Tuesday, November 4, 2008

Recent amendment allowing additional 5% creeping acquisition for 55-75% slab – some issues

1) SEBI amended vide notification dated 30th October 2008 the Takeover Regulations Takeover to, in essence, permit an acquirer, with persons acting in concert with him, to increase his holding by 5% by acquiring additional shares or voting rights upto 5% through open market purchases or pursuant to buyback of shares by the target company. This was following a Press Release discussed here and since this Press Release raised concerns on whether increase in buyback can trigger the Takeover Regulations, I submitted an article discussing it here.

2) The notification amends Regulation 11(2) by inserting a 2nd proviso (lets call it the “2nd Proviso” here) and there is also a consequential amendment to Regulation 11(2A). There is another amendment to 11(2). Here are some thoughts and issues.

3) This new creeping acquisition is not available annually and repetitively, unlike the creeping acquisitions upto 55%. Thus, the acquirer will be able to increase his holding by another 5% only. To give an example, the holding of 58% can be increase upto 63% only. It is not as if such a person can go on increasing 5% every year.

a) Having said that, there is no time limit for acquiring this additional 5% and it can be done even in stages. One could say that this facility has been introduced to deal with the low market prices today. However, there is no restriction of time or stock market indices and one can acquire this additional 5% even if the markets have boomed again! Of course, SEBI could drop this facility at that time!!
4) Also, the maximum holding after this additional acquisition can be only upto 75%. Thus, for example, a person holding 73% can acquire only an additional 2% and not 5%.

a) The Regulations recognize the fact that there could be two maximum Promoters’ holding – 75% and 90%. However, there is no special concession in the 2nd Proviso for companies where Promoters could otherwise hold upto 90%.
5) Acquisitions are permitted only through open market purchases in normal segment on the stock exchange or pursuant to buyback of shares by the Company.

a) Such acquisitions cannot be through bulk deals/negotiated deals/preferential allotment.

b) A query was raised by a reader here whether purchases through open offer would also be permitted? I think the better view seems to be acquisitions through open offer route are not covered. Firstly, the requirement is that the acquisition should be through “open market purchase in normal segment of the stock market” (the words “stock market”, incidentally, were missing in the Press Release). These words by themselves should be sufficient to rule out open offers. One could of course then ask what was the need of specifically prohibiting increase through “preferential allotment”. This prohibition seems to mere emphasis and clarification and not intended to change the meaning of the earlier words though often clarifications, even this one, create fresh ambiguities!

c) To deal with yet another query here, what would happen to pending applications for exemptions before SEBI in case of possible increase through proposed buybacks? I think the application may not serve any purpose now. However, note that the exemption is a limited one in quantity and range and otherwise and hence if you are asking for more, then you may need to modify your application. Also, since SEBI has now given a general exemption, it could be that SEBI may not want to allow anything more unless there are special circumstances.
6) Can an acquirer buy a single lot of shares through the open market? This is important from many angles and in fact demonstrates the conflicting objectives of SEBI/small shareholders and the Promoters. SEBI apparently wants that the acquisition should be from retail shareholders or at least the opportunity should be available to all equally and fairly. However, the reality also can be that large quantity of shares may be with shareholders such as FIIs, etc. If the Promoters try to buy from the open market, it is possible that the low liquidity may result in sharp increase in the price even by few purchases. Bulk sellers may agree to sell at an agreed price, though little higher than the market or, in these pathetic times, even lower!!! – considering that there may not be many buyers.

a) To come back to the issue, can the Promoters acquire such large lot of such sellers, albeit through the stock market in normal segment? While strictly speaking such purchase would be an open market purchase in the normal segment of the stock exchange, remember that the amendment specifically prohibits bulk deals though these are meant to be different. SEBI also seems to have a paranoid view of synchronized deals and even holding them indiscriminately to be false, manipulative, etc. Readers’ views are solicited.
7) To deal with a query/comment, this facility of additional 5% increase in holding is not limited to Promoters only but applies to any acquirer and persons acting in concert with him. This issue may of course be academic since there may hardly be cases where a person holds 55% and is not a Promoter.

8) Now, thus, there would be two categories of creeping acquisitions. One creeping acquisition is for the slab 15-55% where an additional 5% is permitted in any manner, whether through open market purchases or otherwise including preferential allotment. The second slab is the newly introduced one. Also, remember that upto 55%, one can acquire additional 5% every financial year.

