HLL-BBLIL Merger – A case of Insider trading

Submitted To:Dr. Rashmi Kumar Agarwal

Submitted By:

PGDM FT – B3 Group 6

Pooja Gaddhyan 09FT-124Rhea Ghosh 09FT-126Shirish Ganesan 09FT-145Sushant Agarwal 09FT-158Varun Sethi 09FT-170

Institute of Management Technology, Ghaziabad

Acknowledgement

We are thankful to Dr. Rashmi Kumar Agarwal who is not only our internal training guide but also our professor in-charge of Legal Aspects of Business.

Her consistent support has enabled us to bring this project to its completion.

Abstract:

The case study analyzes the charges of insider trading by SEBI (Securities and

Exchange Board of India) against the merger of HLL (Hindustan Lever Ltd.) and BBLIL

(Brooke Bond Lipton India Ltd.). The legal controversy involved HLL’s purchase of 8

lakh shares of BBLIL two weeks prior to the public announcement of the merger of the

two companies (HLL and BBLIL). SEBI suspected insider trading and conducted

enquiries. After about 15 months, in August 1997, SEBI issued a show cause notice to the

Chairman, all Executive Directors, the Company Secretary and the then Chairman of

HLL. Later in March 1998 SEBI passed an order charging HLL with insider trading.

Insider Trading:

Insider trading is buying and selling of securities by the insider [*] of a company

who has price sensitive information [**] about the company. It can be both legal as well

as illegal. If the material information is made public before insider trading takes place, it

is legal and if it is not made public, it is illegal. The provision is made so, as trading while

having special knowledge is unfair to other investors who don’t have access to any such

knowledge. It also includes the tipping off of such kind of information to select few, who

may gain undue advantage from the fact, and trade in securities there off. Any insider

trading has to be reported to SEBI. It is one of SEBI’s enforcement priorities as it

undermines the confidence of investors and questions the integrity and fairness of

securities market.

Insider trading is dealt with for listed companies only. Company which is not

listed doesn’t come in the purview. Also advisers (merchant bankers) and intermediaries,

involved in the trading come in the purview. It is to be understood that insider trading is

punitive in nature. It means that they describe what constitutes insider trading and then

seek to punish this act in various ways.

Merger:

Merger is the combination of two companies into one larger company. Generally

such actions involve stock swap (A stock swap, also known as a share swap, is a

business takeover or acquisition in which the acquiring company uses its own stock to

pay for the acquired company) or cash payment to the target. In stock swap, swap ratio of

share is decided, which is the ratio in which an acquiring company offers its own shares

in exchange for the target company's share. Merger takes place due to several reasons.

One of the most common and natural reasons for a merger is to eliminate competition.

Also Economies of Scales come into play by way of elimination of duplicate department

and expansion. Sometimes companies also want to venture into a different field

altogether and at other times it wants to control price so as to protect market share and

ensure no new players are able to make an easy entry into the market.

THE CASE:

Parties Involved:

Hindustan Lever Ltd. (HLL) is one of India’s leading FMCG companies with

presence all over India. Its origin dates back to 1885, when the Lever Brothers set up

"William Hesketh Lever", in England. It merged with 'Margarine Unie' (a Netherlands

based company which exported vanaspati to India) to form Unilever in 1930 and in the

coming years it set up three subsidiaries in India. In November 1956, the three Indian

subsidiaries merged to form Hindustan Lever Ltd. (HLL).

Brooke Bond's presence in India dates back to 1903, when Brooke Bond Red

Label tea was introduced. Unilever acquired Brooke Bond through an international

acquisition in 1984. Similarly, Lipton's link with India date back to 1898. Unilever

acquired Lipton in 1972, and Lipton Tea (India) Ltd. was incorporated in 1977. Brooke

Bond and Lipton India merged in July 1993 to form BBLIL.

