Not another ‘fantastic’ non-compete fee

In the Idea – Spice deal, announced yesterday in the media, Idea is expected to pay Rs. 543 crores (Rs. 5.43 billion) as non-compete fees to promoters of Spice.

This works out to the suspicious number of 24.99%, the maximum allowed by SEBI regulations.

An interview of Kumar Mangalam Birla (of Idea) in the Business Standard states:

Isn't the non-compete fees of Rs 544 crore to BK Modi a bit high?

The non-compete fees is nothing unusual and we believe that it is very much in line with the industry and Sebi norms. The debt of Spice Communications, which is around Rs 1,000 crore, is also coming to Idea Cellular's books.

I would think the price would be lower if a large debt is assigned to the acquirer, not higher or selectively higher. Also SEBI regulations put a cap on the non-compete fees – it should not be seen as a permission to exchange favours in the guise of non-compete so as to short change other shareholders. In fact SEBI has over the past year or more rejected most of the non-compete payments (most of which are suspiciously 24.99% exactly), or rather asked the acquirer to pay the same to other shareholders as well.

Spice is not a profitable company, it seems to have made some odd non-operating profits out of "Profit on Sale of Passive

Infrastructure" in 2007. The notes to the accounts available on the company website do not explain what this fantastic profit is. Excluding the extraordinary profit, the company is consistently making large losses. It only operates in two circles, and even in Punjab, where it has a higher share it only controls 23% of the market. In the other circle, Karnataka, it controls 10% of the market. While the company is optimistic (and has got some other circles) about a pan-India presence, the spectrum scarcity means that it is nearly impossible for a new player to get such a presence. Clearly, this does not even offer any remote competition in the future to the big players (including Idea), particularly with the entry barriers of the industry. The brand name 'Spice' is being phased out as well according to media reports.

Clearly, the 'non-compete' fee is being paid for some reasons other than buying off future competition. SEBI should clearly mandate the acquirer to pay the same per share price to the other shareholders. It is also time the Board repeals this exemption which is being misused 90% of the times.

Delisting for violating anti-competitive laws

A news report states that the Competition Commission of India (CCI) has written to SEBI asking it to a) include compliance with anti-competitive behaviour a violation of the listing agreement b) the consequence of such violation could potentially result in delisting of the company.

While a) is debatably unacceptable, b) should clearly be rejected by the securities regulator.

Accepting the first proposal would open the floodgates to every other regulator/governmental body asking for similar rights. Imagine having a clause in the listing agreement which bars companies from evading taxes based on a recommendation by the Central Board of Direct Taxes (CBDT) to SEBI. The effect of such insertions would be that for violations of various assorted legislations and even delegated legislations, SEBI would need to take corrective steps even though it has no competence or jurisdiction to determine if a violation had occurred. In the same example, SEBI would need to rely on the competence of the tax authorities based on which it would take enforcement action. This is both a convoluted form of enforcement and is the wrong means of dividing investigation (with CCI etc.) from enforcement (with SEBI) across two agencies neither of which have any formal duty to each other.

The second proposal is even less acceptable. Delisting is a very difficult remedy for a securities regulator. When a company stops substantial compliance with the various enactments including the listing agreement, the regulator (or the exchange) could possibly either take penal action or delist the company. Were the company to be delisted, the non-control shareholders lose any possible exit option. Often the company deliberately violates the norms so that they can be delisted without a need to pay the shareholders the share price as determined by reverse book building method (which applies to the voluntary delisting process). While the promoters get a freer hand in committing further misconduct, the other shareholders suffer the lack of an exit option. Thus in the cartel context, a cartel operator company's management may in fact be happy with the delisting which would result from such violation – thus the violator gets twice the bang for the buck.

SEC & SEBI appointments

Corporate debt market – the last of the R.H. Patil Recommendations implemented by SEBI

The third big ticket regulation – one simplifying the issue and listing of corporate debt securities is notified. It has been put on the SEBI website only today, though the notification shows it as 6^th June 2008. The SEBI (Issue and Listing of Debt Securities) Regulations 2008 rewrites the entire regulatory philosophy of regulating debt securities where the equity of a company is already listed. Since extensive set of disclosure norms are already prescribed, the philosophy is to give a light touch set of regulations and disclosures – and virtually make the issue shelf. Of course, the liabilities for misstatement etc of merchant bankers and other intermediaries is not diluted. The point of the regulation is to encourage private placement of corporate debt followed by listing in the markets. Even if there is a public issue by a company whose equity is listed, the burdens are substantially lowered for the reason cited above – though compliance with Schedule II disclosure as mandated by the Companies Act 1956 cannot be and is thus not diluted – but at the same time is made principle based. A reasonable explanation is given in the press release of today. To get a fuller idea, see the consultative paper issued when the draft regulations were exposed for public comment – the philosophy of that paper is retained in full in the final regulation.

