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HLL BBLIL Merger A Case of Insider Trading
HLL BBLIL Merger A Case of Insider Trading
Submitted To:
Dr. Rashmi Kumar Agarwal
Submitted By:
PGDM FT B3 Group 6 Pooja Gaddhyan 09FT-124 Rhea Ghosh 09FT-126 Shirish Ganesan 09FT-145 Sushant Agarwal 09FT-158 Varun Sethi 09FT-170
Acknowledgement
We are thankful to Dr. Rashmi Kumar Agarwal who is not only our internal training guide but also our professor in-charge of Legal Aspects of Business. Her consistent support has enabled us to bring this project to its completion.
Abstract:
The case study analyzes the charges of insider trading by SEBI (Securities and Exchange Board of India) against the merger of HLL (Hindustan Lever Ltd.) and BBLIL (Brooke Bond Lipton India Ltd.). The legal controversy involved HLLs purchase of 8 lakh shares of BBLIL two weeks prior to the public announcement of the merger of the two companies (HLL and BBLIL). SEBI suspected insider trading and conducted enquiries. After about 15 months, in August 1997, SEBI issued a show cause notice to the Chairman, all Executive Directors, the Company Secretary and the then Chairman of HLL. Later in March 1998 SEBI passed an order charging HLL with insider trading.
Insider Trading:
Insider trading is buying and selling of securities by the insider [*] of a company who has price sensitive information [**] about the company. It can be both legal as well as illegal. If the material information is made public before insider trading takes place, it is legal and if it is not made public, it is illegal. The provision is made so, as trading while having special knowledge is unfair to other investors who dont have access to any such knowledge. It also includes the tipping off of such kind of information to select few, who may gain undue advantage from the fact, and trade in securities there off. Any insider trading has to be reported to SEBI. It is one of SEBIs enforcement priorities as it undermines the confidence of investors and questions the integrity and fairness of securities market. Insider trading is dealt with for listed companies only. Company which is not listed doesnt come in the purview. Also advisers (merchant bankers) and intermediaries, involved in the trading come in the purview. It is to be understood that insider trading is punitive in nature. It means that they describe what constitutes insider trading and then seek to punish this act in various ways.
Merger:
Merger is the combination of two companies into one larger company. Generally such actions involve stock swap (A stock swap, also known as a share swap, is a business takeover or acquisition in which the acquiring company uses its own stock to pay for the acquired company) or cash payment to the target. In stock swap, swap ratio of share is decided, which is the ratio in which an acquiring company offers its own shares in exchange for the target company's share. Merger takes place due to several reasons. One of the most common and natural reasons for a merger is to eliminate competition. Also Economies of Scales come into play by way of elimination of duplicate department and expansion. Sometimes companies also want to venture into a different field altogether and at other times it wants to control price so as to protect market share and ensure no new players are able to make an easy entry into the market.
'guilty' verdict for an insider trading offence and on the other hand was Unilever subsidiary, Hindustan lever ltd (HLL). y On August 4, 1997, SEBI issued a show cause notice to HLL claiming that there was prima facie evidence of the company indulging in insider trading through the use of 'Unpublished price sensitive information' prior to its merger with Brooke Bond Lipton India Ltd. (BBLIL). y In March 1998, SEBI passed an exhaustive order, which sent shock waves through the country's corporate sector. SEBI found HLL guilty of insider trading because it bought shares of BBLIL from Unit Trust of India (UTI), knowing that HLL and BBLIL were going to merge.
