolansky, acting alone or together hold any rights and entitlements in the form of shareholding equal to or more than ten percent in LinkedIn India along with voting rights and rights to participate in the dividends arising from such shares, the RoC didn't see any merit in qualifying them as SBO under sub-clauses (i), (ii) or (iii) of clause (h), Rule 2(1) of SBO Rules.

Further, for Mr. Nadella and Mr. Rolansky to be held as SBOs, their indirect rights and entitlements in LinkedIn India need to be proved as required under Rule 2 (1) (h) of the SBO Rules. Here too, Explanation III clarifies that an individual shall be considered to hold a right or entitlement indirectly in the reporting company, where the member of the reporting company is a body and the individual -

(a) holds majority stake in that member; or

(b) holds majority stake in the ultimate holding company (whether incorporated or registered in India or abroad) of that member;

However, in the present scenario both Mr. Nadella and Mr. Rolansky do not hold majority stake either in the holding company of LinkedIn India or even in Microsoft Corporation/LinkedIn USA. For this reason, it appears that the RoC decided to take the control/significant influence route under the subjective test within the SBO Rules instead of applying the objective test under which there were no merits to hold LinkedIn India liable for non-compliance.

Therefore, the question of whether reliance can be placed on sub-clause (iv) of clause (h), Rule 2(1) of SBO Rules and the subjective test on that account independently of Explanation I, III or any other legal provisions relating to SBOs, is something that the LinkedIn Order does not clarify. However, it is pertinent to note that the statutory provision relating to SBOs under the CA 2013, section 90 (1) (as explained above under the legal framework section) includes ‘right to exercise or actually exercises control and significant influence.’

Accordingly, we understand that RoC examined the case by taking the control/significant influence route under SBO Rules. However, to hold that Mr. Satya Nadella and Mr. Ryan Rolansky exercised control over LinkedIn India, it had to be established that they independently had the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.²⁴ In terms of ‘significant influence,’ it had to be established that Mr. Nadella and Mr. Rolansky had the power to participate, directly or indirectly, in the financial and operating policy decisions of LinkedIn India.²⁵

From the facts of the instant case, it emanates that none of the aforesaid persons had a majority shareholding in LinkedIn India nor exercised any special rights through separate contractual agreements with LinkedIn India. All appointments and policies of LinkedIn India were decided by the Board of Directors of LinkedIn India who, as directors, were bound to act independently, in good faith and in the best interests of LinkedIn India.²⁶ Since Mr. Nadella and Mr. Rolansky were not shareholders of LinkedIn India, they did not have the power/right to participate in day-to-day operations and financial policies of LinkedIn India. Such right could have also not been exercised indirectly as for any decisions in this regard to be adopted would have to be approved by the Board of Directors of LinkedIn India.

Further, usage of instances of foreign CEOs visiting Indian subsidiaries or excerpts from their speeches (which may not always be taken in the right context) and looking at wide-worded bye-laws of the parent entity instead of approaching the facts within the bounds of a defined matrix under law for the ‘control’ or ‘significant influence’ test, leads to misinterpretations which may be based on one’s perception of how visible and charismatic the CEOs may look like rather than any actual authority or rights that they may have, independently of the holding company/parent company that they are representing.

Since none of the definitions of ‘significant beneficial owner,’ ‘control,’ and ‘significant influence’, as explained in the above paragraphs, have been satisfied, the LinkedIn Order is likely to be challenged before the higher authorities.

It is pertinent to keep in mind that adopting RoC’s interpretation in the instant case, appears to go against the very intent of the SBO provisions, which is to identify who is actually benefiting from or owning the shares in a company beyond the shareholders of the said company²⁷. Therefore, CEOs, who are only deriving salaries/allowances for performing their functions under employment contracts with the parent companies, should not be held to be exercising control/significant influence for the purposes of being classified as significant beneficial owners of the subsidiary companies.

Furthermore, if the instant interpretation of the SBO provisions in the LinkedIn Order were to be accepted, then it would lead to a potential situation allowing RoCs to proceed against all the CEOs of foreign holding companies with a global presence, with scrutiny stretching over many layers of the holding company-subsidiary structure and piercing of the corporate veil of such body corporates, to hold individuals from the holding companies of the reporting company in India, in violation of the compliance requirements.

– Faiza Khanum, Maulin Salvi and Sahil Kanuga

(The authors would like to acknowledge and thank Dev Adwani, Fourth Year, BA.LLB (Hons.), West Bengal National University of Juridical Sciences, Kolkata, for his contribution to this article.)

You can direct your queries or comments to the authors.

¹ Section 90 of CA 2013.

² Recommendation 24 of the FATF Recommendations.

³ Point 45 of the FATF Guide on Beneficial Ownership of Legal Persons (2023) available at www.fatf-gafi.org/content/dam/fatf-gafi/guidance/Guidance-Beneficial-Ownership-Legal-Persons.pdf.coredownload.pdf

⁴ www.mca.gov.in/Ministry/pdf/Report_Companies_Law_Committee_01022016.pdf

⁵ www.mca.gov.in/Ministry/pdf/CAAct2017_05012018.pdf

⁶ www.mca.gov.in/bin/dms/getdocument?mds=san%252BPg76sI9tkgd5lcHzZg%253D%253D&type=open

⁷ www.mca.gov.in/Ministry/pdf/CompaniesOwnersAmendmentRules_08020219.pdf

⁸ Rule 2(1)(h) of the SBO Rules.

⁹ Section 90 (1) of CA 2013.

¹⁰ Ibid., Explanation III(i).

¹¹ Rule 2(1)(h)(i) to Rule 2(1)(h)(iii) of the SBO Rules.

¹² Rule 2(1)(h)(iv) of the SBO Rules.

¹³ Section 90(1) of the CA 2013.

¹⁴ Section 90(2) of the CA 2013.

¹⁵ Section 90(4) of the CA 2013.

¹⁶ Section 90(4A) of the CA 2013.

¹⁷ Section 90(5) of the CA 2013.

¹⁸ Section 90(7) of the CA 2013 r/w Rule 7 of the 2018 Rules.

¹⁹ www.mca.gov.in/bin/dms/getdocument?mds=pJZaasqhxL5W9F46Ukp5lw%253D%253D&type=open. See also our hotline on this - www.nishithdesai.com/NewsDetails/12833

²⁰ Page 39 of LinkedIn Order

²¹ Page 44 of LinkedIn Order

²² Page 50 of LinkedIn Order

²³ Explanation III (v) to Rule 2 (1) (h) of SBO Rules

²⁴ Section 2(27) of CA 2013

²⁵ Rule 2 (1) (i) of SBO Rules

²⁶ Section 166 of CA 2013

²⁷ Page 32 of Companies Law Committee Report 2016, Supra note 4.

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