Last week, the Securities and Exchange Board of India (Sebi) directed HDFC MF to cancel the allotment it made to distributors and return the money along with an interest of 12 per cent per annum.
While the diktat was meant to avoid a conflict of interest situation in the Rs 23-trillion mutual fund industry, it posed a legal challenge as equity shares once issued cannot be revoked or extinguished.
KKR, an active investor in the domestic financial services ecosystem, sensed this as an opportunity and offered to buy the shares from 140-odd distributors, who were staring at a revocation of their allotment. Sources said the private equity player also offered to pay the 12 per cent interest on behalf of the fund house.
“The deal between KKR and distributors is a win-win for everybody. The allocation to distributors had to be revoked following the Sebi directive. As cancellation of the shares was not an option, it had to go to a neutral party,” said a person with the direct knowledge of the development.
A message sent to KKR and HDFC MF seeking comment on the issue didn’t elicit any response. Legal experts say one way to extinguish equity shares is a buyback, which is a lengthy process.
“Once equity shares are issued by a company, these cannot be revoked or extinguished. Unlike debt or other instruments, equity shares are risk ownership in the company. Only way to probably revoke the shares is to do a share buyback, which can be a long-drawn process. Therefore, a more feasible way for the company is allotting the same shares to some other entity,” said Rishabh Mastaram, founder, RGM Legal.
The treatment of shares issued to distributors had become a critical issue for HDFC MF. Sources say a final nod for its Rs 35-billion IPO was subject to the refund to distributors who subscribed to the shares through a private placement in April.
An allotment of 1.44 million shares to distributors was made at Rs 1,050 a share of face value of Rs 5 each. Close to 200 distributors and advisors had applied for shares, however, the allotment could be made to only 140 distributors. Soon after the allotment, certain industry players had complained to Sebi, stating that it was a distortive trade practice. The asset management industry generates bulk of its business through distributors. HDFC MF, in particular, gets nearly 70 per cent of assets from distributors, while the rest comes from direct plans, where an investor deals directly with the fund house.
Some felt giving shares to distributors could lead to the practice of mis-selling. The share allotment made to distributors by HDFC MF was also at a discount to its IPO price. Sources say shares of HDFC MF are likely to be priced between Rs 1,400 and Rs 1,500 apiece in the IPO — that’s a premium of 30-40 per cent to the private placement price. If shares of HDFC MF are indeed priced at these levels, KKR stands to make decent gains. However, the private equity may have to adhere to a one-year lock-in.
Industry experts say Sebi should issue a formal guidance on whether distributors can buy shares of AMCs. “The market regulator has ruled the private placement as inappropriate to avoid mis-selling. However, distributors and advisors are free to buy shares from the open market, which too could potentially lead to conflict of interest,” said an industry player.
Righting a wrong
HDFC MF makes private placement of Rs 1.5 billion to distributors, advisers
Some industry players see the move as conflict of interest
Sebi asks HDFC MF to scrap the allotment and refund investors with interest
Legal experts say shares issued cannot be revoked
KKR offers to buy shares allotted to distributors