BUY BACK OF SECURITIES.........AN OVERVIEW.

BUY BACK OF SECURITIES

Introduction

Buy Back of Securities is done by the company with the purpose to improve liquidity in its shares and enhance the shareholders’ wealth. Under the SEBI (Buy Back of Securities) Regulations, 1998.

The company has to disclose the pre and post-buy back holdings of the promoters. To ensure completion of the buyback process speedily, the regulations have stipulated time limit for each step. For example, in the cases of purchases through stock exchanges, an offer for buy back should not remain open for more than 30 days. The verification of shares received in buy back has to be completed within 15 days of the closure of the offer. The payments for accepted securities has to be made within 7 days of the completion of verification and bought back shares have to be extinguished and physically destroyed within 7 days of the date of the payment. Further, the company making an offer for buy back will have to open an escrow account on the same lines as provided in takeover regulations.

Objectives of Buy Back

 Shares may be bought back by the company on account of one or more of the following reasons
i. To increase promoters holding
ii. Increase earning  per share
iii. Rationalize the capital structure by writing off capital not represented by available assets. 
iv. Support share value
v. To thwart takeover bid
vi. To pay surplus cash not required by business
Infact the best strategy to maintain the share price in a bear run is to buy back the shares from the open market at a premium over the prevailing market price.

Sources of Buy Back

Section 77B provides three sources to  Buy Back its own shares or other specified securities out of three sources:

1. Free reserves
2. Securities premium account
3. Proceeds of an earlier issue of shares or other specified securities. [Section 77A(l), The Company's Act 1956].

Buy back of any kind of shares is not allowed out of the proceeds of any earlier issue of the same kinds of shares.

1. Free reserve

The term free reserve has been defined to carry same meaning as has been assigned in clause (b) of Explanation to section 372A of The Company’s Act 1956.  For the purpose of section 372A the term ‘free reserve’ has been defined as those reserves which as per the latest audited balance sheet are free for distribution as dividend and it includes balance of securities premium account. Free reserve means the balance in the share premium account, capital and debenture redemption reserves shown or published in the balance sheet of the company and created by appropriation out of the profits of the company.

2. Securities premium Account

Securities Premium Account is a broader term than Share Premium Account. Share Premium account represents only premium on issue of equity and preference shares, whereas securities premium account represents premium on issue of debentures, bonds and other financial instruments.

3. Proceeds of an earlier issue

Buy back of shares of any kind is not allowed out of fresh issue of shares of the same kind. If it were so, it would frustrate the very purpose of buy back. Fresh issue of equity shares for buying equity makes no financial sense. However, financial logic of buy back could very well be served if preference shares are issued and proceeds are used for buying back equity shares.

• Preference shares carry fixed rate of dividend. Also they are easy to market.
• Preference shares may give better yield to the investor than after tax yield on loan or debentures. At the same time it is possible to lever the capital structure by slimming the dividend paying equity.

That apart buy back of shares is allowed utilizing proceeds of an earlier issue. Proceeds of an earlier issue is an unqualified term. Any issue means any issue of hybrid instruments, debentures, bonds, secured and unsecured loans etc. Thus buy back of equity shares is allowed byissue of any pure or hybrid debt instruments.

Then appropriate source of buy back should be the following if the intention is to swap equity for debt or fixed income bearing instruments:

• Issue of debentures;
• Issue of loans.

Condition for Buy Back

(1) No company shall purchase its own shares or other specified securities under sub-section (1), unless-

(a) the buy-back is authorised by its articles;

(b) a special resolution has been passed in general meeting of the company authorising the buy-back:

Provided that nothing contained in this clause shall apply in any case where-

(A) the buy-back is or less than ten per cent, of the total paid-up equity capital and free reserves of the company; and

(B) such buy-back has been authorized by the Board by means of a resolution passed at its meeting:

Provided further that no offer of buy-back shall be made within a period of three hundred and sixty-five days recokned from the date of the preceding offer of buy-back, if any.

