Bulk Deals and Order Matching

The availability of income tax exemptions (on long term capital gains) for share transactions that are executed through stock exchanges have caused otherwise negotiated share sale and purchase deals to be implemented through the stock exchange mechanism. This would require parties to bear only the securities transaction tax (STT) at rates which are negligible compared to the erstwhile capital gains tax that would have applied to such deals.

In his blog, Professor J R Varma has an interesting post that deals with some practical issues that arise while putting a negotiated bulk deal through the stock exchange mechanism. Specifically, there is the likelihood of a leakage of some shares owing to orders that are placed at the same time by other purchasers in the market. Professor Varma notes:

“It is quite clear that it is possible to do a large trade on the exchange at any price if one is willing to burn through the whole order book and thus share part of the “control premium” with these orders. For example, suppose the current market price is 100 and there are sell orders at prices ranging from 100-110 for a total of say 500,000 shares. The promoter puts in a limit sell order for 100 million shares at a price of 127 and the acquirer immedately thereafter puts in a market buy order for 100 million shares. The market order would first burn through the entire pre-existing order book of 0.5 million shares and then execute the remaining 99.5 million shares against the sell order of the promoters at 127. The only problem is that 0.5 million shares would have been bought at prices above the market price of 100 and this is a small price to pay in relation to the tax that is saved.”

The other problem identified relates to fraudulent and unfair trade practices under the SEBI Prohibition of Fraudulent and Unfair Trade Practices Relating to Securities Market Regulations, 2003. This would arise if the market places sell orders at high prices in anticipation of acquirers executing bulk deals on stock exchanges. Professor Varma notes here:

“The first problem is that if the whole world can see that this is what is going to happen, it makes sense for anybody who holds Ranbaxy stock to put in limit sale orders at a price of 125 or 126 to take advantage of the bulk deal whenever it happens.

I am not sure how regulators would look at this issue, because on the one hand, the trade of 100 million shares is a genuine and legitimate trade. On the other hand, it does create a false market and does artificially inflate the price for a short period of time. To this extent, it does appear manipulative.”

While there may be a possible exposure to the regulations that prohibit fraudulent and unfair trade practices, it is often extremely difficult for regulators to succeed in an action under these regulations, for the element of ‘mens rea’ is a necessary ingredient of an offence under those regulations, and proving ‘means rea’ especially in secondary market transactions is an onerous task.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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