Events of the case:

The merger of HLL and BBLIL was always on cards. HLL had started

consolidation and BBLIL was a product of this consolidation. So it was not a question

that whether BBLIL would be merged with HLL or not, the only question was when this

merger would actually take place. Before formal announcement only, it was reported by

several newspapers. The events that took place at that time in their chronological order:

HLL purchased 0.8 million shares of BBLIL from UTI at Rs.350.35 per share (At

a premium of 9.5% of the ruling market price of Rs.320). UTI was on the verge of

closing its accounts for 1995-96 and had been selling shares in the market to fund

its dividend payouts. This transaction took place on March 25, 1996, just 25 days

before the HLL-BBLIL merger was announced.

On 19 April 1996, HLL notified the stock exchanges of its proposal to merge

BBLIL. A day after the announcement of the merger, the BBLIL scrip quoted at

Rs.405, thereby leading to a notional gain of Rs.4.37 crore for HLL, which then

cancelled the shares bought, thus igniting the contentious issue. On one corner

was the capital market regulator SEBI, cracking down with India's first-ever

'guilty' verdict for an insider trading offence and on the other hand was Unilever

subsidiary, Hindustan lever ltd (HLL).

On August 4, 1997, SEBI issued a show cause notice to HLL claiming that there

was prima facie evidence of the company indulging in insider trading through the

use of 'Unpublished price sensitive information' prior to its merger with Brooke

Bond Lipton India Ltd. (BBLIL).

In March 1998, SEBI passed an exhaustive order, which sent shock waves

through the country's corporate sector. SEBI found HLL guilty of insider trading

because it bought shares of BBLIL from Unit Trust of India (UTI), knowing that

HLL and BBLIL were going to merge.

Charges and Analysis:

There is a thin line in every action and it’s very difficult to judge whether an insider

trading has actually taken place. SEBI charged HLL of being an insider as in accordance

with section 2(e)[**] of the SEBI (Insider Trading) Regulations. As understood by the

section 2(e), an insider is a person connected to the company and having price sensitive

information by virtue of such connection. SEBI argued that both these conditions were

met when HLL bought the BBLIL shares from the UTI. HLL and BBLIL had a common

parentage as subsidiaries of the London-based $33.52-billion Unilever and were then

under a common management. Thus, HLL and its directors had prior knowledge of the

merger. Also both HLL and BBLIL were deemed to be under the same management even

under Section 370 (1)(b)[***] of the Companies Act, 1956.

“No company can be an insider to itself”. HLL argued that the transactional

knowledge of the merger was because it was a primary party to the process, and not

because BBLIL was an associate company. To underpin this point, HLL maintained that

if it had purchased shares of Tata Oil Mills Co. (TOMCO) before the two merged in

April, 1994, SEBI would not consider it a case of insider trading only because it was not

associated with TOMCO.

But then here even if it is considered that HLL and BBLIL were not involved in

any way other than merger, it can be said with surety that HLL-BBLIL merger was going

to take place. It happens that deal in speculation may get cancelled due to unfavorable

terms. But then the timing of the deal also has to be considered. Just two weeks before

merger, it can be speculated that the company was about to finalize the deal. Such a

“coincidental” timing of a deal, even if between HLL and any shareholder of TOMCO

would have raised questions about management’s intention. BBLIL being an associate

company, only added to such charges and also gave conformity to the whole situation. So

although the point raised by HLL is true, the timing of deal cannot be ignored.

Also the merger could have been cancelled if TATA Oil Mills Co. didn’t find the

terms of mergers to be actually acceptable. This was not so in this case. HLL was aware

of the merger as the managing team was same for both companies and no uncertainty was

prevalent. So it was an insider in this case. Also, if merger of BBLIL would have taken

place with another company not related to Unilever, then also HLL would have been

aware of the merger.

SEBI accused HLL of dealing with BBLIL shares on the basis of unpublished

price-sensitive information which is prohibited under Section 3[****] of the Regulations.

Section 2 (k)[*****] states that unpublished, price-sensitive information relates to

amalgamations, mergers, and takeovers or is of concern to a company and is not

generally known or published. SEBI held that there can be no dispute that the information

of the overall fact of the merger fell under this definition. 

