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A Case of Insider Trading



The case study analyses the charges of insider trading by SEBI (Securities and Exchange
Board of India) against the merger of HLL (Hindustan Lever Ltd.) and BBLIL(Brooke Bond
Lipton India Ltd.).
The legal controversy involved HLL 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 suspected insider trading and 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.

Insider trading involves buying and selling of securities by the insider of a company
who has price sensitive information about the company.
It can be both legal as well as illegal. If the material information is made public before
insider trading takes place, it is legal and if it is not made public, it is illegal.

Merger is the combination of two companies into one larger company.
It involves stock swap or cash payment to the target.
The most common and natural reasons for a merger is to eliminate competition.
Hindustan Lever Ltd. (HLL) is one of India's leading FMCG companies with presence all
over India. Its origin dates back to 1885, when the Lever Brothers set up "William
Hesketh Lever", in England. It merged with 'Margarine Unie' (a Netherlands based
company which exported Vanaspati to India) to form Unilever in 1930 and in the
coming years it set up three subsidiaries in India. In November 1956, the three Indian
subsidiaries merged to form Hindustan Lever Ltd. (HLL).

Brooke Bond's presence in India dates back to 1903, when Brooke Bond Red Label tea
was introduced. Unilever acquired Brooke Bond through an international acquisition in
1984. Similarly, Lipton's link with India date back to 1898. Unilever acquired Lipton in
1972, and Lipton Tea (India) Ltd. was incorporated in 1977. Brooke Bond and Lipton
India merged in July 1993 to form BBLIL.

HLL purchased 0.8 million 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). UTI was on the verge of closing
its accounts for 1995-96 and had been selling shares in the market to fund its dividend
pay outs. This transaction took place on March 25, 1996, just 25 days before the HLL-
BBLIL merger was announced.

On 19 April 1996, HLL notified the stock exchanges of its proposal to merge BBLIL. 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, thus igniting the contentious issue. On one corner was the capital market
regulator SEBI, cracking down with India's first-ever 'guilty' verdict for an insider trading
offence and on the other hand was Unilever subsidiary, Hindustan lever ltd (HLL).
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
SEBI charged HLL of being an insider as in accordance with section 2(e) of the SEBI (Insider
Trading) Regulations which defines an insider is a person connected to the company and
having price sensitive information by virtue of such connection.

SEBI argued that both the conditions of Section 2 (e) were met when HLL bought the BBLIL
shares from the UTI as 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.

HLL came up with counter argument that " No company can be an insider to itself " . It only
knew about the merger because it was the primary party to the process and not because
BBIL was as associate company. To support this they even said that SEBI would not have
considered it a Insider Trading if HLL purchased the shares of Tata Oil Mills Co. (TOMCO).
SEBI accused HLL of dealing with BBLIL shares on the basis of unpublished price-sensitive information
which is prohibited . Unpublished, price-sensitive information relates to amalgamations, mergers, and
takeovers of concern to a company and is not generally known or published. SEBI held that there can
be no dispute that the information of the overall fact of the merger fell under this definition.

HLL argued that the price-sensitive and this ratio was not known to HLL or its directors when the BBLIL
shares were purchased in March, 1996. It further argued that the news of the merger was not price-
sensitive as it had been announced by the media before the companys announcement. HLL also
pointed 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.

HLL argues that the merger was " generally known" but BBLIL didn't make it clear to UTI as a major
shareholder that a merger was on the way.HLL contended 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
felt 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.
SEBI alleged that if Unilever wanted to keep its stake constant in HLL, then why it not followed the path of
preferential allotment of shares to raise its stake. As per the SEBI charge sheet, such a step would have
involved various compliances/clearances, and required Unilever to bring in substantial funds in foreign
exchange. The implication being HLL depleted its reserves to ensure that Unilever did not have to bring in
additional funds.

HLL argued that the issue of preferential share would have been cheaper and beneficial to the company but
would have been dilutory for the shareholders it would have resulted in an expanded capital base, leading to
lower earnings per share in the future. It also defended itself saying that SEBI had to establish the financial
benefit from the transaction in order to prove an insider trading.

SEBI argued that Levers cancelled the entire holding of HLL in BBLIL. HLL agreed to the point that the shares
had been bought back with the sole intention of increasing the stake of HLL in BBLIL. It was planned that the
shares would be extinguished after the buyback to increase the value of shares still available (reducing
supply). By the process of amalgamation which happened in the merger, the voting rights of Unilever went up
and in the process the rights of shareholders have also been propped up. By extinguishing shares, HLL wanted
to maintain Unilevers shareholding at 51% and not realize any financial gains. However, section 3 clearly
defines insider trading irrespective of the fact whether profits have been made or not.
It is very difficult to conclude as to whether HLL was an insider or not and whether
insider trading actually took place

The case however clearly shows that the merger had price sensitive information which
would have affected UTI decision of selling share had it been aware of such merger, it
would have then waited for better valuation which was a surety.

Also HLL depleted its own reserves to buy the shares for one privileged shareholder,
Unilever. That in itself is a sin in corporate governance favouring one set of shareholders
at the expense of others.

Moreover, HLL's action violated the legal proposition that, what cannot be done directly
cannot be done indirectly.
Thank You