Draft Companies (Buy-back of Shares) Regulations, 2009: Make buy-back process similar to voluntary delisting

The efforts of SECP in introducing the concept of "treasury shares for the first time in Pakistan, needs to be appreciated. Previously, companies were often reluctant to buy-back their shares, because of the requirement under Section 95A of the Ordinance that such shares must be cancelled, which means that when circumstances change, these companies may have to incur the expense of issuing new shares.
Necessary amendments in the Companies Ordinance 1984 (Ordinance) have now been made to include the concept of treasury shares. Now, our regulatory framework allows a company to repurchase its own shares for various purposes and hold them as treasury shares, and reissue or redeem them without a limited time.
The introduction of treasury shares will give companies greater flexibility to manage their capital structures effectively and to achieve optimum financial gearing without the cost of issuing new shares. The Draft Regulations which propose to replace the Companies (Buy-Back of Shares) Regulations, 1999, provide detailed guidelines in respect of the buy-back process. The Draft Regulations prescribe two methods for carrying out the buy-back process.
I. PURCHASE OF TREASURY SHARES THROUGH TENDER OFFER This procedure involves the purchasing company making a tender offer to all the shareholders at a specific price, which shall remain open for a period of 30 days. The shareholders, interested in selling their shares to the purchasing company, will tender their shares, in book-entry or physical form, to the manager to the purchase. Upon expiry of the offer period, the manager to the purchase will make payment for the shares purchased, and return those shares, which exceed the purchase size.
II. PURCHASE OF TREASURY SHARES THROUGH STOCK EXCHANGE(S) This procedure involves the purchase agent placing bid for the purchase size on the automated system of the tock 'Exchange, and accepting sate orders from shareholders of the purchasing company. The orders will be accepted on first-come-first-serve basis.
However, the purchase agent will not accept more than one sale order from a UIN in a day, and the order shall not exceed 1% of purchase size or 10,000 shares, whichever is lower. However, in our view, both these methods are practically cumbersome and inefficient, and may discourage buy-back activity in Pakistan for the following reasons:
1. Risk of unauthorised use of shares by the manager to the purchase received from the shareholders.
2. Risk of potential error or fraud while returning unsuccessful shares to the shareholders.
3. Excessive share transfer costs will be incurred to the extent of unsuccessful shares returned to the shareholders in the tender offer process.
4. Stringent rule-based criteria for determination of purchase price.
5. The process of routing sate orders through the purchase agent involves significant bottlenecks, and will be highly burdensome for the purchase agent.
6. The condition of maximum sale of 10,000 shares in a single day from a UIN is very restrictive.
7. Risk of counterfeit physical shares being tendered in the offer process, which may cause loss to the purchasing company.
8. Verification of the physical shares will be a very cumbersome and time-consuming exercise for the manager to the purchase and the purchase agent.
9. The purchase agent represents the buy side and the sell-side of all the executed trades, which means that the purchase agent will have no settlement obligation to NCCPL. The entire settlement process will be carried out at the level of the purchase Agent, which may increase risk of potential errors or fraud.
10. The implementation of purchase through stock exchange will require development of a system in order to efficiently cater to the requirements under the Draft Regulations. This extensive development will involve time and costs.
We recommend the following model for the buy-back process, which, to some extent, is similar to the buy-back process followed under voluntary de-listing from the stock exchange.
a) The board of directors of the purchasing company, at its meeting, shall propose the buy-back of company's shares. The said decision of the board of directors shall be communicated to the SECP and the stock exchange(s) on the same day.
b) The proposal for buy-back of company's shares shall be approved by way of special resolution passed by the shareholders in a general meeting held within a period of five weeks of the date of meeting of the board of directors proposing the purchase.
c) The purchasing company shall appoint a purchase agent.
d) The shareholders' approval obtained through special resolution shall remain valid till 180 days. Till the expiry of the said approval, the board of directors of the purchasing company may, at any time, decide to buy-back the approved quantity of shares. The decision of the board of directors shall be communicated to the SECP and the stock exchange(s) on the same day.
A public announcement to this effect shall also be issued by the purchasing company on the next day following the board of directors decision. The purchase period shall commence after seven days of the said decision of the board of directors, and offer for purchase shall remain open for not less than 10 working days.
e) The purchase agent shall ensure that during the purchase period, bids for the purchase are available in the automated trading system of all those stock exchanges on which the purchasing company is listed. The bids shall be made available at the price approved by the shareholders.
However, it is recommended that the purchase price should not be subject to stringent rule-based criteria prescribed under thd4raft regulations. The purchasing company and its shareholders should be allowed flexibility in determination of the purchase price.
f) During the Purchase period, the shareholders pray sell their holdings by placing orders through their stockbrokers, including the purchase agent. The sale orders will be matched with the available bid, and executed trades will be settled through NCCPL.
g) Only book-entry securities should be eligible for sale. Where any person, holding physical shares of the purchasing company, intends to sell the same, the shares must first be converted into book-entry form.
h) A sale order exceeding 1% of the size of the purchase cannot be placed. More than one order with same UIN shall not be entertained on same day. This compliance shall be ensured at the level of each stock exchange by applying automated checks.
i) Risk management regulations of the stock exchange(s) relating to margin requirements shall apply on all such transactions.
j) Sale orders, entered in the automated system of the stock exchange(s), shall be executed based on time priority.
k) Regulation 3(1)(d) provides that after the purchase of treasury shares, free float of the purchasing company shall not be less than certain thresholds. The continued compliance of this criterion is not within the control of the purchasing company.
A company has no control over the float available in the market at any given time, since it cannot control the investment decisions of the Government of Pakistan, directors sponsors, associated companies and associated undertakings. It is not appropriate to impose a condition, whose compliance is not within the control of purchasing company. Moreover, the definition of free float should be reconsidered by SECP and amended in the light of the guidance provided in the document which explains the construction of KSE-3O index.
l) Regulation 10(5) of the Draft Regulations provides that in case of withdrawal of the offer for purchase the purchase agent, in case of purchase through the stock exchange, shall decline and refuse all sale orders made and yet not settled, if any, immediately on intimation of the withdrawal by the purchasing company.
Apparently, this regulations aims to cancel executed, but unsettled trades. In our view, executed trades are valid contracts, which cannot be cancelled or annulled. It may also be noted that in the recent stock market crisis, one of the litigating points was the cancellation of CFS Mk-II trades by the SECP.
We are in concurrence with the provision in the draft regulations which relate to "disposal of the treasury shares" by the purchasing company. However, we would like to highlight the fact that the recent changes in Companies Ordinance, 1984 relating to "treasury shares" will also require changes in the Income Tax Ordinance, 2001. From the perspective of the shareholders, who are selling their shares to the purchasing company, the income may be treated as:
1. Capital gains arising from the disposal of shares of the purchasing company, or;
2. Dividend income, arising from the distribution of un-appropriated profits by the purchasing company. The SECP, in consultation, with the Federal Board of Revenue, should prescribe treatment for the above transaction, which is either more beneficial or at par when compared to the taxation of dividend income.