Discussion paper on ‘Proposed modifications to the existing framework for
buy back through open market purchase’
Background
(I) Section 77A of the Companies Act, 1956 contains the basic framework for companies to buy back its own securities. Section 77A (5) provides the methods of buy back .Excerpts from the same are reproduced below:
“The buy-back under sub-section (1) may be –
(a) from the existing security holders on a proportionate basis ; or
(b) from the open market ; or
(c) from odd lots, that is to say, where the lot of securities of a public company, whose shares are listed on a recognised stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange ; or
(d) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.”
(II) Further, Section 77A (2) (f) gives power to SEBI to frame regulations in this regard. Accordingly, the existing framework for buy back through open market purchase is being reviewed.
Buy back is usually resorted to due to following reasons:
- Return surplus cash to the shareholders
- Support share price during periods of temporary weakness
- Increase the underlying share value
Reasons for review
It has been observed that buy back through open market has failed to achieve its objectives in spirit, due to the following reasons:
a) 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 buyback, usually keep the buyback offer open for the entire period of 12 months. However, even after keeping the buyback 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 buyback quantity. It has been observed that the companies place buy orders at their discretion instead of placing them on regular basis and that too at a price away from the market price.
b) 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.
c) It has also been observed that many companies took shareholders/board approval for buyback proposals and in some cases even published public notice but did not take a single step to buy the shares.
d) 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.
e) It has been observed that in 75 buyback 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 buyback offer, the buyback offer is not used as an opportunity for enhancing the book value of the shares of the company.
f) In view of the above, the following ‘Modifications to the existing framework for buy back through open market purchase are proposed:
Proposed Broad Framework for buy back through open market purchase
1. Minimum buy back quantity:
1.1 Pursuant to the order of the Securities Appellate Tribunal dated 26.09.2008 in the matter of Sasken Communications Limited and after observing instances of companies not buying a single share or buying negligible quantity after buy-back announcement, the Merchant Bankers are being advised to ensure that a minimum of 25% of maximum buy-back proposed/disclosed n bought back.
1.2 The aforesaid measure has resulted in significant increase in the percentage of buy-back quantity as may be seen from the following table :