9) How will the amendment affect a person holding between 50-55% and who, if he acquires 5%, crosses 55%? There are more than one complication here and let me raise some issues. Let me take for this purpose an example of an acquirer holding 53% (I am rounding off figures for simplification).

a) Can he acquire, firstly, 2% under any form of purchases under creeping acquisition under Regulation 11(1) and further purchases under the new 2nd proviso only through the restricted route of open market purchases/buybacks? I seek readers’ views but I think that, on balance, he should be able to acquire 2% under 11(1) to reach 55% and further purchases only under the new 2nd proviso to 11(2). However, I must admit there, strictly and technically, there is scope for holding the other view is also possible particularly if the purchase is through one lot and shoots, for example, straight by one shot to additional 5% as for example in a preferential allotment. Readers - any comments?

b) Will such person, after having acquired 2% (or even 5% under another interpretation and circumstances) under Regulation 11(1) be restricted to a further acquisition only 3% (0%) or can he acquire yet another 5% under the new 2nd proviso? The answer seems to be he can acquire yet another 5%. In fact, this would allow a person to acquire about 10% (using rounded off figures for simplicity) in a single financial year – 5% under 11(1) and another 5% under new proviso to 11(2). Thus, a person holding 50% can increase his holding to 60% in a single financial year.
10) Now let us consider the amendment by the 2nd Proviso permitting creeping acquisition also through buyback of shares. Let us consider what the amendment is first and then consider the earlier controversy surrounding it and what is the change, if any.

a) The amendment permits an acquirer to “acquire..additional shares or voting rights… (provided)…the acquisition is made through open market…. or the increase in the shareholding or voting rights of the acquirer is pursuant to a buy back of shares by the target company” (emphasis supplied).

i) Thus, if a person holds, say, 55%, his holding, post-buyback can increase upto 60% under the 2nd Proviso.

ii) However, this is not simple as it may sound because of peculiar mathematics. Let me explain as follows. The persons have to between 55-75% for such increase. The buyback would affect differently for different holdings. To give an example, if a person holds 55%, a mere 8% buyback would result in increase of his holding by 5% (55/92% is 59.78%, i.e., there would be a 4.78% increase). A person holding 60% would find his holding increased by 5% at 7% buyback and at 70%, at just 6% buyback. This problem would effectively limit the buybacks that a Company could carry out to 8% only, as compared to the maximum legal 25%. Of course, the simple solution is that the Promoters should also sell their shares to the appropriate level to ensure that net increase is only 5%. This may defeat the purpose of really giving retail investors a chance to sell their shares through this amendment. Also, in case of open market buyback, there is the issue of Promoters not being permitted to offer their shares.
b) I had written an article here on the issue as to whether increase in percentage holding arising solely out of buyback of shares would amount to acquisition under the Takeover Regulations and thereby trigger an open offer or be counted as part of creeping acquisitions, etc. My view was that, on balance, even considering the fact that buybacks are initiated by the Promoters, the express law does not result the Takeover Regulations being triggered (whether for open offer, creeping acquisitions, etc.). This may be an anomaly and even an unfair loophole but I had suggested that to remove this, the law had to be specifically amended rather than bringing it indirectly through grant of exemptions.

c) To recollect further, in essence, the argument is that Regulation 10, 11 and others require a specific acquisition of shares or voting rights. If there was no acquisition, these Regulations do not get attracted. A buyback of shares results in an increase in percentage holding without any such acquisition. While the Promoters cannot shrug off the issue saying that the increase is on account of the company’s decision when they are in control of the Company, the fact remains that the express provisions of law do not cover, in my view, increase in percentage purely through buybacks. SEBI, however, apparently required or permitted a practice by companies to seek an exemption for such increase and then worsened it by assuming in the Press Release that this is also the law. The amendment following such press release also maintains this stand and assumption of SEBI that increase in percentage holding through buyback should attract the said Regulations without amending 10, 11 and other Regulations. So where does this new amendment leave the view that percentage increase through buyback should not be counted for 10, 11, etc.?

d) Let us repeat here the exact wording of the 2nd proviso. It permits an acquirer to “acquire..additional shares or voting rights… (provided)…the acquisition is made through open market…. or the increase in the shareholding or voting rights of the acquirer is pursuant to a buy back of shares by the target company” (emphasis provided). Clearly, even this amendment is self-contradictory when it permits an acquirer to acquire additional shares and then clarifies that increase through buyback is also covered. Further, a strict view can be that even if increase through buyback is to be covered, it would be solely for the purposes of this clause only. You cannot, thus, require a person holding 14.99% shares whose holding increases to, say, 15% on account of buyback to make an open offer. Nor, being consistent, can you require a person holding 25% and whose holding increases to 30.1% on account of buyback, to make an open offer.

