The said modification comes as a result of the Discussion Paper on 'Proposed modifications to the existing framework for buy back through open market purchase' dated 02nd January 2013 by SEBI wherein discussion was held to provide solutions to failure of present policies on buy back through open market.
Here, it shall be worth mentioning that buy back is usually resorted to due to following reasons:
- Return surplus cash to the shareholders; or
- Support share price during periods of temporary weakness; and
- Increase the underlying share value;
NEED FOR THE AMENDMENT
It has been observed by the SEBI that buy back through open market has failed to achieve its objectives in spirit, due to the following reasons:
- The companies place buy back orders at their discretion instead of placing them on regular basis and that too at a price away from the market price- Section 77A (4) of the Companies Act, 1956 specifies that every buy back shall be completed within a period of 12 months. Companies, instead of fixing a definitive period for buy back, usually keep the buy back offer open for the entire period of 12 months. However, even after keeping the buy back offer open for such a long time, there have been instances where companies did not buy a single share or failed to achieve the minimum buy back quantity.
- There are no provisions that determine the price or quantity permissible for company to buy back- There are no explicit provisions in the Companies Act, 1956 or in the SEBI (Buy Back of Securities) Regulations, 1998 regarding the price or quantity for which the company shall place orders for buying back its shares or the periodicity of placement of such orders. Therefore, on which days, for how long and in what quantity the company will buy back its shares is entirely at the discretion of the company’s management. This lack of clarity is further burdened with the fact that disclosure is not made to the public shareholders as to how the discretion will be exercised and what are consideration/basis guiding the management in this regard.
- Failure on part of companies to actually execute the buy back process- It has also been observed that many companies took shareholders/board approval for buy back proposals and in some cases even published public notice but did not take a single step to buy the shares.
- There are no current disclosure requirements to be fulfilled by company with regards to buy back- The company discloses the maximum price only and eventually purchases the shares near market price which could be significantly lower than the announced price. This may convey a misleading message to the shareholders and to the market. Moreover, buy back from open market has not proved to be beneficial to the shareholders as against the tender offer method in which the company buys back shares at a premium to the market price.
- Buy back offer is not successful in enhancing book value of shares. It has been observed that in 75 buy back cases through open market purchases, which closed during the last three financial years (from April 01, 2007 to March 31, 2010), an average of 49.91% of the maximum offer size (as disclosed in public announcement to shareholders) was utilized by the companies for the buy back. This suggests that despite the intention disclosed by companies to their shareholders at the time of making buy back offer, the buy back offer is not used as an opportunity for enhancing the book value of the shares of the company.
THE KEY CHANGES
The Amendment to SEBI (Buy Back of Securities) Regulations, 1998 governing buy-back through open market purchase, as a part of SEBI's constant endeavour to align regulatory requirements with the changing market realities as well as to enhance efficiency of the buy-back process, the following changes to buy back of shares or other specified securities from the open market through stock exchange mechanism have been approved and includes mostly all the changes proposed in discussion held on 02nd January 2013. These changes are aimed towards ensuring lower volatility and reduce unpredictability in the capital markets. Also these changes are likely to affect the rights which the companies possessed before the amendment, in respect of open market transactions.
Following spheres have been introduced with changes:
Cardinal requirement of minimum buy-back: In the discussion, SEBI observed that companies majorly used buy backs as a medium to support share price during periods of temporary weakness and to artificially increase underlying share value. To prevent misuse of buy back offers by using them as a share-price stabilizing activity, the obligatory 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%.
This requirement has been introduced to prevent the manipulation of share prices and if the company fails to fulfill this requirement, then the amount in escrow account would be forfeited subject to a maximum of 2.5% of the total amount taken by company.
Buy Back Period: Currently, the Buy Back provisions are clearly laid down in section 77, 77(A), of the Companies Act, 1956. Also the Buy Back Regulations of SEBI prescribes certain standards which apply to listed companies. The Companies Act mandates 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).
By the amendment, SEBI has limited the Buy Back Period to 6 months, from the time the approval has been sought from the board or shareholders, because practically the companies did not utilize the entire period to carry- out and perform the complete Buy Back.
However, the provisions of the Companies Act [which remain intact] provide that the Buy Back period of shares extends up to 12 months from the date of the shareholder/board resolution, which upon the amendment will stand contrary to the regulation. This move shall take its toll on flexibility provided by the Companies Act; a point noteworthy here, is that it is yet unclear if SEBI can reduce a time period that is determined by the Companies Act.
- Escrow account requirement: SEBI has introduced the requirement of creating an escrow account on part of the companies, and a deposit has to be made as a security, to ensure that a company which announces a buy-back goes ahead with the proposed transaction. This security shall be equivalent to 25% of the buy-back amount. This move will be happily welcomed by the shareholders as it safeguards their interests. But it is being widely perceived being an unnecessary burden given the 50% mandatory buy-back rule.
Requirements after completion of Buy Back process: SEBI has changed the duration of the restrictive period for further issue of capital from prevailing 6 months to 1 year, to be calculated from date of closure of the buy back. Although this requirement can be relaxed in discharge of latent obligations.
This change is contradictory to the period specified by the Companies Act, 1956. Before the amendment, there was no provision for by SEBI for cooling-off period i.e. the period between two Buy Back offers, it was decided by way of a board resolution. Also no cooling-off period is mentioned in the Companies Act. But now the cooling-off period is 1 year. That means a company cannot make another buy-back offer within a period of one year from the date of closure of the preceding offer. This 1 year Cooling-off Period will be applicable to all buybacks (irrespective of whether they are launched following a board or shareholder resolution).
Also, SEBI has allowed the companies to subvert the shares procured in the buy back during the month within 15 days of the succeeding month, provided the last extinguishment is concluded within 7 days of the completion of the offer.
Requirements during Buy back: SEBI now requires all the information related to shares bought back to be disclosed on a daily basis on the website of the company and the stock exchange on cumulative basis. Before the amendment, the aforementioned disclosure had to be made on a daily, fortnightly and monthly basis.
To tackle and reduce the unpredictability in the market, SEBI now prevents the promoters of the company from executing any transaction, during the buy-back period, regardless of whether these transactions are on-market or off-market.
- Buy Back Method: In order to increase stability in share prices of a company, SEBI has restricted the Buy Back method only to Tender offer method. SEBI permits the company to buy 15% or more of capital which may include both paid-up capital as well as free reserves. This amendment takes away the freedom of company to choose the method for buy back.
- Procedure for Buy back: Procedure for buy-back of physical shares (odd-lot) has been modified which includes creation of separate window in the trading system for tendering the shares, requirement of PAN/Aadhaar card for verification, etc.
Although this amendment comprehensively addresses the concerns apprehended by the regulators of SEBI in the discussion paper of 02nd January 2013, the amendments substantially take away the freedom from the public companies, which currently exist by virtue of the Companies Act.
The modifications to the existing framework for Buy Back through open market purchase have been done by holding the shareholder’s interest as the paramount consideration. Now the companies cannot misuse the Buy Back for promotion of their own interest.
Further, this amendment raises a conflict between existing provisions for Buy Back laid down in the Companies Act, 1956. Since a lot of provisions of the Companies Act are not in sync with this amendment, the question is whether SEBI possesses the power to override the Companies Act’s provision by this amendment and which one of the two would prevail in an event of a conflict.