Time to reform takeover pricing

It is that time in policymakers’ lives when everyone would have some suggestion or the other on what must be done. The events of the past several days are extraordinary. One will never know if the containment measures taken worldwide to halt the spread of Covid-19 is disproportionate.

If the fears die down eventually and one were to conclude that the measures were disproportionate, the conclusion would be irrelevant — measures that are extraordinary and unthinkable have al­ready been taken. If the fears die down eventually and one were to conclude that the measures were indeed proportionate, it would still be irrelevant — there will al­ways be a moot argument about whether the measures led to the containment or the fears were in any case unfounded.

Looked at from the prism of what a reasonable man can decide, it can only be based on material available at hand at the time the decision is taken. Thanks to the World Health Organization having declared a pandemic, with no known drug or vaccine on consumer shelves, every measure on every count has been in the extreme. That the spread started in an authoritarian and populous state like China without free flow of information has made assuming the worst easy. That India has followed a stringent and better-safe-than- sorry approach that is similar to what one hears about China, has meant that nearly 40 per cent of humankind has responded in similar terms.

At this juncture, a regulatory agency such as the Indian capital market regulator would also be flooded with requests on what must be done – what is an imperative and what is unnecessary would be subject matter of intense debate and confusion. Simpler measures such as being soft-handed with enforcement, and having a light-touch approach with regulatory deadlines are easy measures to implement. Indeed, the regulator has reacted well so far with going soft with deadlines, although some orders that take immediate effect have indeed been passed in cases that are many years old and could have well waited.

Enforcement apart, this is a good time to think about getting some structural reform underway. Covid-19 may affect human beings but the measures taken in the wake of Covid-19 would indeed affect the economy adversely. Most regulatory provisions written into law are bull market regulations – the assumption in writing them is always that the market price of securities would go up. The regulator has to wear a new thinking cap and think through how to deal with quickly re-orienting itself to write regulations for a bear market. The answer is not simple. The same balancing of multiple stakeholders' interests are involved and one has to maintain a careful counterbalancing of competing considerations.

For example, listed companies that may not be able to finalise their March 31-ending financials by the end of May, could now do so by end-June. A strange request has been made for suspending the prohibition under the insider trading regulations pending finalisation of results, which the regulator has correctly rejected – there is no logical link between a matter of procedural extension of timeline and a substantial waiver on insiders trading while drafting final accounts.

More important than tweaks is the need to rethink provisions linked to pricing of securities. Regulating pricing in open offers during takeovers and diluting ownership cheap through preferential allotment are two obvious areas.

Open offer pricing is unnecessarily linked to market pricing. Price discovery in an M&A transaction is far superior to price discovery in the secondary market — it is a more informed one, with the acknowledged benefit of due diligence. The price to be paid for taking over a company involves a far better and more realistic assessment of its prospects, as compared with trading decisions on the stock exchange. When the takeover regulations were rewritten in 2011, it was felt (again, bull-market regulatory thinking) that ignoring the market entirely would not be wise, at least if the shares are “frequently traded”. Therefore, the volume-weighted average price for 60 trading days was taken as one of the factors for pricing. That is old logic. A decade later, it is time to reform.

Linking the minimum open offer pri­ce to market price also incentivises price manipulation in the secondary market. Most M&As are, in any case, at a premium to the market price. In a long-term bear market, irrational pricing by the secondary market could make takeovers expensive, and thereby impair M&A transactions. In the post-Covid world, M&A would be vital for businesses, jobs and even shareholder interests to survive in the long term. This needs serious attention.

On the other hand, the law governing pricing of dilutive preferential allotment would need attention only for stressed companies and not for all companies. A bear phase in the market is indeed a good opportunity for controlling shareholders to pick up shares if they believe in their companies — it would also be a show of confidence. To use the negative zone to expand capital and dilute other shareholders is to be guarded against. On this, Sebi would do well to examine how to reform pricing for stressed companies that can be turned around instead and not get pressured or be carried away to make it easy to dilute shareholders in every single listed company.

The author is an advocate and an independent counsel; Tweets @somasekharS