A recent strange decision of SEBI, upheld by the Securities Appellate Tribunal leaves companies and others puzzled as to how at all securities laws should be interpreted and applied. Should, for example, a particular interpretation which is not only followed by SEBI, which itself confirms in writing as correct and is otherwise widely applied in practice without objection by SEBI, be overturned? And if such an interpretation which is almost certainly not harming any public interest and is well within the spirit and perhaps even the letter, should be so overturned and, moreover, a person severely penalised for it?
This is exactly what SEBI has done recently and the SAT has upheld such a decision (Order of SAT in matter of Hanumesh Realtors Private Limited v. SEBI dated 25th July 2012).
What was the issue?
The broad issue and background is explained as follows:
SEBI Takeover Regulations 1997 (“the Regulations”) require that a person who acquires substantial shares in a listed company or acquires control over it, should make an open offer to acquire shares from the public shareholders. A person already holding substantial shares can increase his holding without having to make an open offer by a small percentage only every year – normally upto 5%. This is called “creeping acquisition” in common parlance. For the purposes of the 5% limit holding not only the acquirer himself is considered but that of persons acting in concert with him is aggregated. To ensure that there is no misuse of the provisions, inter se transfer of shares amongst the persons acting in concert is allowed with certain safeguards.
In case of acquisition of shares by way of a fresh issue, a slightly peculiar situation arises on account of a calculation/mathematical issue. Take a situation where a person holds 40% of equity share capital of Rs. 10 crore. If he seeks to acquire another 5% in accordance with creeping acquisition provisions, and if he is accordingly allotted Rs. 50 lakh worth of equity shares, then his holding will increase only by 2.86% to 42.86%. The reason is that as his holding increases by Rs. 50 lakh, the equity share capital also increases by Rs. 50 lakh. Thus, his increased holding of Rs. 4.50 crore is calculated with reference to the equity share capital that has also increased to Rs. 10.50 crore. To enable him to increase his holding by 5%, he would have to be allotted equity shares of about Rs. 91 lakh, i.e., almost double.
Now, a further peculiar situation may arise when the acquirer group consists of more than one person. Unless shares are acquired by all the persons in the group in proportion of shares already held by them, there could be increase of holding of more than 5% by the acquirer and dilution of holding by those who do not acquire.
To continue the above example, let us say that the 40% or Rs. 4 crores was held by two persons – one holding Rs. 1.50 crores and another holding Rs. 2.50 crores. If shares are acquired by the person holding Rs. 1.50 crores, then his percentage holding increases from 15% to 22.09%, i.e., by 7.09%. However, the holding of the other person gets reduced by way of dilution from 25% to 22.91%. The overall holding of the two persons taken together, of course, increases to 45%, i.e., within the prescribed limits.
The question is whether the holding and the increase is to be considered individually or as a group. If it is considered individually, then the first holder may be deemed to have exceeded the limit of 5%.
Facts of the present case
The Promoter Group held 49.62% in the share capital of the Company. Further shares were allotted to a particular person in the Promoter Group. The overall holding of the Promoter Group consequent to such allotment increased from 49.62% to 54.59%, i.e., by 4.97% i.e., well within the prescribed limits. However, the individual holding of the person who was allotted shares increased from 36.62% to 42.87%, i.e., by 6.25% which is more than 5%. Needless to add, the holding of the other persons in the Promoter Group decreased by way of dilution. The question is whether such increase is to be considered on a stand alone basis or on a group basis.
SEBI had issued an interpretive letter in 2009 where SEBI had opined that if overall holding did not increase by more than 5%, there would not be any violation of the limits. To be fair, firstly, the facts in that letter were not identical to the present facts, since there was nothing on record to show that one individual’s holding increased more than 5% but was balanced by another person’s dilution of holding. However, the interpretation given was broad enough. Secondly, interpretive letters, in law, do have limited application and are even officially termed as “informal guidance”. Thus, one may not want to apply analogy of other laws such as tax laws where circulars of CBDT are given considerable weight. Still, in securities laws, a certain level of sanctity is to be given to such interpretive letters and SEBI ought to take a consistent view on the issue.
