Insider Trading Case Study

HLL & BBLIL

Abstract

The case study analyses the issues related to the insider trading charges against HLL
with regard to its merger with Brooke Bond Lipton India Ltd. The case focuses on the
legal controversy surrounding these charges. The controversy involved HLL's purchase
of 8 lakh shares of BBLIL two weeks prior to the public announcement of the merger of
the two companies (HLL and BBLIL). SEBI, suspecting insider trading, conducted
enquiries, and after about 15 months, in August 1997, SEBI issued a show cause notice
to the Chairman, all Executive Directors, the Company Secretary and the then Chairman
of HLL. Later in March 1998 SEBI passed an order charging HLL with insider trading.

SEBI directed HLL to pay UTI compensation, and also initiated criminal proceedings
against the five common directors of HLL and BBLIL. Later HLL filed an appeal with the
appellate authority, which ruled in its favour. Through a description of the legal causes
surrounding the SEBI's charges against HLL, this case, is designed to enable students to
understand and appreciate the role of the legal framework under organizations function.

Locking Horns

 It was battle royale, a unique one at that. In one corner was the capital market
regulator SEBI, cracking down with India's first-ever 'guilty' verdict for an insider
trading offence.
 In the other corner was Unilever subsidiary, Hindustan Lever Ltd. (HLL)
marshalling its formidable corporate resources to defend itself. On August 4,
1997, SEBI issued a show cause notice to HLL claiming that there was prima
facie evidence of the company indulging in insider trading through the use of
'Unpublished price sensitive information' prior to its merger with Brooke Bond
Lipton India Ltd. (BBLIL).
 In March 1998, SEBI passed an exhaustive order, which sent shock waves
through the country's corporate sector. SEBI found HLL guilty of insider trading
because it bought shares of BBLIL from Unit Trust of India (UTI), knowing that
HLL and BBLIL were going to merge.
 Since it bought the shares before the merger was formally announced, SEBI held
that HLL was using unpublished, price-sensitive information to trade, and was
therefore guilty of insider trading.
 SEBI directed HLL to pay UTI Rs 3.4 crore in compensation, and also initiated
criminal proceedings against the five common directors of HLL and BBLIL: S.M.
 Datta, K.V. Dadiseth, R. Gopalakrishnan, A. Lahiri, and M.K. Sharma, who were
on the core team which discussed the merger.
 Predictably, HLL decided to appeal against the SEBI verdict to the Union
Ministry of Finance, the appellate authority in such cases.

The question, which lingered in everyone's mind was - Is HLL, guilty of insider trading
and would SEBI's charges hold?

Back ground note

 The merger of HLL and BBLIL had always been on the cards. The HLL group
had started the process of consolidation with mergers of some Tea Estates with
Brooke Bond, and then the latter with Lipton India.
 With the formation of BBLIL, the question was not if HLL and BBLIL would be
merged, but when.
 After these mergers, it was clear that HLL wanted to follow in the footsteps of
Unilever, its global parent, in India. As a result of the relaxation of controls after
liberalization, the HLL group could operate in India in much the same way as
Unilever did globally.
 Besides, the operations of the two (HLL and BBLIL), when combined bestowed
considerable cost advantages. In April 1996, HLL announced its merger with
BBLIL. At the time of the merger, there was market gossip about insider trading.
 In the days preceding the merger announcement, the BBLIL counter had seen
heavy trading and SEBI was known to be making discreet inquiries about the
spurt in BBLIL's trading volumes at that time.
 It was only after about 15 months of detailed analysis that SEBI issued a notice to
HLL asking why it shouldn't be slapped with an insider trading charge.
 And then in March 1998, SEBI announced criminal prosecution of five HLL
directors for insider trading and asked it to pay Rs. 3.04 crores to UTI as
compensation.

