The Securities and Exchange Board of India (Sebi) released a discussion paper on proposed modifications to the framework for open-market buyback offers. The modifications appear irrational, bordering on excessive. It appears that the fundamental theme of the proposed amendments relates to "manipulation of share prices through buyback offers launched with wrongful intent".
The only proposal that appears reasonable is the one on increasing the minimum buy quantity to 50 per cent of the offer size. The current Sebi regulations require the company to disclose the minimum number of securities that it proposes to buy back. However, the regulations do not fix a minimum buy quantity. In 2008, the Securities Appellate Tribunal had directed the minimum buy quantity to be one per cent of the offer size. In recent buyback offers, Sebi has, in practice, insisted on a minimum buy quantity of 25 per cent. This appears to be agreeable to most companies. The fact that most companies actually buy back more than 25 per cent of the offer size may be one reason for their acceptance of this directive.
In this context, increasing the minimum buy quantity to 50 per cent seems a fair proposal given the objectives of increasing the actual number of shares bought back and discouraging the use of buyback offers to manipulate share prices. Of course, the company is not forced to buy back any shares if the shares trade at a price higher than the maximum price announced by the company.
On the other hand, the proposal to limit the maximum period of buyback to three months is devoid of logic.
Both the Companies Act and the Companies Bill, 2011 state that the shares should be bought back within 12 months from the date of the shareholder/board resolution. Sebi's proposal to reduce the time period is contrary to the flexibility provided in the Companies Act. If Sebi intends to impose a minimum buy quantity, it is only fair that companies be provided adequate time to comply with it. Reducing the buyback period neither serves the interests of the investing public nor the companies that make such offers.
Then again, Sebi has proposed that 25 per cent of the maximum buyback amount be placed in escrow. Currently, open market buyback offers do not entail an escrow mechanism. Sebi's proposal, intended to ensure that only "serious" companies launch buyback offers, appears arbitrary, given that such offers are executed through a registered stockbroker after complying with the requisite norms on margin money and so on. Given that other capital market transactions of this nature (such as an offer for sale on the stock exchange and block deals that are conducted on the floor of the exchange) do not entail depositing funds into escrow, Sebi should continue to dispense with an escrow requirement for open market buyback offers, too.
Sebi's proposal prohibiting a further issue of shares for two years after a buyback issue closes also seems unreasonable. Both the Companies Act and the Companies Bill, 2011 prescribe a six-month cooling-off period. Given that the legislature has, in its wisdom, reduced the period from two years to six months in 2001, Sebi's current proposal merely on the ground that "companies should have a long-term view on utilisation of funds when launching a buyback" appears excessive. This is especially so after having imposed a minimum buy quantity of 50 per cent to ensure that the offer is not frivolous or manipulative.
Currently, the cooling-off period of one year between two buyback offers is limited to offers made solely following a board resolution. No cooling-off period is prescribed in the Companies Act if the offer is made after a shareholder resolution. Sebi has proposed that a one-year cooling-off period for all buybacks be imposed in case the company has failed to exhaust the maximum offer size in its first buyback. It is interesting to note that the Companies Bill, 2011 also prescribes a one-year cooling-off period between two buybacks (irrespective of whether they are launched following a board or shareholder resolution). Therefore, an increase in the time period in order to align with the Companies Bill, 2011 seems rational - but an increase in the time period as a form of penalty seems extremely unreasonable and onerous.
Further, Sebi is of the view that a buyback of 15 per cent or more of paid-up capital and free reserves must be only by way of a tender offer. Sebi thinks buyback offers through the tender offer process are more favourable to investors since they are generally at a premium to the market price. Open-market buyback offers are normally done closer to the market price (and, naturally, between a willing buyer and seller). Sebi's proposal to limit open-market buyback offers to 15 per cent will only result in future buyback offers being made with an offer size of 14.9 per cent of paid-up capital and free reserves. It will not result in any benefit to shareholders - since it is fairly clear that companies prefer the open-market purchase method over the tender offer process.
Given the scope and ambit of the Sebi (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Markets) Regulations, which adequately cover offences of manipulation of share prices and fraudulent or unfair trade practices, the market regulator should utilise them to address any mischief, rather than make wholesale changes to the existing buyback-related rules. Sebi should also reconsider proposed amendments that are in contradiction to the provisions of the Companies Act.
Agrawal is a partner and Puri is an associate in the corporate transactions team of Amarchand Mangaldas. These views are their own
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