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Aparna Viswanathan
Its strength lies in its simplicity: "No person can be an insider to himself." This is the proposition of law relied upon by the defence for Hindustan Lever (HLL) in the case arising out of HLL's purchase of eight lakh shares in Brooke Bond Lipton India Ltd (BBLIL) before the public announcement of the merger between HLL and BBLIL. Sebi, however, disagreed, and on March 11, ordered the prosecution of HLL and five of its directors on charges of insider trading.
On July 14, the appellate authority of the finance ministry dismissed the Sebi order and said the latter had no reason to conclude that the finding of insider trading was of a degree of seriousness warranting prosecution.However, the Sebi order was correctly based on a simple, but well-accepted, proposition of law: what cannot be done directly cannot be done indirectly.
An "insider" is defined by law as a person who is "connected" with a company and is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitive Its strength lies in its simplicity: "No person can be an insider to himself." This is the proposition of law relied upon by the defence for Hindustan Lever (HLL) in the case arising out of HLL's purchase of eight lakh shares in Brooke Bond Lipton India Ltd (BBLIL) before the public announcement of the merger between HLL and BBLIL. Sebi, however, disagreed, and on March 11, ordered the prosecution of HLL and five of its directors on charges of insider trading.
On July 14, the appellate authority of the finance ministry dismissed the Sebi order and said the latter had no reason to conclude that the finding of insider trading was of a degree of seriousness warranting prosecution.However, the Sebi order was correctly based on a simple, but well-accepted, proposition of law: what cannot be done directly cannot be done indirectly.
An "insider" is defined by law as a person who is "connected" with a company and is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitiveinformation. HLL did not dispute that it was "connected" to BBLIL because of the fact that the two are affiliated companies in the same group. However, HLL argued that it did not access any information by virtue of such connection. Instead, HLL claimed that it received its information independently because it was one of the principal parties to the merger. Therefore, it was not an insider. The appellate authority, too, rightly rejected this view.
HLL claimed that the purpose of the purchase of eight lakh shares was to enable Unilever to acquire 51 per cent of the shares of BBLIL. However, only three lakh shares were required to raise Unilever's holding in BBLIL to 51 per cent prior to the merger. The fact that eight lakh shares were purchased indicates that the real purpose was to increase Unilever's holding to 51 per cent in the post-acquisition entity, that is, the merged company formed by HLL and BBLIL.
Furthermore, Unilever would have had to bring in Rs 45-50 crore in order to raise its stake in themerged company to 51 per cent. Instead, HLL depleted its reserves in order to purchase the eight lakh shares before the announcement of the merger. HLL thus enabled Unilever to raise its equity stake without making a fresh infusion of cash.
The foregoing facts show that HLL was acting on behalf of Unilever and secured an advantage for its holding company. However, if Unilever had directly purchased shares in BBLIL, such a purchase would have clearly constituted insider trading, even according to HLL as Unilever was not a principal party to the merger.
In fact, HLL acted on its behalf and accomplished indirectly what Unilever could not do directly. Such indirect acts attract the same liability as the prohibited direct acts.
The Sebi insider trading regulations (ITR) cannot be interpreted in a manner which contradicts well-established propositions of law. A purchase of shares by HLL on behalf of Unilever cannot be viewed as legal while a direct purchase of shares by Unilever would clearly constituteinsider trading.
In addition, accepting the HLL defence would violate a fundamental concept of Company Law, which is that the management of a company may never act in the interests of only one group of shareholders. Instead, management must take decisions which protect the interests of the company as a whole. That is the basic underpinning of corporate democracy. All the shareholders' interests must be protected, not only a selected few. However, in this case, HLL's purchase of eight lakh shares in BBLIL by depleting its reserves was clearly an act which favoured Unilever's interests at the expense of the interests of its remaining shareholders.
Third, the HLL defence seeks to conceal violations of the legal rules governing preferential allotment of shares contained in Section 81(1A) of the Companies Act. In essence, HLL's purchase of shares in BBLIL, intended to raise Unilever's holding in the merged company to 51 per cent, constitutes a backdoor preferential allotment of shares to Unilever.
As aresult of HLL's share purchase, it was no longer necessary to make a preferential allotment of shares to Unilever at the time of the merger. In fact, notably absent from the HLL-BBLIL merger is any preferential allotment of shares to Unilever as part of the merger agreement in sharp contrast to the 1993 merger between HLL and Tomco.
By disguising the preferential allotment of shares to Unilever as an ordinary purchase of shares by HLL, the company avoided the requirement of passing a special resolution of shareholders as required in Section 81(1A) of the Companies Act. Unilever also avoided having to comply with the pricing formula set forth in the RBI guidelines. Importantly, structuring the transaction as a share purchase by HLL instead of a preferential allotment of shares eliminated the need to obtain any governmental approvals for increasing Unilever's shareholding in the merged company.
In sum, the proposition that no person can be an insider in his own case is not legally sustainable as itcontradicts well-established propositions of law which say that what cannot be done directly cannot be done indirectly. The basic tenets of corporate law requiring management to take decisions in the interests of all shareholders and the legal rules governing preferential allotment of shares were given the go-by. Therefore, it is irrelevant that HLL obtained information regarding the merger because it was one of the parties being merged. Irrespective of the fact that it was a principal party in the transaction, HLL was required under the Sebi insider trading regulations to either publicly disclose the impending merger or refrain from trading. Accordingly, Sebi correctly dismissed the argument that no person can be an insider to himself and found HLL guilty of insider trading.
The author, Aparna Viswanathan, is a corporate lawyer trained at Harvard University and the University of Michgian Law School. She has practised law for the past 10 years in New York City, Los Angeles and New Delhi, and currentlyrepresents international clients at the firm Viswanathan & Co, Advocates, New Delhi.
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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