e) However, while we could debate endlessly, consider the context earlier and now particularly by the amendment. The reality is that Companies/Promoters have already been making applications for exemption for increase on account of buyback. SEBI has also expressly and publicly granting such exemptions on a case to case basis discussing the merits. SEBI has then issued a Press Release indirectly stating its view that it holds increase through buyback as a creeping acquisition. The recent amendment further substantiates this view/assumption of SEBI and all of this is public knowledge. Consider also this in the background of the reality that it is the Promoters who really push the buyback and it is the Promoters who may not participate in the buyback which they pushed and which results in such increase. All of this still cannot change the express law. But, surely, a Judge interpreting this law, which requires a purposive interpretation, would want to inquire the Company/Promoters how he should ignore all these realities and also hold the amendment to be effectively redundant? Perhaps the time has come to accept this “change”, howsoever shabby, and live with it!
11) SEBI has also made what seems to be a consequential amendment to 11(2A). Consistent with Regulation 11(2), Regulation 11(2A) provided that if a person holding between 55-75/90% seeks to acquire, he can do so only by an open offer. Now, the word “only” has been dropped, apparently to suggest that one can acquire upto 5% under the 2nd Proviso but one could also go straight through the open offer route also. This seems to be the intention though the wording could have been better.

12) There is yet another interesting amendment to Regulation 11(2). Regulation 11(2) prohibits acquisition of “additional shares”. These words are amended and now read “additional shares entitling him to exercise voting rights”. I confess I do not understand this amendment and its intent. The Takeover Regulations define shares as shares carrying voting rights including securities that entitle the holder to receive shares with voting rights but excluding preference shares. The amendment now says that the additional shares should be such that should entitle the acquirer to exercise voting rights. Numerous questions arise of which I do not have answer and seek readers’ views:-

a) Does this mean that, for acquisitions under 11(2), only shares presently carrying voting rights are now covered? Does this mean, therefore, that, for example, fully convertible debentures can be acquired? But then, what would happen at the time of their conversion?

b) Why have not these additional words included in the 2nd Proviso which is freshly made? The 2nd Proviso obviously is intended to be an exception to 11(2) and in such case, how can it have broader scope then 11(2) itself? Of course, under the 2nd Proviso one has to acquire “shares or voting rights” through open market on the stock exchange and hence this issue may be academic.

c) Why has 11(1) not also been so amended? Does this mean that creeping acquisition upto 55% may be of any type of “shares” but thereafter, only by acquisitions of additional shares with such voting rights?

13) To conclude, I am immensely grateful that many readers participated, here and otherwise, courteously but forcefully and knowledgeably on the discussion earlier giving some well-reasoned counter views to some issues and also other angles which did not occur to me. I hope this discussion also does the same. My only parting comment is that at times we get confused between (i) what the law should be, why it is unfair and anomalous, etc. and (ii) what the express provisions of law are. While these two categories are not perfectly distinct when one deals with purposively interpreted securities laws, we still need to consider this distinction.

(C) Jayant Thakur, CA.

7 comments:

Jayant Thakur, CA said...

:)

Renu Gupta said...

“Can he acquire, firstly, 2% under any form of purchases under creeping acquisition under Regulation 11(1) and further purchases under the new 2nd proviso only through the restricted route of open market purchases/buybacks? I seek readers’ views but I think that, on balance, he should be able to acquire 2% under 11(1) to reach 55% and further purchases only under the new 2nd proviso to 11(2). However, I must admit there, strictly and technically, there is scope for holding the other view is also possible particularly if the purchase is through one lot and shoots, for example, straight by one shot to additional 5% as for example in a preferential allotment. Readers - any comments?”

A view but less palatable could be that if the purchase as in your example (at 53 % ownership presently), is done in one transaction, it should fall within the ambit of 11 (1) and not the proviso, even though the resulting shareholding exceeds 55%. Reason being that there was no gap/stop where the increase in shareholding could be identified to have increased from 53 to 55 and then lets say 58. The increase is directly from 53 to 58.

Jayant Thakur, CA said...

True, Ms. Renu Gupta, and that is the point I was precisely trying to make highlighting the ambiguity in the wording but at the same emphasising that such a view that one could thereby go beyond 55% may not be in accordance with the Scheme/intent of the provisions.

Thanks.

- Jayant

Anonymous said...

Given these new regulations, I was wondering if a company is permitted to issue warrants to the promoters, who already have a stake of 54% in the company. Furthermore, would they be allowed to convert these warrants as such conversion would imply an increase in their stake to nearly 60%. Would this trigger off the takeover code and if not what are the regulations governing this?

Anonymous said...

Given these new regulations, I was wondering if a company is permitted to issue warrants to the promoters, who already have a stake of 54% in the company. Furthermore, would they be allowed to convert these warrants as such conversion would imply an increase in their stake to nearly 60%. Would this trigger off the takeover code and if not what are the regulations governing this?

Annie Philip said...

Are there are SEBI clarifications on the issues raised in paragraph 9 of your post?

Jayant Thakur, CA said...

Annie, SEBI has not issued any clarifications directly dealing with issues raised in paragraph 9. However, the clarifications of last week (see my post of last week) can be reviewed and the issues seen in their light. The specific issues raised remain though.

- Jayant Thakur