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New Buyback Regime: The Good, The Bad & The Surprising!

Published on Tue, Jul 02,2013 | 16:47, Updated at Tue, Jul 02 at 16:47Source : Moneycontrol.com 

By: Srinivas Parthasarathy, Partner & Tejal Velambath, Senior Associate, Trilegal

The Securities and Exchange Board of India (SEBI), at its board meeting held on 25 June 2013, approved certain changes (Proposed Changes) to the Securities and Exchange Board of India (Buy Back of Securities) Regulations, 1998 (Buy Back Regulations). While the Proposed Changes have been watered down from the amendments as originally proposed by SEBI in its discussion paper issued on 2 January 2013, it addressescertain irregularities connected to open market buy-backs. The Proposed Changes are aimed towards ensuring lower volatility in the capital markets, but may impact the leeway companies previously had in terms of the timelines attached to open market purchases. The key changes are set out below:

Increase in mandatory minimum buy-back: It was observed by SEBI that buy-backs were widely employed by companies to support share price during periods of temporary weakness and to artificially increase underlying share value. In a move to ensure that buy backs should not be employed as a share-price stabilizing activity, the mandatory minimum amount which a company is required to buy back from its existing shareholders has been increased to 50% of the offer size, against the existing practice of 25%. In recent buyback offers, SEBI has, in practice, insisted on companies buying back a minimum quantity of 25%. This, however, did not prevent the manipulation of share prices, and therefore, to address such concerns, SEBI proposes to introduce the 50% mandatory buy-back requirement as a rule in the Buy Back Regulations.

Reduction in Buy-Back Period: The current buy-back provisions are broadly set out in the Companies Act, 1956 (Companies Act). In addition, SEBI prescribes certain standards under the Buy Back Regulations which apply to listed companies. The regulatory requirements of the Companies Act mandate that a company looking to buy back its securities should seek approval of its shareholders by way of a special resolution or a resolution of its board of directors, and such buy-back must be completed within 12 months from the date of the shareholder/board resolution (Buy Back Period). The SEBI proposes to limit the Buy Back Period to 6 months (from the prevailing 1 year period) from when the approval has been sought from the board or shareholders, since it was empirically observed by the regulator that companies did not utilize the entire period for concluding the buy-back. However, this requirement departs from the regulatory position under the Companies Act. The Companies Act provides that the shares should be bought back within 12 months from the date of the shareholder/board resolution. SEBI’s proposal to reduce the Buy Back Period is contrary to the flexibility provided in the Companies Act, and absent an amendment of the Companies Act, it is unclear if SEBI can reduce a time period that is determined by the Companies Act.

Amounts to be deposited in escrow account:  Currently, the open market buy-back offers do not entail an escrow mechanism. However, to ensure that a company which announces a buy-back goes ahead with the proposed transaction, SEBI intends to introduce a provision which would require 25% of the buy-back amount to be placed in escrow as performance security. While such a move would safeguard the interests of the shareholders, it is being widely perceived being an unnecessary burden given the 50% mandatory buy-back rule. Also, SEBI’s concern appears arbitrary and devoid of logic, given that open market purchases are executed through a registered stockbroker after complying with the requisite norms on margin money, which are adequate safety measures to ensure that the companies have requisite funds to complete the open market buy-backs.

Post buy-back obligations: SEBI has mandated that companies which resort to a buy-back of its shares shall not issue the same class of capital for a period of 1 year unless it is in discharge of its extant obligations (Restrictive Period). At present, the Companies Act prescribes a 6 month Restrictive Period. Given that the Companies Act stipulates a shorter period, SEBI’s current proposal to limit the Restrictive Period to 12 months appears to be severe. Also, without an amendment to the Companies Act, it is unclear whether such Proposed Changes can extend a time period stated in the Companies Act.

Also, to effectively combat market volatility, the Proposed Changes indicate that during the period of the buy-back offer, the promoters of the company will not be allowed to execute on or off market transactions, and companies will be precluded from undertaking another buy-back of shares within a period of 1year from the date of close of the preceding offer (Cooling- off Period). Currently, the Cooling-off Period of 1 year between two buy-back offers is limited to offers made solely pursuant to a board resolution. No Cooling-off Period is prescribed in the Companies Act if the offer is made after a shareholder resolution. However, SEBI’s proposal mandates that 1 year Cooling-off Period will be applicable to all buybacks (irrespective of whether they are launched following a board or shareholder resolution). This again is contrary to the flexibility provided under the Companies Act, and SEBI may need to reconsider such proposals which are in direct contradiction to the provisions of the Companies Act.

Tender Offer Method: Other changes proposed include mandating that buy-back of 15% or more of the total of the paid up capital and free reserves must be done only by way of a tender offer. In a move to increase stability of the stock price of a company and ensure that shares are sold at a premium to the prevailing market price of the stock, SEBI intends to confine buy-back of 15% or more of the capital to the tender offer process. This proposal appears to be drastic and retracts the freedom available to companies to determine the manner/method of the buy-back under the Companies Act. 
Conclusion: The Companies Act provides certain basic rights/leeway to public companies. This leeway cannot be taken away from public companies unless it has been specifically provided for in the Companies Act. Therefore, the question that arises is whether SEBI is bestowed with powers to introduce amendments which alter the rights available under the Companies Act. It appears that SEBI may need to reconsider some of these proposals as they may be viewed as fetters to the central statute – the Companies Act.

Disclaimer:
The contents of this article are intended for informational purposes only and do not constitute legal opinion or advice. Readers are requested to seek formal legal advice prior to acting upon any of the information provided herein.

 
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