HLL argued that only the information about the swap ratio is price-sensitive and

this ratio was not known to HLL or its directors when the BBLIL shares were purchased

in March, 1996. It further argued that the news of the merger was not price-sensitive as it

had been announced by the media before the company’s announcement. HLL also

pointed out that it was a case of a merger between two companies in the group, which had

a common pool of management and similar distribution systems. Therefore, the merger

information in itself had little relevance; the only thing that was price-sensitive was the

swap ratio.

When HLL argues that it had a common management, it is itself admitting in a

way of fact that it was an insider as it had sensitive information that merger was a surety

and was impending. Also though the market was aware that such merger will take place,

the certainty of event in near future was questionable to the outsider. A company cannot

perform its day to day activities on the basis of mere speculation that an event will take

place in future without being ascertained of its timing. So fingers cannot be raised on UTI

that it should have been aware. Also HLL said that merger was “generally known”. If a

company takes such kind of decision, it is important that shareholders are made aware of

the fact which was not so in this case. Also BBLIL didn’t make it clear to UTI as a major

shareholder that a merger was on the way. Also when merger takes place, it is not only

the swap ratio which is price sensitive but other aspects, like terms and conditions of

merger, evaluation of company, current market share price, all are important. So it cannot

be said with certainty that only swap ratio was price sensitive.

HLL contended that it purchased the BBLIL shares so that its parent company,

Unilever, could maintain a 51 per cent stake in the merged entity. Before the merger,

Unilever had a 51 per cent stake in HLL, but only 50.27 per cent in BBLIL. Thus, the

HLL management felt that the SEBI should consider if it had any additional information

which it should not, legitimately, have had as a transferee company in the merger.

SEBI alleged that if Unilever wanted to keep its stake constant in HLL, then why

it not followed the path of preferential allotment of shares to raise its stake. As per the

SEBI charge sheet, such a step would have involved various compliances/clearances, and

required Unilever to bring in substantial funds in foreign exchange. The implication:

HLL depleted its reserves to ensure that Unilever did not have to bring in additional

funds.

HLL argued that issuing of preferential share would have been a cheaper option to

ensure that it had a 51 per cent stake in HLL. If HLL followed this route, it would have

had to pay Rs.282.35, instead of Rs.350.35, per share. In other words, it would have

made a profit of Rs.5.41 crore by doing so. HLL also stated that while the preferential

route would have been beneficial for itself, it would have been dilutory for other

shareholders since it would have resulted in an expanded capital base, leading to lower

earnings per share in the future. Also HLL defended itself by pointing out that SEBI had

to establish the financial benefit from the transaction in order to prove an insider trading

charge. It pointed out that though establishing "financial benefit" was not explicit in the

law, it was implied, because the act said that it should be taken into account when levying

penalties.

It is true that the issue of preferential share was a cheaper option but it cannot be

ruled out that it would have meant foreign investment from Unilever in India. Instead

HLL followed the route of depleting its reserves which would generally have been

remained untouched by parent company unless warranted by business needs. Also it was

more convenient for Unilever to follow the path as clearance for preferential allotment

from SEBI and the Reserve Bank of India (RBI) would have taken its own course of

time.

SEBI argued that Levers cancelled the entire holding of HLL in BBLIL. HLL

agreed to the point that the shares had been bought back with the sole intention of

increasing the stake of HLL in BBLIL. It was planned that the shares would be

extinguished after the buyback to increase the value of shares still available (reducing

supply). By the process of amalgamation which happened in the merger, the voting rights

of Unilever went up and in the process the rights of shareholders have also been propped

up.

By extinguishing shares, HLL wanted to maintain Unilever’s shareholding at 51%

and not realize any financial gains. However, section 3 clearly defines insider trading

irrespective of the fact whether profits have been made or not.

Conclusion:

It is very difficult to conclude as to whether HLL was an insider or not and

whether insider trading actually took place. In this case however it can be drawn, that

merger was price sensitive information which would have affected UTI’s decision of

selling share had it been aware of such merger. It would have then waited for better

valuation which was a surety. Also HLL depleted its own reserves to buy the shares for

one privileged shareholder, Unilever. That in itself is a sin in corporate governance -

favoring one set of shareholders at the expense of others. Moreover, HLL's action

violated the legal proposition that, what cannot be done directly cannot be done

indirectly.

