[By Mahak Saxena]
The author is a student of National Law Institute University, Bhopal.
Introduction
The Securities Exchange Board of India (SEBI) has been receiving numerous requests from market participants and stakeholders for an overhaul and review of legal provisions and rules related to the buyback of specified securities. In light of which it floated a consultation paper on a review of existing Buy-back Regulations (“Consultation Paper”) in November 2022. The aforementioned paper is a culmination of all suggestions given by the sub-group headed by Mr. Keki Mistry which includes sweeping reforms of the current provisions and also recommends statutory amendments for some issues. The reforms are directed towards eliminating the inefficiency of certain modes of buy-back, optimization of the deadlines, changes in the statutory limits on buy-back, and discouraging the possibility of manipulation in the market.
This article attempts to specifically provide a summary and an analysis of the existing recommendations with respect to the Open Market and Tender Offer Route of Buy- back.
Law Governing Buy-Backs in India and Need for Reforms
Buy-Backs in India are governed by Section 68 of The Companies Act, 2013 (“the Act”), and the provisions of SEBI (Buyback of Securities) Regulations, 2018. As per the regulations, the methods of Buying back shares are through a Tender offer to existing shareholders, Open market mechanism through Book building process and Stock exchange Purchase of shares from odd-lot holders.
If we look at the official numbers from SEBI, Tender Offer is by far the most used method. The reason is its nature of enabling more equitable opportunity for shareholders to reap the benefits of buyback.[1]
The reforms are required because the current scheme has unnecessary procedural barriers in form of limits and approvals that lead to inefficient estimation of the price of securities, delay in the overall process, disproportionate loss to the shareholders and reduces the actual benefit that might have accrued to the shareholders from the Buyback.
Glide Path for Open Market Buybacks
When shares under the Open Market route are brought at the current market price, there is hardly any surety that the shareholders would be able to claim the benefits, therefore, SEBI is proposing to establish a separate window for buyback of shares.
Reduction in maximum limit and closure period
The main need for reducing the limit stems from the fact that while using the route of stock exchange, there is a probability that one shareholder’s entire trade will get matched with the purchase order of a company, preventing other shareholders from benefitting from the buyback which goes against the fundamental idea of fair and equitable treatment. Currently, as per Regulation 4, the Buybacks through the Open Market route are only permitted if it is less than 15% of the paid up capital and free reserves of the Company. SEBI aims to reduce this limit in a phased manner to 10% and 5% in the next two years and then aims to completely remove the Open Markets route from 2025. The aforementioned 15% limit is also proposed to be applied only to open market buybacks and not to the Book Building Route.
However, the open market route should not be completely phased out as it provides more flexibility for selling a higher quantum of shares over a longer period of time due to which the companies as well as investors find it easier to execute. Though the proposal for reducing the current time period of 6 months between the opening and closing of Buyback offer is rational as it addresses the concerns of artificial demand and exaggerated prices of shares and will lead to effective discovery of price.
Contradiction in proposals: Utilization of Amount and Restrictions on Volume and price.
On one hand, SEBI proposes that the company should achieve the minimum buyback threshold (75% of the buyback size) within a fixed time period; but at the same time, it places restrictions on the volume, price and time (No share purchases to be made in the first and last 30 minutes of the regular trading hours) at which it can buy from the market. Hence, these proposals should be revaluated.
Through Tender Offer Route
Permission to Revise Offer Price and Removal of SEBI Review Process: A welcome Change
Since there is a considerable time gap between the approval of Buy back and the actual opening of the offer, it is a justifiable suggestion that revision be allowed. However, an increase in buyback price will lead to a decrease in the number of securities, which negatively impacts the shareholders. Hence, along with price, the companies should be permitted to increase the aggregate buyback size as well.
Presently, Regulation 8 requires a draft letter of offer to be submitted to the SEBI for review. A window is provided to the SEBI to submit its comments which are later incorporated. However, in order to reduce the time and ease the procedure, the SEBI review process is proposed to be removed, though the merchant bankers will be mandatorily required to certify compliance with the regulations in the Letter and to the SEBI before the offers open. Another reasonable proposal is the specification of a time limit of 2 days within which the escrow account has to be opened after the public announcement.
