It was in early August 1997 that Hindustsan Lever (HLL), the largest multinational company (MNC) operating in India, was accused of insider trading in the shares of Brooke Bond Lipton India Ltd. (BBLIL) by the Securities & Exchange Board of India (SEBI). Here we analyse whether HLL needs to worry merely about insider trading accusations or whether it should be pulled up for much more.

Much water has flowed since the allegations of insider trading were made by SEBI on HLL. SEBI issued a show cause notice to the company, HLL asked for additional time and at the time of writing had just submitted its reply. Except for the initial washing of dirty linen in public, matters have calmed down and while HLL might be admonished if it is found guilty I don't really see why SEBI would end up making a spectacle of itself if HLL is found innocent. Any capital market regulator anywhere in the world including the Securities Exchange Commission (SEC) of the USA which probably would be the most experienced in such matters, would surely have done what SEBI did.

But probably the line between the company indulging in insider trading or not is too thin. It might just be that HLL might go Scot-free being absolved of these charges, or that SEBI might still stand vindicated in taking its insider trading stand against the multinational. I would prefer to leave the controversy to reach its logical end at this stage and rather look at the event - of HLL purchase of BBLIL shares - from a different perspective.

To recap the event - HLL purchased eight lakh equity shares of BBLIL from UTI in March and a further 4.7 lakh shares in April/May 1996. The former lot was purchased at Rs 350.35, a premium of 10 per cent on the then market price but before the merger announcement, while the latter lot was purchased again from UTI at a premium of five per cent to the market price, but after the merger announcement was made.

It was on April 19, 1996 that the merger of BBLIL with HLL was announced consequent upon which the boards of BBLIL and HLL decided to go ahead with the scheme of amalgamation of the two companies. Nine shares of HLL were to be exchanged for every 20 shares of BBLIL. As per the scheme of amalgamation, the appointed date for the transfer of business of the erstwhile BBIL to HLL was fixed retrospectively as 1st January, 1996. This date holds a lot of relevance as will be highlighted later.

In the words of HLL, this purchase was made with the express intention of ensuring that Unilever's stake in the merged entity would not fall below 51 per cent. Incidentally, while Unilever held 51 per cent in HLL, it held only 50.2 per cent in BBLIL which would have resulted in a lower than 51 per cent stake in HLL after the merger.

It may be recalled here that in a similar situation at the time of purchase of Tomco, HLL, in order to raise Unilever's stake to 51 per cent, had made a preferential offer to Unilever at a throwaway price of Rs 105 after the merger of Tomco with itself had resulted in a fall in Unilever's stake. An analysis done by us had shown that Unilever would have made a clean profit of Rs 39.46 crore had the preferential allotment been approved by the authorities. But better sense prevailed and HLL/Unilever had to eat humble pie when the Reserve Bank of India (RBI) forced it to pay for the preferential allotment at a higher price. It is now understood that HLL had to recently backtrack when it entered into an out of court settlement with RBI for the preferential allotment of shares to Unilever, Ponds etc. by paying close to Rs 117 crore for the above cases.

It may be noted that (in the words of the HLL Chairman) in order to avoid any `hassles at a later date' Unilever avoided the preferential allotment route (that was followed in the Tomco merger case) to hike its stake. But the point is it used HLL's funds - rather than its own funds - to hike its stake. This raises three important points - (a) to what extent is it fair to use shareholder's funds to hike the promoter's holding, (b) in case there is nothing wrong with (a), does the purchase snot amount to buy back of its own shares - not permitted under the existing Companies Act, 1956 - particularly after the merger announcement has been made, and (c) the loss of foreign exchange to the country if company promoters use such methods to hike their stakes.

It is obvious that for the purchase of BBLIL shares, HLL used shareholder's funds to hike Unilever's stake in HLL. An investment of between Rs 45 - 50 crore (eight lakh shares at: Rs 350 and 4.73 lakh shares at a higher price) was made for the purchase of the BBLIL shares for which HLL or its shareholders did not drive any material gain. As against this, had Unilever paid for hiking its stake in HLL, not only would this amount have been saved in HLL's coffers, it would have acquired sizeable cash flow through the fresh issue of shares to Unilever. Since HLL's shares were then quoted at around Rs 750, the amount that Unilever would have had to invest at the average of six month's prices would have been significant. As against this, the rise in HLL's equity would have been marginal while the addition to the share premium account would have been substantial. The tables give details of the shareholding pattern for both the companies.

