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Sebi moots open offer for reverse mergers

Rakesh P Sharma & Sangita Shah

The Securities and Exchange Board of India has sought to make amendments to the takeover regulations to make a public offer mandatory in the event of a change in management control pursuant to a preferential allotment in case of reverse merger.

In its report to the Joint parliamentary Committee probing the stock market scam, the markets regulator has also suggested an amendment to provide for passing of a special resolution prior to taking a decision to dispose off the whole or a substantial part of an undertaking.

Currently, there is no requirement to make an open offer in cases where the business of an unlisted company is transferred to a listed company as a going concern and preferential shares are issued to shareholders of the unlisted company having a large share capital.

This tantamounts to a change in control of the management of the listed company without involving the approval of the high court. Since there is no opportunity for a minority shareholder to participate in the merger decision, their interest is not protected, Sebi has pointed out.

A reverse merger happens when an unlisted company merges with a listed company. The unlisted company offers its shares to the shareholders of the listed company in a pre-determined proportion. Thus, there is only swapping of shares and no monetary consideration is involved.

Though the Sebi disclosure and investor protection guidelines lay down stringent entry norms and disclosures for a company accessing the capital market, these are circumvented in case of reverse mergers.

For example, the requirement of a track record of profitability and networth gets diluted when an unlisted company gets merged with a listed company and the share swap ratio is decided on the basis of a non-transparent criteria.

Generally, a listed company with a low share capital concentrated in a few hands is chosen as a vehicle for a reverse merger.

This facilitates assignment of an artificial valuation for share swap ratio. Despite the change in management, minority shareholders of such listed companies are deprived of an opportunity to participate in the merger decision and do not get an exit opportunity at the intrinsic value of their shareholding.

This procedure also indirectly helps in tax avoidance and tax evasion. A company having large immovable property can, on merger, transfer it to the other company without going through the stringent tests of valuation by income-tax authorities and procedures for obtaining NOC prior to the disposal of property.

By assigning an arbitrary valuation, capital gains tax is also avoided and properties are transferred at less than the fair market value.

Even the Companies Act does not provide for passing of a special resolution at a shareholders meeting prior to taking a decision to dispose off whole or substantial part of the undertaking, which may have large assets in the form of immovable property.

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