While SEBI's  ruling is, technically, damning, HLL is taking its defence to the people.

By Roshni Jayakar & Chhaya

The Ides Of March have come a-visiting the Rs 8,342.75-crore Hindustan Lever Ltd (HLL). On March 11, 1998, the Securities & Exchange Board of India (SEBI) finally proved that it could bite. In a landmark verdict--the first since the promulgation of the SEBI (Insider Trading) Regulations, 1992--the SEBI pronounced HLL guilty of insider trading, and ordered the prosecution of HLL, and its five directors, including chairman K.B. Dadiseth.

Predictably, HLL has decided to appeal against the SEBI verdict to the Union Ministry of Finance, the appellate authority in such cases. Will HLL's defence be vindicated, or will the SEBI charges hold? BT examines the issues.

THE BACKGROUND: The SEBI's charges were triggered off by HLL's purchase of 8 lakh shares of Brooke Bond Lipton India Ltd (BBLIL) from the Unit Trust of India (UTI, 1996-97 income: Rs 7,481 crore) at Rs 350.35 per share. This transaction took place on March 25, 1996, before the HLL-bblil merger was announced on April 19, 1996. 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.

THE SEBI CHARGE: HLL is an insider, according to Section 2 (e) of the SEBI (Insider Trading) Regulations. It states: "An insider means any person who is, or was, connected with the company, and who is reasonably expected to have access, by virtue of such connection, to unpublished price-sensitive information." The SEBI has 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. Agrees L.V.V. Iyer, 43, a Hyderabad-based corporate lawyer: "Both HLL and BBLIL are deemed to be under the same management even under Section 370 (1)(b) of the Companies Act, 1956."

THE HLL DEFENCE: No company can be an insider to itself. The transnational's knowledge of the merger was because it was a primary party to the process, and not because BBLIL was an associate company. To buttress this point, HLL maintains 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. Why? Because HLL was not associated with the Tata-owned TOMCO.

HLL contends 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 feels 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.

According to the SEBI guidelines, HLL can be deemed to be an insider. But the SEBI's definition of an insider has to be fleshed out by it to provide a clearer picture.

THE SEBI CHARGE: HLL dealt in, or purchased, the BBLIL shares on the basis of unpublished price-sensitive information which is prohibited under Section 3 of the Regulations. Section 2 (k)(v) states that unpublished, price-sensitive information relates to "the following matters (amalgamations, mergers, and takeovers), or is of concern to a company and is not generally known or published " According to the SEBI, there can be no dispute that the information of the overall fact of the merger falls under this definition.

THE HLL DEFENCE: Only the information about the swap ratio is deemed to be price-sensitive. And this ratio was not known to HLL--or its directors--when the BBLIL shares were purchased in March, 1996. The two audit firms, S.S. Billimoria & Co. and M.N. Raiji & Co., recommended the ratio to the HLL board only in mid-April, 1996. Moreover, HLL argues that the news of the merger was not price-sensitive as it had been announced by the media before the companies' announcement, April 7, 1996). HLL also points 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.

Says a Mumbai-based corporate lawyer: "Technically, one could say that HLL violated the provisions of Section 3 of the SEBI (Insider Trading) Regulations, 1992." Thus, prior knowledge of the merger, as well as the swap ratio, could be price-sensitive since HLL made a notional profit of Rs 4.37 crore on the transaction.

THE SEBI CHARGE: Why did HLL not follow the route of issuing preferential shares to allow Unilever's stake to rise to 51 per cent in HLL? As per the SEBI chargesheet: "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.

THE HLL DEFENCE: Issuing of preferential shares would have, indeed, been a cheaper option to ensure that Unilever had a 51 per cent stake in HLL. Had 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. However, Unilever always enjoyed the option. Says a senior manager with HLL: "The forex angle falls flat on that ground itself." HLL also states 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 a lower earnings per share in the future.

HLL was probably worried that the clearances for a preferential allotment from the SEBI and the Reserve Bank of India (RBI) would take their time in coming--or not be given at all. It had already faced a time-consuming and expensive run-in with the RBI during the HLL-TOMCO merger in 1994.

THE SEBI CHARGE: Levers cancelled the entire holding of HLL in BBLIL.

THE HLL DEFENCE: HLL was upfront that its entire holding in BBLIL--1.60 per cent--including the lots purchased from the UTI would be cancelled after the merger in March, 1997. HLL maintains that this is perfectly legal. In addition, shareholders of both HLL and BBLIL approved of the cancellation of shares as part of the merger scheme. Says Iyer: "By this process of cancellation, which normally happens in every amalgamation, the voting rights of Unilever have gone up. However, so have the voting rights of other shareholders. So, no exclusive benefit--profits or avoidance of loss--has accrued to HLL or Unilever."

By extinguishing the shares, HLL wanted to maintain Unilever's shareholding at 51 per cent and not realise any financial gains. However, Section 3 defines insider trading irrespective of whether profits are made or not.

By virtue of being in uncharted territory, the parallel hearing before the Union Ministry of Finance will be disposed of within four or five months from the date of filing. And if the verdict goes against Levers, the group will then go to court. If so, expect a long-drawn legal battle. For now, the SEBI verdict is a black spot on a company that excels in cleaning them up.

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