From the table it is clear that had HLL not purchased BBLIL shares from UTI, it would have had to further issue approx. 23.60 lakh shares by way preferential allotment to Unilever at the average price of the previous six months, approximately Rs 750 so that Unilever's holding in the merged entity would rise to 51 per cent. The outlay for Unilever would have been a whopping Rs 177 crore while the increase in HLL equity would have been a mere Rs 2.95 crore (to approx. Rs 202.11crore .) as compared to what it is today - Rs 199.16 crore. beside a hefty increase in its reserves.

There is no doubt that as a company, HLL is a highly respected entity, well known for its transparency of operations. It is revered and liked by most shareholders and this is reflected in the high price to earnings ratio its shares command.

Unfortunately both in the HLL-Tomco merger as well as the HLL-BBLIL merger, the HLL shareholders have not really benefited from the high confidence levels and the corresponding high P/E ratio that the scrip commands. What sort of `corporate governance' is it when a company of this stature looks more from its promoter's viewpoint at the expense of that of the common shareholders'. From the accompanying tables it manifests that both the company and the country would have benefited if a preferential allotment at six month's average price had been made to Unilever instead of a market purchase of BBLIL shares. Conversely, Unilever, by virtue of its majority holding is taking decisions that are solely in its own interests and not that of the other shareholders.

It may be argued here that under the new proposed company's Bill which permits buy back of shares, a similar situation is likely to arise where the company's funds would be used to indirectly increase promoter's holdings. What then is wrong with HLL's purchase of BBLIL shares ?

True, but then the key word is `buy back'. After the merger announcement was made in April 1996 with 1st January, 1996 as the effective date, except for the fact that the Court had not approved the merger, would it not amount to buy back of its own shares if HLL purchased the 4.73 lakh shares after the merger announcement was made? By the plain reading of the merger scheme, I would certainly believe so and under the present Companies Act, buy back of shares is not permitted.

Even if one looks at it from the point of view of loss of foreign exchange to the country, the national exchequer lost an opportunity to garner close to US $49.17 million from Unilever even as HLL purchased BBLIL shares from UTI. Statistics show that up to August 4, 1994, when SEBI issued guidelines for pricing of preferential issue of shares, the country lost nothing less than Rs 738.58 crore due to preferential allotment made to foreign collaborators and foreign promoters at a price which was at a substantial discount to the then market price. And this does not include the benefits derived by preferential allotments made to Unilever, Ponds and Stepan Chemicals.

Beneficiaries in this list include worthies like Daewoo Motors (Rs 231.05 crore) and Whirlpool - Kelvinator (Rs 200.34 crore). The Department of Company Affairs needs to be questioned here as to what it was doing when several foreign collaborators were making fancy (though notional) profits at the expense of the Indian shareholders, merely by passing resolutions under section 81(1)(A) of the Companies Act.

In fact if one were to take the argument a little further, statistics also show that the lot of Indian promoters and their associates benefited by nothing less than Rs 6317.37 crore in 479 cases up to November 3, 1994 through preferential allotment of shares to themselves at a discount to the market price. It was at this time that SEBI announced the preferential issue pricing guidelines on August 4 and allowed three months time to companies to comply with their board resolutions (hence statistics up to November 3). Should the DCA not be taken to task for all such cases where the gains have been made at the expense of the shareholders? But then that is another story.

In sum, irrespective of the level of transparency claimed to have been shown by HLL, facts of the case manifest that HLL could have set a better example of corporate governance and should certainly not have compromised the interests of its common shareholders at the altar of financial gains to its promoters. Also, if DCA is proactive, HLL might still get snared under the Companies Act if the buy back of its own shares angle is seriously examined. If this is not a fit enough case for HLL to be pulled up by its shareholders, what is ?

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.