Explanation.-For the purposes of this clause, the expression "offer of buy-back" means the offer of such buy-back made in pursuance of the resolution of the Board referred to in the first proviso;]

(c) the buy-back is or less than twenty-five per cent of the total paid-up capital and free reserves of the company:

Provided that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capital in that financial year;

(d) the ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-back:

Provided that the Central Government may prescribe a higher ratio of the debt than that specified under this clause for a class or classes of companies.

Explanation.-For the purposes of this clause, the expression "debt" includes all amounts of unsecured and secured debts;

(e) all the shares or other specified securities for buy-back are fully paid-up;

(f) the buy-back of the shares or other specified securities listed on any recognised stock exchange is in accordance with the regulations made by the Securities and Exchange Board of India in this behalf;

(g) the buy-back in respect of shares or other specified securities other than those specified in clause (f) is in accordance with the guidelines as may be prescribed.

(2) The notice of the meeting at which special resolution is proposed to be passed shall be accompanied by an explanatory statement stating-

(a) a full and complete disclosure of all material facts; -.

(b) the necessity for the buy-back;

(c) the class of security intended to be purchased under the buy-back;

(d) the amount to be invested under the buy-back; and

(e) the time limit for completion of buy-back.

(3) Every buy-back shall be completed within twelve months from the date of passing the special resolution or a resolution passed by the Board .

(4) The buy-back may be-

(a) from the existing security holders on a proportionate basis; or

(b) from the open market; or

(c) from odd lots, that is to say, where the lot of securities of a public company, whose shares are listed on a recognized stock exchange, is smaller than such marketable lot, as may be specified by the stock exchange; or

(d) by purchasing the securities issued to employees of the company pursuant to a scheme of stock option or sweat equity.

(5) Where a company has passed a special resolution under clause (b) of sub-section (2) or the Board has passed a resolution under the first proviso to clause (b) of that sub-section] to buy-back its own shares or other securities under this section, it shall, before making such buy-back, file with the Registrar and the Securities and Exchange Board of India a declaration of solvency in the form as may be prescribed and verified by an affidavit to the effect that the Board has made a full inquiry into the affairs of the company as a result of which they have formed an opinion that it is capable of meeting its liabilities and will not be rendered insolvent within a period of one year of the date of declaration adopted by the Board, and signed by at least two directors of the company, one of whom shall be the managing director, if any:

Provided that no declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognised stock exchange.

Duties/Responsibility

A.     Where a company buy-back its own securities, it shall extinguish and physically destroy the securities so bought-back within seven days of the last date of completion of buy-back.

B.      Where a company completes a buy-back of its shares or other specified securities under this section, it shall not make further issue of the same kind of shares (including allotment of further shares under clause (a) of sub-section (1) of section 81) or other specified securities within a period of six months] except by way of bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares.

C.      Where a company buy-back its securities under this section, it shall maintain a register of the securities so bought, the consideration paid for the securities bought-back, the date of cancellation of securities, the date of extinguishing and physically destroying of securities and such other particulars as may be prescribed.

D.     A Company shall, after the completion of the buy-back file with the Registrar and the Securities and Exchange Board of India, a return in form 4 C containing such particulars relating to the buy-back within thirty days of such completion. 
No return shall be filed with the Securities and Exchange Board of India by an unlisted company.

Precausion of Buy Back

While approving the buy back resolution the following points should be carefully scrutinized as regards cash flow linkage of free reserve and securities premium account as they are not necessarily represented by free cash:

• How much of the free reserve and securities premium account are readily available in the form of free cash?
• Whether owned investments in current assets are released for buy back? If so, its impact on current ratio?
• Whether non-trade investments will be disposed to generate free cash? If yes, what is the possible profit/loss?
• If trade investments are proposed to be sold, what is the possible adverse impact on operating activities?
• If any fixed assets are sold, whether it has been intended to reduce the scale of operation of the company

Penalty

The company or any officer of the company, who is in default shall be punishable with imprisonment for a term which may extend to two years, or with fine which may extend to fifty thousand rupees, or with both.