Five Years On, Sebi Makes Amends (16 September 2002)
Last Thursday, the Securities and Exchange Board of India (Sebi) cleared amendments to one of its most controversial regulations — the Substantial Acquisition of Shares and Takeovers Regulations of 1997. These blatantly pro-corporate sector regulations had showed up so many loopholes that, under a year after the rules were notified, the committee which drafted them was recalled to plug the holes. This only made matters worse. In the previously relaxed regime at Sebi, the committee delayed its report for nearly five years and allowed the most anti-investor acquisitions to slip through the loopholes. And Sebi remained impervious to the barrage of investor complaints that followed every acquisition.
Worse still, it became clear that scores of these acquisitions were guided, advised and managed by committee members. So much so that nearly 84 per cent of all acquisitions managed to avoid the open offer provision aimed at protecting retail investors. The committee finally submitted a revised code in May 2002, but although the revision plugged several procedural loopholes and tightened specific definitions, it caused further outrage among investor groups by what it left out. In fact, Mr G N Bajpai, who had just taken over as Sebi chairman, had to face the brunt of investor outrage. He reacted by asking investors to write to Sebi and promised to give serious thought to their views.
The Sebi board has taken into account investor concerns and in doing so, has been forced to reject some of the most controversial recommendations of the P N Bhagwati committee. But it has finally levelled the field for investors. Among the most important departures from the Bhagwati committee recommendations was the decision to bring preferential allotments under the purview of the code. Sebi has decided that a preferential allotment of 15 per cent or more would attract the open offer and such allotments would be referred to the Takeover Panel on a case-by-case basis.
In the mid-1990s, Indian industrialists and multinational companies had allotted themselves cheap shares and warrants through preferential allotments, and enriched themselves to the tune of Rs 5,000 crore. While litigation filed against such allotments is still pending in various courts, they found a new way to pervert the system by allotting shares to a potential acquirer on a preferential basis, in order to avoid making an open offer to retail investors. Although most investment bankers privately admit that developed markets do not permit preferential allotments, the Bhagwati committee had recommended that they be kept out of the takeover rules.
Although Sebi’s Takeover Panel will now oversee such preferential allotments, it would have been far better to ban them altogether. Sebi has also capped the price of inter se transfers of shares between promoters by stipulating that if the transfer premium is more than 25 per cent above market price, there will be no automatic exemption from making an open offer. This still does not address those rare L&T and ACC type situations, where the Aditya Birla group and Gujarat Ambuja respectively, acquired a strategic stake in the two companies. They are now in the driver’s seat, by acquiring less than 15 per cent of the shares at an exorbitant premium to market price and using dubious arguments to avoid making an offer to retail investors. Ironically, both these deals involve corporate houses that claim the best corporate practices.
Although the amended rules do touch such acquisitions, they have still opened one door for investors. Under the new rules, a change in management has to be ratified through a special resolution, that too by a postal ballot. Investors can now bide their time until the acquirers seek direct control over the two companies. After all, nobody really believes that they have paid such a hefty premium to remain on the sidelines and merely sit in on board meetings. The Sebi board has also dropped another needless recommendation to extend the enhanced 10 per cent creeping acquisition limit until 2004 and has cut it down to 5 per cent instead. This limit was controversially enhanced through an ordinance, ostensibly to prop up the capital market.
The new takeover rules have also added another element to the open offer price. In addition to the 26-week high-low price, Sebi will also consider the price in the two weeks preceding the announcement to determine the offer price. Although this is good for retail investors, it could cause Sebi a lot of embarrassment. Empirical studies have shown that most takeovers are preceded by hectic insider trading and price fluctuations. Sebi will have to beef up its investigation department if it wants to keep its two-week price formula free of controversy.
Another pro-investor decision is to permit investors to withdraw shares tendered in an open offer and opt for a higher offer in case of competitive bidding. This is to avoid a repeat of the situation that developed during the Indian Aluminium (Indal) takeover, where investors who had accepted the Sterlite offer were stuck when its bid fell through. Yet another issue addressed by the new rules is indirect acquisitions. Sebi has clarified that any indirect acquisition of a 15 per cent stake or more would trigger an open offer. This means that if an acquirer gets control of company A and that company has a stake of over 15 per cent in company B, then the acquirer would have to make an open offer to investors of both companies. Finally, the regulations have enhanced Sebi’s power to initiate action and give directions to companies in order to protect investor interest and ensure compliance with its rules.
But there are several important lessons to be learnt from the five-year saga of formulating and revising the takeover rules. The first lesson is that Sebi has to be a lot more careful in deciding the composition of its committees. The second is that it has to fix a time frame for the submission of committee reports (after all, Sebi committees cannot behave like the Joint Parliamentary Committee and go on forever). Thirdly, howsoever high powered the committee, Sebi needs to have some ground rules. After Mr Bajpai has taken over as Sebi chairman, he has insisted that committee members should keep committee deliberations confidential. He needs to go a step further. Investment bankers, accountants, judges and lawyers on Sebi committees should be asked to refrain from being associated with, or opining on, issues that are being deliberated upon by the committee. Although this may sound onerous, it will ensure that committees submit their reports faster and attract less controversy. -- Sucheta Dalal