In another case, as explained in the SAT Order, SEBI even passed an adjudication order on similar principles. In that case, the holding of one acquirer increased from 0.43% to 28.22% ! In other words, he even crossed the 15% threshhold which would require an open offer to be made. However, because of non-acquisitions by other persons in the group, their holding decreased from 40.13% to 16.79%, thus the overall increase being from 40.56% to 45.01% which was within 5% limit. SEBI held that this was in consonance with law since the net increase was within 5%. Admittedly, the acquisition in that case was under the rights issue route, but the findings of SEBI were categorical enough to mean that such acquisitions through issue of new shares will be counted as a group.
However, in this particular case, SEBI took a stand and relied on a much earlier decision of the Supreme Court in Swedish Match AB’s case (Appeal No. 2361 dated 25th August 2004). In that case, there were two Promoters – an incoming foreign promoter who already held a substantial quantity of shares and the existing promoter. The incoming promoter acquired most of the remaining shares of the existing promoter and such shares were substantial in number. While deciding on the issue whether this resulted in an open offer or not, the Supreme Court analysed the provisions of Regulations 11 of the 1997 Regulations and held that the increase in holding can take place in three ways only. The acquirer may himself acquire or he may acquire through some other person or he may acquire alongwith other persons.
SEBI took a stand that this principle will have to be applied in the present case in the manner explained as follows. As soon as a person within a group acquires more than 5% shares, he will have to make an open offer even if the holding of the other person, solely on account of this mathematical peculiarity reduces and overall increase in holding remains within the limits. SEBI not only discarded its own decision and interpretation which were much later in date and consistent too, but also applied the above decision of the Supreme Court in perhaps what were different facts at least to a degree and peculiarity. SEBI levied a huge penalty of Rs. 1.87 crores on the party.
Aggrieved, the party appealed to SAT. Strangely, SAT focussed only on the decision of the Supreme Court and applying it, held that the legal position as now canvassed by SEBI was correct. It did not criticise SEBI’s stand of arbitrarily reversing its stand and then – to top it – levying severe penalty. However, SAT did reduce the penalty and while reducing it, it did take into account as part of the consideration, though not sole one, the mitigating factor being SEBI’s earlier decisions and stand. Though the penalty was reduced substantially to Rs. 10 lakhs, it is submitted that it sounds low only in comparison to the original amount. Otherwise, it still remains a substantial penalty considering, in my submission, the blameless act of the acquirer.
This decision and stand of SEBI places persons concerned with applying securities laws in a dilemma particularly since securities laws are often interpreted consistent with SEBI’s stand in practice. If SEBI takes a particular stand and also gives an interpretive circular in writing, it ought to honour it in future cases. And if it wishes to change the stand, a better view may be to give a clarification and in cases where other parties have followed the earlier stand, no action ought to have been taken. This is more so when no harm whatsoever could conceivably have been caused in the present facts.
The author has also observed in numerous other cases of acquisitions by way of issue of new shares, a similar position has existed though none of these cases were acted against. This would show that a particular practice was widely followed and the appellant had every reason to adopt it and could not be faulted particularly since no harm whatsoever could have conceivably been caused to any person.
It is also submitted that the decision of the Supreme Court could have been distinguished. That was a case of inter se transfer of shares between two distinct groups and the holding of acquirer as well as of the acquirer group both increased substantially and by more than 5%. Even the control of the company changed hands from joint control to sole control. The present case was not a case of inter se transfer of shares even if in theory one person in the group increased his holding and holding of the remaining, purely on account of dilution, decreased.
It may be mentioned that this decision is in respect of the earlier law, viz., the 1997 Regulations. Recently, the new Takeover Regulations, 2011 have been notified. Under the 2011 Regulations, it is now expressly stated that the increase in individual shareholding shall also be considered and even if the holding of the remaining shareholders in the group decreases, still, if the limits are exceeded qua a single shareholder, the open offer requirements would apply. However, it is submitted that this in fact would go to show that earlier this was not the case since otherwise, such an express provision was not required.
All in all, this represents an unhealthy trend by SEBI where persons concerned with compliance will always remain on edge as to whether SEBI would change its stand. The importance of interpretive letters – which officially of course is limited to the facts of the case and not binding interpretation of law – will further get diluted. SEBI’s stand appears almost vindictive and arbitrary, since this was a case where even if the matter was taken up for consideration, it was a fit case of not levying any penalty whatsoever while at same time laying down the law for guidance in the future for other persons. Let us hope that this decision is an exceptional decision influenced solely by the binding precedent of the Supreme Court and such arbitrary stand is not repeated in the future.
