Strong-arm Tactics Don’t Always Work (4 November 2002)
After some behind-the-scenes pushing, the Sterlite Industries scrip re-opened for trading last Friday marking a very important victory for minority shareholders against oppression by the promoter group. By refusing to yield to strong-arm tactics, investors ensured that Sterlite was unable to buy back enough of shares to get delisted from the Bombay Stock Exchange (BSE). The share price rose a smart 15 per cent to close near its 52-week high at Rs 163.80. The price was also substantially higher than the Rs 140 plus at which Sterlite was quoted when trading was suspended in May following the court-cleared buyback scheme.
Before we look at the lessons from the Sterlite manoeuvre, here is the background. Sterlite Industries sparked off a controversy last May when it filed a “scheme of arrangement” with the Bombay high court under Sec 391 of the Companies Act, seeking to buyback its shares at Rs 150 each (of this Rs 100 was a cash payment and the rest was in secured non-convertible debentures, or NCDs, redeemable in the fourth, fifth and sixth years).
Sterlite further attempted to force investors to tender their shares by mailing them cheques worth Rs 100 per share and seeking a negative consent to its offer (if they did not say no, it would mean a yes). It also obtained permission from the court to sweep the shares out of investors’ depository accounts if they had either encashed the cheques or failed to send in a rejection when the scheme closed.
The structure of the proposal caused a furore. Investors protested against both the attempt to force their compliance and the paltry price of Rs 150 per share, when Sterlite’s book value was Rs 300 (moreover, a part of the payment was in debentures which could well remain illiquid). The National Share Depository Ltd objected to the permission to sweep shares out of investors’ account without their positive consent. It said that this was against the depository regulations and would undermine investor confidence in the entire depository system. The Securities and Exchange Board of India (Sebi) and the Department of Company Affairs (DCA) objected to the company circumventing specific buyback rules and seeking court approval through a scheme of arrangement under Sec 391 of the Companies Act.
Among the many firsts triggered off by Sterlite’s action was that both Sebi and DCA went to court on behalf of shareholders against Sterlite’s action (of course, after strong persuasion by the Investor Grievances Forum headed by MP Kirit Somaiya). Astonishingly, however, the court threw out the objections of DCA and Sebi (they have now moved the Supreme Court) and even allowed shares to be moved out of investors’ account without their consent. The court also cleared a similar scheme by Godrej Industries. Earlier, Sierra Optima got delisted in a similar manner when its US business alliance with Sierra Atlantic conveniently and temporarily broke down.
Yet, when the buyback was complete Sterlite had managed to collect just around 74 per cent of the equity, inspite of the fact that several shareholders who failed to encash their cheques in time are stranded, with neither the money nor the shares.
That investors comprehensively defeated Sterlite’s buyback becomes more obvious when you consider that the promoters control 67.34 per cent of the equity. Of the rest, institutional investors hold nearly 10 per cent and the rest is with retail investors. The Sterlite case sends out an important message that if retail investors act in concert they can fight oppressive management and defeat their plans.
Interestingly, this is one case where Life Insurance Corporation and General Insurance Corporation — which together hold over 7 per cent of the equity — had objected to the offer. If these institutions continue to hold firm, then Sterlite will find it very difficult to delist its equity even if it mops up more floating stock.
A second signal comes from Friday’s closing stock price of Rs 163.80 which is substantially higher than Sterlite’s offer price of Rs 150, that too only partly in cash. It suggests that investors were correct when they complained that Sterlite’s offer was priced too low. Incidentally, Sterlite had announced a share buyback programme once before and had offered a price of Rs 200 per share, but later withdrew it.
It could be argued that the price increase is due to a reduction in floating stock. It is also possible that promoters themselves were attempting to mop up shares through a creeping acquisition. Either way, the shareholders who refused to tender their shares in the buyback offer have gained substantially. They not only walk away with a better price but it is all in cash. On the other hand, those who accepted the offer will be stuck with a lower price and NCDs of doubtful liquidity. Maybe Sterlite will still be delisted sometime in the future, but at least investors may get a better price for their shares.
The Sterlite episode also holds important lessons for the regulators and the courts. Both DCA and Sebi have won investors’ gratitude by fighting their cause — they now know that they were on the right track even if the Bombay high court strangely refused to stay the scheme. Hopefully, the Supreme Court will correct the damage caused to investor confidence by the high court decision.
One of the factors that apparently weighed with the court was that the shareholders had “approved” Sterlite’s scheme of arrangement. If the courts paid more attention to how shareholders meetings are ‘managed’ by companies, they would realise that without a postal ballot, such a meeting is usually meaningless. And when the promoter group controls over 67 per cent of the equity, it usually manages to do pretty much as it pleases, except on the rare occasion like this one. The Sterlite case needs to be widely publicised in order to ensure that high courts are reluctant to support either anti-investor decisions or attempts to circumvent the supervisory authority of clearly designated regulators like Sebi.
The defeat of Sterlite’s buyback offer effectively demonstrates how the promoter groups and majority shareholders have frequently short-changed retail investors in India. It not only strengthens the case for eliminating the indiscriminate use of Sec 391 by companies but also supports a more extensive use of postal ballots to seek shareholder approval for a variety of corporate decisions. -- Sucheta Dalal