to take place. It happens that deal in speculation may get cancelled due to unfavorable terms. But then the timing of the deal also has to be considered. Just two weeks before merger, it can be speculated that the company was about to finalize the deal. Such a coincidental timing of a deal, even if between HLL and any shareholder of TOMCO would have raised questions about managements intention. BBLIL being an associate company, only added to such charges and also gave conformity to the whole situation. So although the point raised by HLL is true, the timing of deal cannot be ignored. Also the merger could have been cancelled if TATA Oil Mills Co. didnt find the terms of mergers to be actually acceptable. This was not so in this case. HLL was aware of the merger as the managing team was same for both companies and no uncertainty was prevalent. So it was an insider in this case. Also, if merger of BBLIL would have taken place with another company not related to Unilever, then also HLL would have been aware of the merger. SEBI accused HLL of dealing with BBLIL shares on the basis of unpublished price-sensitive information which is prohibited under Section 3[****] of the Regulations. Section 2 (k)[*****] states that unpublished, price-sensitive information relates to amalgamations, mergers, and takeovers or is of concern to a company and is not generally known or published. SEBI held that there can be no dispute that the information of the overall fact of the merger fell under this definition. HLL argued that only the information about the swap ratio is price-sensitive and this ratio was not known to HLL or its directors when the BBLIL shares were purchased in March, 1996. It further argued that the news of the merger was not price-sensitive as it had been announced by the media before the companys announcement. HLL also pointed out that it was a case of a merger between two companies in the group, which had a common pool of management and similar distribution systems. Therefore, the merger information in itself had little relevance; the only thing that was price-sensitive was the swap ratio. When HLL argues that it had a common management, it is itself admitting in a way of fact that it was an insider as it had sensitive information that merger was a surety and was impending. Also though the market was aware that such merger will take place, the certainty of event in near future was questionable to the outsider. A company cannot
perform its day to day activities on the basis of mere speculation that an event will take place in future without being ascertained of its timing. So fingers cannot be raised on UTI that it should have been aware. Also HLL said that merger was generally known. If a company takes such kind of decision, it is important that shareholders are made aware of the fact which was not so in this case. Also BBLIL didnt make it clear to UTI as a major shareholder that a merger was on the way. Also when merger takes place, it is not only the swap ratio which is price sensitive but other aspects, like terms and conditions of merger, evaluation of company, current market share price, all are important. So it cannot be said with certainty that only swap ratio was price sensitive. HLL contended that it purchased the BBLIL shares so that its parent company, Unilever, could maintain a 51 per cent stake in the merged entity. Before the merger, Unilever had a 51 per cent stake in HLL, but only 50.27 per cent in BBLIL. Thus, the HLL management felt that the SEBI should consider if it had any additional information which it should not, legitimately, have had as a transferee company in the merger. SEBI alleged that if Unilever wanted to keep its stake constant in HLL, then why it not followed the path of preferential allotment of shares to raise its stake. As per the SEBI charge sheet, such a step would have involved various compliances/clearances, and required Unilever to bring in substantial funds in foreign exchange. The implication: HLL depleted its reserves to ensure that Unilever did not have to bring in additional funds. HLL argued that issuing of preferential share would have been a cheaper option to ensure that it had a 51 per cent stake in HLL. If HLL followed this route, it would have had to pay Rs.282.35, instead of Rs.350.35, per share. In other words, it would have made a profit of Rs.5.41 crore by doing so. HLL also stated that while the preferential route would have been beneficial for itself, it would have been dilutory for other shareholders since it would have resulted in an expanded capital base, leading to lower earnings per share in the future. Also HLL defended itself by pointing out that SEBI had to establish the financial benefit from the transaction in order to prove an insider trading charge. It pointed out that though establishing "financial benefit" was not explicit in the law, it was implied, because the act said that it should be taken into account when levying penalties.
It is true that the issue of preferential share was a cheaper option but it cannot be ruled out that it would have meant foreign investment from Unilever in India. Instead HLL followed the route of depleting its reserves which would generally have been remained untouched by parent company unless warranted by business needs. Also it was more convenient for Unilever to follow the path as clearance for preferential allotment from SEBI and the Reserve Bank of India (RBI) would have taken its own course of time. SEBI argued that Levers cancelled the entire holding of HLL in BBLIL. HLL agreed to the point that the shares had been bought back with the sole intention of increasing the stake of HLL in BBLIL. It was planned that the shares would be extinguished after the buyback to increase the value of shares still available (reducing supply). By the process of amalgamation which happened in the merger, the voting rights of Unilever went up and in the process the rights of shareholders have also been propped up. By extinguishing shares, HLL wanted to maintain Unilevers shareholding at 51% and not realize any financial gains. However, section 3 clearly defines insider trading irrespective of the fact whether profits have been made or not.
