Sucheta Dalal :Retail investors remain in the cold on takeover rules (24 June 2002)
Sucheta Dalal

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Retail investors remain in the cold on takeover rules (24 June 2002)  

As far as the takeover rules go, retail investors continue to remain out in the cold. If it weren’t bad enough that the committee headed by Justice Bhagwati took five long years to submit its report; and that the report itself has raised a storm of protest from investor groups across the country; the delay in amending the takeover rules continues to hurt retail investors every day.

Last week, ING Bank followed some of India’s blue chip companies in leaving retail investors in the lurch. It announced a decision to fork out Rs 340.8 crores to acquire a 24 per cent stake in Vysya Bank by buying out the GMR group’s holding at a whopping Rs 626.92 per share. That is a premium of nearly a 100 per cent over the ruling market price. Media reports quote ING Bank’s spokesperson as claiming that the deal would not attract the open-offer provision under Sebi’s takeover rules. In effect, it would be part of the 84 per cent of takeover deals that were exempted from making an open offer to retail investors. The Bhagwati committee, whose amendments to the takeover code are to be discussed by the Sebi board next week, had a long discussion on ‘inter se’ transfer of shares among promoters. The committee concluded that “ if such transfers are made at a price not exceeding 25 per cent” of the open offer price, it would be entitled to an automatic exemption; otherwise it would be referred to the Takeover panel. Had the amended regulations, as proposed been cleared, the ING Bank deal would at least have been referred to the Takeover Panel. Investor groups however feel that any discrimination between ordinary investors and those in ‘control’ of management is unfair – after all when a company makes losses, equity holders are treated as co-owners and considered on par with those in ‘control’.

The Bhagwati Committee’s report says that the committee “appreciated the concern” that this clause allows shareholders, with a substantial holding to exit at a high price. It also refers to a Sebi study, which showed that 46 per cent of all inter se transfers were at well above market price and only benefited those with substantial shareholding. Yet, the committee felt the need to create a caste system among equity holders by taking “cognisance of business expediency” and permit a premium to exiting shareholders. It now remains to see whether the Sebi board retains this anti-retail investor bias in the name of “business expediency” or chooses to bring the equity back into equity shareholdings. Last week also saw Sterlite Industries’ controversial buy-back offer take an unprecedented turn. Sterlite had routed the offer through a “scheme of arrangement” under Section 391 of the Companies Act and had it cleared by the Bombay High Court.

However, Sebi and the Department of Company Affairs (DCA), have responded to investor complaints and both moved court in order to protect retail investors. Of course, the regulators needed some prodding from Investor Grievances Forum chief Kirit Somaiya. Sterlite’s little scheme only reaffirms the need for capital market related issues to be handled by a specialised regulator – otherwise companies tend to arrange facts to suit their convenience.

The route itself raises many questions. For starters, why should a company go to the court for a simple share buyback, when the capital market regulator has specific rules for the purpose? Secondly, although the “scheme of arrangement” was cleared by shareholders, Sterlite apparently did not hold the meeting correctly. Since Sterlite’s promoters do not plan to participate in the offer (at least that is what was declared during a previous aborted buyback offer), the scheme ought to have been cleared only by those 57 per cent of its investors who are not part of the promoter group. Instead, it was offered to all shareholders.

With LIC a large institutional shareholder having voted against the scheme, Sterlite would probably not have obtained the three-fourth consent that it required from the meeting. These facts would have to be brought to the attention of the court during its next hearing.

The third problem is Sterlite’s modus operandi of hustling investors into accepting its offer of Rs 150 per share (Rs 100 in cash and Rs 50 in the form of Non Convertible Debentures). The company mailed a cheque for Rs 100 per share along with the application form and stipulated that if investors fail to specifically reject the offer within 21 days it would be deemed as accepted. The company wrote to the National Share Depository Ltd (NSDL) asking it to transfer shares out of investors’ depository accounts to Sterlite at the end of 21 days.

Fortunately, NSDL chose to seek a clarification from Sebi and refused to transfer shares out of depository accounts. Another question is, can Sterlite use a scheme of arrangement under Section 391 to circumvent separate sets of rules that govern share buyback and delisting of shares? That is exactly what it seems to do. The IGF also points out that Sec. 77 A of the Companies Act would only allow Sterlite to buyback 25 per cent of its shares in one financial year. Sterlite’s offer for 50 per cent of its shares seems a clear violation. Had it followed the provisions of Sec. 77, it would also be subject to several other rules. The scheme would have to be cleared by a postal ballot and it would only be allowed to pay cash consideration for the shares (its offer of five NCD’s of Rs 10 each along with a cash would be disallowed). This leads to another issue.

Since the scheme was aimed at delisting its shares, Sebi would have less control over its actions after the buyback. Sterlite’s investors would then be stuck with illiquid NCD’s or residual shares of an unlisted company, and would be at its mercy. The silver lining to this distasteful episode is that it has brought Sebi and DCA together to fight for minority shareholders.

For investors, the lesson is that unless they are constantly on guard, companies would always stick them with a deal that is against their interest.

-- Sucheta Dalal