Face To Face

 The SEBI's charges were based on HLL's purchase of 8 lakh shares of BBLIL
from UTI at Rs 350.35 per share (At a premium of 9.5% of the ruling market
price of Rs. 320). This transaction took place on March 25, 1996, just 25 days
before the HLL-BBLIL merger was announced on April 19, 1996. UTI was on the
verge of closing its accounts for 1995-96 and had been selling shares in the
market to fund its dividend payouts. On 19 April 1996, HLL notified the stock
exchanges of its proposal to merge BBLIL...

Is HLL An Insider?

 According to HLL, though it was deemed to be connected to BBLIL, and though

it knew about the merger before it bought BBLIL's shares, it received the
information only because it was one of the parties to the merger itself and not
 merely because of its connection to BBLIL. According to HLL this distinction
was important because, to be considered an insider, HLL should have received the
information "by virtue of such connection" to the other company. HLL's defense
revolved around the fact that as an initiator and also the transferee, it was the
'primary party' to the merger. M.K Sharma, Legal director, HLL, said, "Nowhere
in the world is the primary party to a merger considered to be an insider from the
point of view of insider-trading." (Refer Box)...

Is the Information Un-Published?

 HLL contended that before the transaction, the merger was the subject of wide
speculation by the market and the media. After the formal announcement, press
articles mentioned that the merger was no surprise to anyone. HLL pointed out
that the share price of BBLIL moved up from Rs. 242 to Rs. 320 between January
and March, before the transaction, indicating that the merger was "generally
known information"...

Information about Merger-Price-Sensitive?

 In this regard, HLL argued that only the information about the swap ratio could be
deemed to be price-sensitive and that this ratio was not known to HLL or its
directors when the BBLIL shares were purchased in March, 1996. HLL pointed
out that the two audit firms who valued the merger, S.S. Billimoria & Co. and
M.N. Raiji & Co., recommended the ratio to the HLL board only in mid-April,
1996, which was only after the UTI transaction, i.e. after HLL's purchase of
shares from UTI. HLL further argued that the news of the merger was not price-
sensitive as it had been announced by the media before the official
announcement..

Did HLL Gain Financially?

 HLL defended itself by pointing out that SEBI had to establish the financial
benefit from the transaction in order to prove an insider trading charge. It pointed
out that though establishing "financial benefit" was not explicit in the law, it was
implied, because the act said that it should be taken into account when levying
penalties. Said Justice Bhagwati, "though the SEBI regulations did not contain
any specific requirement of the presence of any element of making profit or
avoiding loss, this factor is inherent in the offence of insider trading"...

Prosecution Not Justifiable

 Round two of the battle between SEBI and HLL took place under the aegis of the
Appellate Authority of the Finance Ministry.
 In response to the SEBI's charge, HLL appealed to the Appellate Authority
pleading that it be absolved of the charges of insider trading. UTI later filed an
 appeal with the Appellate authority, claiming a higher compensation of Rs. 75.2
million (7.52 crore).
 It pleaded that it had to incur a notional loss as it was not aware that a merger of
the two Unilever group companies was on the cards...

HLL Not Guilty-Proposal 'Generally Known'

 In support of its ruling, the Appellate Authority cited press reports that indicated
"prior market knowledge of the merger." However, by its own admission, there
were only a few reports "prior to the actual purchase (of shares from UTI)." The
Authority had cited 21 news reports to support the contention that the prospect of
a merger between HLL and BBLIL was widely known. In its judgement, the
Appellate Authority said that under Regulation 11B, SEBI was not capable of
initiating investigations and then taking recourse to powers under the Act for
awarding compensation without passing an order under the above mentioned
regulation...

Time to Introspect

 The charge against HLL had brought to the fore the debate over SEBI's role as a
watchdog of the Indian Capital market and its ability to control financial crimes
such as insider trading. It also highlighted the inability of the legal machinery to
handle such cases.
 Though SEBI issued regulations governing this area in 1992, there had been no
proven case of insider trading since then. But the question here was: did the
market regulator have any system in place to monitor such instances and take suo
moto action as provided in the Regulations?

Source: http://www.icmrindia.org/casestudies/catalogue/Finance/FINC014.htm