Bulk Trade in Ranbaxy

Prof. Jayanth Varma has a thoughtful piece on exchange microstructure with respect to the Ranbaxy deal executed on the exchange. I have a few comments on the piece.

"The first problem is that if the whole world can see that this is what is going to happen, it makes sense for anybody who holds Ranbaxy stock to put in limit sale orders at a price of 125 or 126 to take advantage of the bulk deal whenever it happens."

A "Bulk" deal is a regular market transaction and if the broad Ranbaxy agreement is not public domain the problem can be escaped. All relevant disclosures under the Bulk Deal circular are end of the day. Similarly, insider trading and takeover regulation details are also post facto. So I don't think this is a problem (only if the agreement is not in public domain) as the specific trade date/time are not required to be disclosed. While there will be some minor leakage on the order book this would not be prohibitive in cost. As this is a very small cost to escape huge tax liabilities, it is the only way to transact such a deal. However, in the present case, the deal was in the public domain, so anyone putting limit orders each day, waiting for the negotiated deal to occur could make the extraordinary profit as pointed out.

If it is such a no brainer, I wonder if a look at the limit order book each of these days would reveal such a pattern in Ranbaxy over the past few days (though nobody outside the surveillance cells of the exchange/SEBI would be able to throw light on the size of the limit order book). My guess is, there will not be a prohibitive limit order book these days in Ranbaxy for the following reason. The buyer and seller in the deal can hold out for a few weeks if not a few days. This would tire out and possibly destroy the strategy of shorts (short sellers) who having sold stock though will be unable to profit from a lower price as the unspecified event has not materialised. Coupled with a limited market for borrowed stock, the limited amount of time available for a borrowed position (7 days if I recall right) and a virtual prohibition against a naked shorts (making them very expensive if delivery stocks cannot be found), the strategy is unlikely to be profitable. Ordinary limit order traders would also be faced with fatigue after a few days and also "dummy filters" will not allow them to enter orders way out of whack with current prices, further limiting their strategy.

I am certain that here is no issue of manipulation of the market merely because the negotiated price exceeds the current market price. Manipulation centres around intent rather than knowledge. So even if a large buyer or seller in a market may know that his/her trade will have a big impact on the prices, his/her trade would not be manipulative. Manipulation only occurs where there is an intentional interference with the free forces of demand and supply.

I am also pro the Securities Transaction Tax till such time as Mauritius and other such abusive tax treaties are repealed. I see no reason why an Indian should be penalised with large capital gains tax when any other person in the world, setting up a shell company, in Mauritius is exempt. STT only puts the Indians at a level playing field as foreigners have been using the treaty to skip capital gains since the early 90s. From an interpretational viewpoint of tax laws, tax law and equity are strangers and an equitable interpretation view is not a valid tool to interpret tax laws. Thus STT is not available to very legitimate transactions like sponsored ADRs or tender offers, while it is available to per se non exchange transactions like Ranbaxy.

New SEBI Regulations escape press coverage

Looks like two of the big ticket regulations of SEBI have totally escaped the notice of the press – one revamping the regulatory framework for registration and regulation of securities intermediaries and the 'enquiry' process for disciplining intermediaries – the SEBI (Intermediaries) Regulations 2008. A consultative paper and the draft regulation at the time of issuing these for public comment explains the purpose of this complex task.

 

The other is introduction of a regulatory framework for securitised debt, SEBI (Public Issue and Listing of Securitised Debt Instruments) Regulations 2008.

 

SEBI has not come out with a press release and the 26^th May notification appears to have been put up only recently – probably explains why it's not covered. Both were work in progress for a long time given their complexity and the recent sub-prime issues.

Ranbaxy sale – capital gains

Today's Times of India asserts that SEBI and the tax authorities may not allow previously negotiated sale of shares to be executed via the stock exchange as it will escape capital gains (though the transaction will be subject to Securities Transaction Tax - STT). To the best of my understanding, SEBI does not take any views on where a transaction occurs – if at all SEBI would prefer transactions to occur on the exchanges. There is reverse analogy to sponsored ADRs not being given benefit of STT because they don't occur on exchanges.