Opportunistic Delisting in the Times of Covid-19: Need for Checks and Balances

[Tanvi Prabhu is a IV year student and Mansi Mishra a III year student, both at National Law Institute University, Bhopal]

With Covid-19 adversely affecting the markets, stocks are trading at multi-year lows. Companies, investors and shareholders are enduring the brunt of a bearish market. But, unsurprisingly, a few companies are embracing this opportunity to exit the stock market completely. Recently, Vedanta Ltd., a Nifty 50 stock, announced its voluntary delisting and is presently seeking approval from public shareholders. Not far behind, Adani Power has also announced consideration of a delisting proposal, as has Hexaware Technologies. Reports also suggest that United Spirits and several other companies are planning to delist. Historically, multiple companies have delisted during recessions, as the harsh economy outweighs the benefits of remaining listed. However, a fundamental question arises: are these firms being opportunistic by delisting during a recession causing pandemic, taking advantage of the uncharacteristically depressed stock prices? If so, what protections, if any, are present or can be introduced into the SEBI (Delisting of Equity Shares) Regulations, 2009.

The Good and Bad of Voluntary Delisting

Voluntary delisting is essentially a strategic move resorted to when a company’s shares are trading extraordinarily below its intrinsic value wherein the company can regain complete control by becoming private at a subsidised cost. Another major advantage is the saved cost of listing, i.e., the cost of compliances that a company has to incur under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and bye-laws of the stock exchanges, which seem unjustified due to low market capitalization. From the remaining shareholders’ point of view, delisting serves the benefit of increased earnings per share and being rewarded with substantial returns.

However, there are certain downfalls associated with the process as well, both from the company’s and investors’ point of view. Voluntary delisting prevents the company from raising funds from the public for at least five years. It is harmful to minority shareholders and can cause loss of goodwill, trust and transparency in the company from all stakeholders. Additionally, the mere announcement of delisting drives the price of the securities into a free fall, hampering its liquidity and risking crashing of the stock altogether. This causes long-term losses to the shareholders by bringing down the expected delisting offer price. In case no consensus is reached between the promoters and the shareholders on the price, then consequent failure of the delisting offer results in irreparable harm to both.

Voluntary Delisting Process and the Lacunae Therein

Board and Shareholder’s Approval

A voluntary delisting of a company from all recognised stock exchanges under regulation 8 of the SEBI Delisting Regulations begins with the company’s board of directors approving by resolution the delisting proposal presented by any promoter. The company informs the stock exchanges of this approval, and discloses all relevant information including an indicative offer price for the shares and seeks public shareholder approval through a postal ballot. For the delisting proposal to go ahead, under regulation 8(1)(b), the number of votes cast by public shareholders voting in favour must at least be twice those voting against it.

Due Diligence by Merchant Banker

Before obtaining the approval of the board of directors for delisting under the SEBI Delisting Regulations, a company is required to appoint a merchant banker under regulation 8(1A) for carrying out due diligence. The merchant banker then has to conduct due diligence to certify that the company has carried out transactions in accordance with the provisions of securities laws, and that there is no wrongdoing on part of the promoter group and the persons acting in concert. During this pandemic crisis, the surge of companies delisting may point towards possible faults in due diligence owing to the timing and practical difficulty of conducting due diligence in the Covid-19 situation. The added risk of the company being opportunistic is aggravated by possible conflicts of interest on the part of merchant bankers who may rush to present a clean chit for delisting. Although there is no fixed time period or a straitjacket formula for due diligence by merchant bankers, the delisting regime should provide for minimum standards to be discharged for thorough due diligence in order to rule out any neglect or connivance.

In-principle Approval from Stock Exchange

As the next step, the company must also request an in-principal approval from the respective stock exchanges in terms of regulation 8(1A)(2). This mechanism does not facilitate or mandate any active scrutiny of affairs by the stock exchanges apart from basic statutory compliances.  Interestingly, there is no safeguard involving approval by the Securities and Exchange Board of India (SEBI) here. There is a requirement that the board of directors certify that the delisting is in interest of the shareholders which, which it may do by referring to the merchant banker’s report. But, there is an absence of any recommendation being provided by any independent authority, specifically the independent directors. In comparison, rule 1309 of the Singapore Stock Exchange Rulebook rules require the opinion of an independent financial adviser that the exit offer given to minority shareholders is reasonable and fair. Recently, SEBI released a discussion paper for easing the delisting norms for subsidiaries of holding companies wherein it has suggested obtaining in-principle approval from both the stock exchange as well as SEBI. This safeguard of expediency could also be employed in a delisting during recession. The authors further suggest inserting a provision for constitution of a committee of independent directors and independent financial advisors for opining as to whether delisting is indeed beneficial to the shareholders or not.

Price Determination

The most contentious part of a delisting, i.e., the offer price, is determined via shareholders’ bids in accordance with the reverse book building process under regulation 15 and schedule II of the Delisting Regulations. It is of utmost importance to ensure that this price be fair and not cause undue loss to shareholders. During a recession, due to the undervalued stock, the delisting floor price calculated with reference to regulation 8 of the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 is very low compared to its book value. Further, such floor price is completely detached from its intrinsic value, i.e., anticipated value indicating future benefits of the stock. Due to the low floor price and deteriorating market scenario, powerless shareholders are compelled to bid lower, giving up their share for way lesser than the book value, without considering the losses faced in comparison to the intrinsic value of the stock. More often than not, retail individual investors are unable to exercise their right to vote or bid due to lack of proper information or exigent circumstances. Additionally, if a major chunk of the public shareholders consists of institutional investors or high net worth individuals, there is a likelihood of lobbying or private transactions that could swing the prices adversely.

Moreover, the acquirer is not bound by this discovered and it can, under regulation 16, make a counter offer not lower than the book value of the company. However, the authors argue that the book value alone may not be an appropriate metric. In times of recession, book value of companies can reduce drastically, similar to Vedanta’s book value reducing from Rs.185 to Rs.146 which is reversible in the long term, whereas intrinsic value remains unaffected. We suggest valuation by independent valuers registered with SEBI, the introduction of a price range based on intrinsic and book values and a requirement of obtaining a no objection from SEBI on the price, which will all go a long way in securing a realistic and fair valuation for investors’ protection in an opportunistic delisting.

Closure of Delisting

Upon the determination of the final offer price by reverse book building or by a counter offer, the tendered shares are accepted by the company and the shareholders receive their consideration. The remaining delisting process is completed in approximately a year in accordance to relevant statutory compliances.

Conclusion

The current surge in companies opting for voluntary delisting owing to the economic downfall does not come as a surprise. This trend is now gradually expanding to information technology companies and other major sectors as well. Even though SEBI issued circulars and altered various regulations and compliances in order to tackle the impact of the Covid-19 crisis on the Indian capital markets, the arena of delisting also calls for immediate attention. Measures to ensure honest due diligence by merchant bankers, control of acquirers’ offer price to secure fair value as well as preventing stock manipulation for delisting in a crisis will protect minority shareholders, retail investors and all stakeholders in the capital markets at large. Therefore, it would be interesting to see what measures SEBI will take in order to make SEBI Delisting Regulations ‘fit’ for this pandemic.

Tanvi Prabhu & Mansi Mishra

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