Ministry Opposes Sebi Proposal On Share Buyback

The buyback proposal was made by Sebi chairman D R Mehta to the finance ministry recently with a view to boosting the sagging capital markets. Mehta has written to the ministry recommending the introduction of buyback of shares by promoters to lift market sentiment, which has remained depressed despite a series of measures announced by the government and Sebi.

However, the ministry fears that the dividing line between buyback and price-rigging is so thin that Sebi's existing level of market intelligence set-up would be inadequate to monitor buybacks.

Though "limited" buyback (with safeguards) is likely to be included in the amended Companies Act, Mehta has argued that buyback by promoters can be permitted immediately if the trust route is opened up.

 

At present, share buyback by companies is permitted under company law, provided the equity reduction is sanctioned by high court. But this is time consuming and cumbersome, and hence unsuited to meet the immediate requirements of corporates. Trusts, too, are permitted to buy shares. Mehta has suggested that promoters can be permitted to set up trusts expressly for the purpose.

The ministry has said that it recognises the importance of buyback as a tool for capital restructuring which can be achieved when the shares bought back are extinguished and not retained for reissuance. It says if shares were allowed to be retained, the company could reissue them at will without seeking the required Sebi clearances. The finance ministry had opposed buyback on the same grounds when the DCA had circulated the recodified companies bill for comments.

Mehta has suggested to the ministry that a tripartite meeting be called to formulate measures to allow for buyback. Capital market experts and intermediaries, too, have argued repeatedly that irrespective of the legal position, buyback is a normal market practice particularly by promoters before a public issue.

An equity reduction shores up the share value. If promoters resort to this practice in a depressed market, it would lifting the index and overall market sentiment. It is also not uncommon -- though illegal -- for promoters to shore up their share prices in the face of price hammering by bear cartels on the eve of expansion plans, joint venture agreements, tie-ups, and mergers and acquisitions.

With the institutionalisation of the capital markets, price hammering has moved out of the realm of the domestic broker to the institutional players, but experts argue that it would be better to legalise the practice subject to tight regulations rather than letting it flourish clandestinely.

Buyback is particularly beneficial to companies which have a bloated equity. It permits the fresh issuance of equity at a later date at a higher premium rather than at present when the value of the share stands eroded on account of a large base.

Such companies can also explore the possibility of expansion through equity post-reduction, failing which they are totally dependent on debt as the only means of funding expansion. Hence the advantage of moving in and out of equity and debt in response to changing return on capital is lost to such companies.