Buyback blues

The Securities and Exchange Board of India’s move to reject Larsen and Toubro’s proposal to buy back part of its shares sends the signal that the regulator is vigilant about protecting investors’ interests and improving corporate governance. The engineering behemoth had sought the permission of the regulator to purchase 6.1 crore shares from its shareholders at price of ₹1,475 per share, amounting to ₹9,000 crore last October. The stated intent of the company, behind the share purchase, was to improve shareholder return by purchasing the shares above the traded price. This buyback has, however, been rejected by the regulator on the grounds that the company’s consolidated debt-to-equity ratio after the buyback would be above the limit stipulated in the regulations.

The company cannot refute the regulator’s objection, since the regulation is so worded that it is open to several interpretations. The company has stated that it considered the post-issue debt-to-equity ratio of the standalone entity before moving the proposal forward. With the parent entity holding negligible debt on its books, the ratio after the issue was well within permissible limits. But SEBI has considered the debt of the consolidated entity, including the share of the subsidiaries to conclude that the company has failed the post-issue debt-equity ratio test. SEBI’s buyback of securities regulation, 2018 as well as the Companies Act, 2013 require that the ‘aggregate’ secured and unsecured debts owed by the company after the buyback and the paid-up capital and free reserves be used for arriving at the debt equity ratio. The word ‘aggregate’ is open to interpretation here as it could mean either, the total secured and unsecured debt of the standalone entity, or consolidated debt, as SEBI has argued in this case. The regulator cannot be faulted for taking a more holistic view of the group finances after the recent experience in the IL&FS issue where most creditors and credit rating agencies had erred, considering only the standalone numbers. A better scrutiny of numbers by the regulator is certainly welcome.

However, Larsen and Toubro was not wrong in interpreting the buyback rules as referring to the debt and equity of the parent alone. Rules and regulations need to be spelled out in an unambiguous manner so that companies and investors are not needlessly misled. Investors who would have already purchased shares of the company in anticipation of the buyback stand to lose. Similarly, the company will have to look at alternative routes to reward its shareholders, which might not be as tax-efficient as share buyback. It would also help if the regulator took a closer look at the composition of the group debt to see if the numbers were elevated due to the nature of business of a group company. SEBI needs to issue a circular removing the ambiguity in the rules, spelling out which numbers companies should consider in buyback issues and exceptions to the rules, if any.

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