Sebi looks to plug loopholes in stock-split regulation

The Securities and Exchange Board of India (Sebi) is considering tougher regulations for stock splits. This is in the wake of certain low value companies using stock splits as part of modus operandi to evade taxes, sources have said.

Stock split is a corporate action in which a company divides its existing shares into multiple shares. Although the number of shares outstanding increases by a specific multiple, the total value of the shares remain the same compared to pre-split amount as it does not add any real value.

“In the recent investigations Sebi observed that certain companies, which have been barred by Sebi from market by way of interim orders, have used stock splits to create liquidity and make it affordable for front entities to subscribe to shares of the original allottees,” said a source.

In the interim order in the matter of Radford capital, where Sebi had banned over 100 entities including the promoter of the company, the regulator had observed that after the expiry of the lock-in period, the stock was split and preferential allottees sold the shares to connected or related entities, thereby raking in huge profits.

“It can be safely assumed that the entire modus operandi of allotting preference shares at a premium, announcing a stock split and then bringing in connected entities to provide exit was a scheme devised to rake in ill-gotten gains,” stated Sebi in the order.

In all these cases, Sebi observed that entities were not violating any regulation and the shares were split at a face value of Rs 10 per share and offer price was less than Rs 500.

These observations have led the regulator to consider further tightening the regulations around stock splits. The issue was debated in the recent Secondary Market Advisory Committee (SMAC).

“The issue was debated by the regulator during the SMAC meeting. However, any decision would be taken only after careful consideration,” said a source.

It is after a decade that the regulator is considering a change in regulations around stock splits. In 2004, Sebi had relaxed the regulations and allowed unlisted company going for an IPO to split shares into those with face values between Rs 1 and Rs 10 per share, if offer price is Rs 500 or more. In case it is less than Rs 500, the face value should be Rs 10 per share.

One of the proposals being mulled by Sebi includes allowing split to only those companies whose share value has been more than Rs 500-600 consistently for the past six months. Market participants say this would make split feasible for only big companies.

The capital markets regulator is also looking into illicit ‘arbitrage’ through derivatives trading from offshore locations besides manipulations through ‘client code modifications,’. Now, this is despite a complete clampdown on this route for the past couple of years.

Under ‘Modification of the client codes,’ brokers change client details in sale and purchase orders of securities after the trades are conducted. Though legally permitted, there are concerns that such modifications could be misused for manipulative activities in the market.

In April 2012, Sebi had also passed an order against NSE for being ‘negligent in discharge of its duties,’ in a case of modification of client codes, but did not impose any penalty.

Sources have said that arbitrage could have taken place through trades in currency and equity derivatives and the modus-operandi typically involved payments being made for ‘bogus losses’ in Indian markets and ‘huge profits’ at overseas locations.