Conclusion:
It is very difficult to conclude as to whether HLL was an insider or not and whether insider trading actually took place. In this case however it can be drawn, that merger was price sensitive information which would have affected UTIs decision of selling share had it been aware of such merger. It would have then waited for better valuation which was a surety. Also HLL depleted its own reserves to buy the shares for one privileged shareholder, Unilever. That in itself is a sin in corporate governance favoring one set of shareholders at the expense of others. Moreover, HLL's action violated the legal proposition that, what cannot be done directly cannot be done indirectly.
Footnote:
[*] Section 2(e) SEBI (Prohibition Of) Insider Trading Regulations, 1992 defines insider as : insider means any person who, is or was connected with the company or is deemed to have been connected with the company, and who is
reasonably expected to have access to unpublished price sensitive information in respect of securities of company, or who has received or has had access to such unpublished price sensitive information; [**] Section 2(ha) SEBI (Prohibition Of) Insider Trading Regulations, 1992 defines price sensitive information as : price sensitive information means any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company. Explanation - The following shall be deemed to be price sensitive information: 1. periodical financial results of the company; 2. intended declaration of dividends (both interim and final); 3. issue of securities or buy-back of securities; 4. any major expansion plans or execution of new projects; 5. amalgamation, mergers or takeovers; 6. disposal of the whole or substantial part of the undertaking; and 7. significant changes in policies, plans or operations of the company;]
[***] - Section 370 (1)(b) of the Companies Act, 1956 : two bodies corporate shall be deemed to be under the same management(i) if the managing director or manager of the one body, is(a) managing director or manager of the other body; or (b) (c)
(ii) if a majority of the directors of the one body constitute, or at any time within the six months immediately preceding Constituted, a majority of the directors of the other body; [or] [(iii) if not less than one-third of the total voting power with respect to any matter relating to each of the two bodies corporate is exercised or controlled by the same individual or body corporate; or (iv) if the holding company of the one body corporate is under the same management as the other body corporate within the meaning of clause (i), clause (ii) or clause (iii); or (v) if one or more directors of the one body corporate while holding, whether by themselves or together with their relatives, the majority of shares in that body corporate also hold, whether by themselves or together with their relatives, the majority of shares in the other body corporate.] [****] Section 3 SEBI (Prohibition Of) Insider Trading Regulations : No insider shall (i) either on his own behalf or on behalf of any other person, deal in securities of a company listed on any stock exchange 17[when in possession of] any unpublished price sensitive information; or 18 [(ii) communicate counsel or procure directly or indirectly any unpublished price sensitive information to any person who while in possession of such unpublished price sensitive information shall not deal in securities : Provided that nothing contained above shall be applicable to any
communication required in the ordinary course of business 19[or profession or employment] or under any law.] 20 21[3A. No company shall deal in the securities of another company or associate of that other company while in possession of any unpublished price sensitive information.] [*****] Section 2(k) SEBI (Prohibition Of) Insider Trading Regulations: "unpublished price sensitive information" means any information which relates to the following matters or is of concern, directly or indirectly, to a company, and is not generally known or published by such company for general information, but which if published or known, is likely to materially affect the price of securities of that company in the market
(i) financial results (both half-yearly and annual) of the company: (ii) intended declaration of dividends (both interim and final); (iii) issue of shares by way of public rights, bonus, etc.; (iv) any major expansion plans or execution of new projects; (v) amalgamation, mergers and take-overs; (vi) disposal of the whole or substantially the whole of the undertaking; (vii) such other information as may affect the earnings of the company. (viii) any changes in policies, plans or operations of the company.