Other Major Recommendations
Presently, the regulations allow only one Buyback in a 12-month period,[2] however, the sub group recommends reducing the cooling off period to six months for the tender offer route. This is a welcome move as the companies may need to give out surplus cash to the shareholders more than once in a year. However, it is to be noted that such exemptions have been proposed only for companies which are net debt free.[3]The phrase Net Debt Free essentially refers to a company with cash reserves and cash balances that, according to its accounts, as audited by a statutory auditor, exceed its borrowings and contingent liabilities. The reserves here include bank deposits, government securities, units of mutual funds investing in gilt funds. However, this definition fails to incorporate components like investment in debt mutual funds which are not gilt funds or overnight schemes.
Further, the definition includes contingent liabilities, which should not be considered as contingent liabilities to be ‘off-balance sheet items’ and it does not get included in the net debt computation. Hence, there is a need for reconsideration of the scope of the phrase ‘net debt free.
It has also been proposed that the buyback size limit in case of tender offers can be increased from 25% to 40% of paid up capital and free reserves of the company, which is justified as tender offers are an efficient mode of returning surplus to the shareholders when seen in contrast with the open market route which is more susceptible to misuse.
However, currently there is ambiguity that whether this limit is based on consolidated or standalone financial statements of the company. Hence the suggestion of specifying the limit on whichever financial statement sets out a lower amount shall bring much needed clarity in this regard. This shall also bring it in consonance with Section 68 of the Act.[4]
Other cogent recommendations include disposing of securities certificates in presence of the company’s secretarial auditor, including stock appreciation rights in the definition of specified securities, modification of Buy Back process through the book building mode, mandating disclosure of lender’s consent in a public announcement.
Taxation: The Elephant in the room
The proposal of shifting of incidence of tax on buyback from the Company to the shareholders is a reasoned move. Meanwhile, SEBI is looking for feedback on whether the firm should be told to disperse the repurchase consideration to the current/tendering shareholders, including the promoters, net of the buyback tax payable under the Income Tax Act, 1961.[5] However, one outcome of this step will be a reduction in the actual volume of the buyback that the company originally intended to do. It can also negatively impact the acquisition on the stock exchange as the real prevailing market price shall be different. Though globally the practice is to tax the share buybacks in the hands of investors, as shifting the tax burden is better than distribution of buyback proceeds net of tax. Under the current taxation rules, companies are paying the tax on behalf of promoters and exiting shareholders from funds which belong to the remaining shareholders. Many large companies such as TCS, GAIL and Zydus Life Sciences, have paid significant amounts as tax for shares purchased by promoters. Therefore, in consonance with the global practice, this anomaly needs to be corrected as suggested in the paper.
Conclusion
Majorly all of the suggestions made by the Sub-Group are made with the objective of rebooting the process by addressing the practical loopholes which the companies, investors and regulatory bodies face in the market. Along with an attempt at making the process effective and efficient, the consultation paper tries to establish an equilibrium between the leverage given to companies and the rights and interests of the public shareholders. However, the taxation scheme if implemented will discourage the shareholders to a great extent. Though it appears to be a mixed bag of recommendations, the intent of the paper is largely beneficial for the future of Buy-backs in India.
[1] Payal Agarwal, Ease of corporate slimming: SEBI proposes substantial relaxation of buy-back norms, Vinod Kothari Consultants (Corporate Laws), Available at: https://vinodkothari.com/2022/11/ease-of-corporate-slimming-sebi-proposes-substantial-relaxation-of-buy-back-norms/, (Accessed: December 10, 2022).
[2]Securities and Exchange Board of India (Buy-back of Securities) Regulations, 2018, Chapter-2, Regulation 4, Available at: https://www.sebi.gov.in/legal/regulations/sep-2018/securities-and-exchange-board-of-india-buy-back-of-securities-regulations-2018_40327.html, (Accessed: December 20, 2022).
[3]Review of SEBI (Buyback of Securities) Regulations, 2018 (2022),Chapter-4 Miscellaneous Matters, Cooling Off Period between Buybacks, Pg 19, Available at: https://www.sebi.gov.in/reports-and-statistics/reports/nov-2022/review-of-sebi-buyback-of-securities-regulations-2018_65136.html (Accessed: November 20, 2022).
[4]The Companies Act, 2013, § 68, No. 18, Acts of Parliament, 2013 (India).
[5]The Income Tax Act, 1961, §115QA, No. 43, Acts of Parliament, 1961 (India).