Footnote:

[*] – Section 2(e) SEBI (Prohibition Of) Insider Trading Regulations, 1992 defines

insider as : “insider” means any person who, is or was connected with the

company or is deemed to have been connected with the company, and who is

reasonably expected to have access to unpublished price sensitive information in

respect of securities of company, or who has received or has had access to such

unpublished price sensitive information;

[**] – Section 2(ha) SEBI (Prohibition Of) Insider Trading Regulations, 1992 defines

price sensitive information as : “price sensitive information” means any information

which relates directly or indirectly to a company and which if published is likely to

materially affect the price of securities of company.

Explanation - The following shall be deemed to be price sensitive information:

1. periodical financial results of the company;

2. intended declaration of dividends (both interim and final);

3. issue of securities or buy-back of securities;

4. any major expansion plans or execution of new projects;

5. amalgamation, mergers or takeovers;

6. disposal of the whole or substantial part of the undertaking; and

7. significant changes in policies, plans or operations of the company;]

[***] - Section 370 (1)(b) of the Companies Act, 1956 : two bodies corporate shall be

deemed to be under the same management-

(i) if the managing director or manager of the one body, is-

(a) managing director or manager of the other body; or

(b)

(c)

(ii) if a majority of the directors of the one body constitute, or at any time within the six

months immediately preceding Constituted, a majority of the directors of the other body;

[or]

[(iii) if not less than one-third of the total voting power with respect to any matter relating

to each of the two bodies corporate is exercised or controlled by the same individual or

body corporate; or

(iv) if the holding company of the one body corporate is under the same management as

the other body corporate within the meaning of clause (i), clause (ii) or clause (iii); or

(v) if one or more directors of the one body corporate while holding, whether by

themselves or together with their relatives, the majority of shares in that body corporate

also hold, whether by themselves or together with their relatives, the majority of shares in

the other body corporate.]

[****] – Section 3 SEBI (Prohibition Of) Insider Trading Regulations : No insider shall

—

(i) either on his own behalf or on behalf of any other person, deal in securities

of a company listed on any stock exchange 17[when in possession of] any

unpublished price sensitive information; or

18 [(ii) communicate counsel or procure directly or indirectly any unpublished

price sensitive information to any person who while in possession of such

unpublished price sensitive information shall not deal in securities :

Provided that nothing contained above shall be applicable to any

communication required in the ordinary course of business 19[or profession or

employment] or under any law.]

20

21[3A. No company shall deal in the securities of another company or associate of that

other company while in possession of any unpublished price sensitive information.]

[*****] – Section 2(k) SEBI (Prohibition Of) Insider Trading Regulations: "unpublished

price sensitive information" means any information which relates to the following

matters or is of concern, directly or indirectly, to a company, and is not generally known

or published by such company for general information, but which if published or known,

is likely to materially affect the price of securities of that company in the market –

(i) financial results (both half-yearly and annual) of the company:

(ii) intended declaration of dividends (both interim and final);

(iii) issue of shares by way of public rights, bonus, etc.;

(iv) any major expansion plans or execution of new projects;

(v) amalgamation, mergers and take-overs;

(vi) disposal of the whole or substantially the whole of the undertaking;

(vii) such other information as may affect the earnings of the company.

(viii) any changes in policies, plans or operations of the company.

References:

http://www.thehindu.com/fline/fl1516/15161070.htm

http://www.rediff.com/money/aug/05hll.htm

http://www.icmrindia.org/casestudies/catalogue/Finance/Case%20of%20insider

%20trading%20-%20HLL-BBLIL%20Merger%20-%20Finance.htm

http://www.vakilno1.com/bareacts/companiesact/s370.htm

http://www.investopedia.com/terms/s/swapratio.asp

http://www.sebi.gov.in/acts/act081.pdf