Tuesday, June 21, 2011

SEBI Reasserts Views on Put and Call Options

In view of the provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA) and notifications issued thereunder, the validity of put and call options on securities of public limited companies entered into outside the stock exchange has been in doubt. In the last year, however, SEBI has been making its stand clearer: such options are invalid. On two previous occasions involving the MCX Exchange and Vedanta/Cairn Energy deal, SEBI outlawed clauses in agreements dealing with forward contracts such as buyback agreements and put and call options. Last moth, SEBI buttressed its position in an informal guidance sought by Vulcan Engineers Limited.
In Vulcan Engineers, the company approached SEBI to determine whether a preferential allotment of 14% shares to SIMEST SpA, an Italian financial institution, would make the allottee a “person acting in concert” with the largest shareholder of the company, being Terruzzi Fercalx SpA, another Italian company. SIMEST was the beneficiary of a put option whereby it could require Terruzzi to purchase its shares in Vulcan Engineers after a predetermined time. The informal guidance was sought as a matter of interpretation under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.
In responding to the request, SEBI observed:
(ii) The legality of the … put/call option in the agreement is examined in terms of provisions of Securities Contracts (Regulation) Act, 1956 [SCRA].
(iii) As this option would be exercised in a future date (June 30, 2015 onwards), the transaction under this arrangement would not qualify as spot delivery contract as defined [in] section 2(i) of SCRA. Further, the aforesaid put/call option would not qualify as a legal and valid derivative contract in terms of section 18A of SCRA as it is exclusively entered between two parties and is not a contract traded on stock exchanges and settled on the clearing house of the recognized stock exchange.
(iv) Therefore, in light of the aforesaid provisions of SCRA read with SEBI Notification No. S.O. 184(E) dated 1st March 2000, the pre-agreed buyback of VEL shares from SIMEST through put/call option is not valid under SCRA. In view of the same, further examination with regard to the guidance sought in the interpretative letter does not arise.
Interestingly, while the informal guidance itself was sought under the Takeover Regulations and not in respect of SCRA, SEBI instead dealt with the (in)validity of the put and call options and refused to proceed to answer the specific questions posed. The same can be said of the earlier instances of MCX Exchange and Vedanta/Cairn Energy where SEBI has been seizing every available opportunity to deal with the options issue quite extensively although that may not have been altogether germane to the principal issues before SEBI.
Such a clear stance adopted by the regulator will likely affect a number of investment transactions in both listed as well as public unlisted companies where the inclusion of put and call options are customary. Some argue (see this column by Sandeep Parekh) that the initial proscription of options in securities has outlived intervening developments in securities markets and their regulation. This is therefore an opportune moment for a regulatory or judicial reconsideration of the policy issues surrounding put and call options and whether they indeed result in speculation (as the original legislation had contemplated).

Update - June 22, 2011: Somasekhar Sundaresan has an interesting analysis in the Business Standards that highlights several unintended consequences that could arise out of SEBI's ruling.


Mandar Kagade. said...

Assuming the regulator is right on the put being violative of SCRA et al, how does that foreclose the consideration of key issue raised in the Informal guidance? ie. Whether the Italian PE player is a PAC with the existing shareholder of VEL. It seems unlikely though that as a matter of law, they would be PACs on the facts narrated.

On a related note, if the SEBI continues with its ill-conceived view regarding put/call agreements, the investors will discount the investment at a higher rate to account for liquidity risk (as thats what a put option guarantees the investor at the back-end); discounting at a higher rate will reduce the pric at which equity (or other convertible) security will issue. That does not augur well for the issuers looking to attract foreign capital.

sunil sheth said...

ROFR & Put/Call options are misused by the corporate worl, India in particular. The laws are twisted by the experts in favout of their clients for heavy fees. Such agreemnts should be allowed but with certain compulsory riders like; minimum price, transparent valuation method of stake in question. Any shareholder should have the power to rstrain the deal with necessary objections. Else, the matter is solved at the management level and the retail investors are deprived of eligible benefits.

Cosidering the above probabilites, it would be advisable to consider such Put/Call options and ROFRs as void to avoid future litigations and injustice to small investors.

sunil sheth said...

It is astonishing that when the market regulator SEBI has asserted its view on specific Put & Call options as invalid, why the matter is debated and not taking its final shape? The corporate bigwigs with the help of legal experts are trying to twist SEBI's ruling in their own interest. However, it is certain that any decision that goes against SEBI's ruling would adversely impact the interest of small investors. This is a classic example of corporate influence in Indian Capital Market.