Avoiding the delisting trap
Rakesh Rai
July 25, 2008
July 25, 2008
Welcome once again to the dark side of stock markets. Despite the renewed focus on investor protection by regulators and stock exchanges, there are companies that continue to tap the market for funds and vanish without a trace or are struck off the exchange for violations. These delisted companies leave in their wake a trail of clueless investors who have been cheated out of a fair value of their investments.
While a massive delisting exercise took place in June 1995, when 209 companies were delisted, it happened again in April 1996 (87 companies) and February 1997 (168). In the latest such move by the Bombay Stock Exchange (BSE) in 2004, 885 out of a total of 5,500 listed companies were struck off. While some of these were profit-making companies, others had a healthy book value per share, and so could tap the stock market for funds again. But what about the nearly 10 lakh shareholders who had bought shares in these companies? A majority weren’t even aware of the exercise as the exchange is under no obligation under the Sebi (Delisting of Securities) Guidelines 2003 to tell them when companies delist or are delisted.
“The pathetic monitoring of listed companies, non-enforcement of financial penalties (up to Rs 25 crore) under the Securities Contract (Regulation) Act 1956 and mechanical delisting by BSE has rewarded corporate misgovernance at the cost of small investors,” says Virendra Jain who runs investorhelpline.in. It has received hundreds of complaints against firms delisted in 2004.
Delisting can take place in two ways—voluntary and compulsory. In case of the former, the promoters approach the exchange and are allowed to delist after they fulfill the specified Sebi guidelines. However, it is the compulsory delisting for noncompliance with the terms of the listing agreement that creates most problems for individual investors. The delisting process begins when the exchange issues a notice to the errant company. If it doesn’t respond or comply within a certain timeframe, the company is suspended. If it continues to play rogue for another six months, it can be delisted. But exchanges normally don’t follow the guidelines and give the company 3-5 years to comply before delisting it.The exchanges justify hauling up such firms, saying they are within their rights to ask them to conform to regulations that are meant to promote good investing practices. The companies are even granted a grace period to fall in line, they argue. And as most violations relate to non-payment of annual listing fee, the exchanges say that they are providing a commercial service for which they deserve to be compensated. For instance, the companies with a share capital of up to Rs 5 crore have to cough up an annual listing fee of not more than Rs 10,000. That is small change for any listed company and promoter.
Delisting is the final step in a long, winding tale. The problem for investors begins when an exchange suspends trading in a company’s shares indefinitely. For investors, the implications are the same as delisting— they cannot sell their shares.
Who is to blame?
On the face of it, the primary responsibility appears to lie with the stock exchange concerned as it is the platform where the funds are raised and the only direct link with the companies. So it would seem natural that it should track the companies regularly and ensure compliance with the requirements under the listing agreement, instead of mechanically suspending and delisting them.But, according to the BSE, “Before suspending companies which are non-compliant, we give adequate notice to the market and media (through releases and advertisements). The existing shareholders should track these notices issued by the exchange.”So the responsibility also lies with the investors, who need to play a proactive role by keeping a close tab on the companies they have invested in. As for the notice period, it is often inadequate. At present, exchanges don’t have to forewarn investors about suspensions. In some cases where a notification is issued, the standard 10 days’ period is not enough for the news to trickle down to investors or for them to act. Experts say there should be a longer period to give investors a chance to exit. The counter-argument is that the time doesn’t matter; those who track it will spot it, those who don’t will miss it anyway.
While a massive delisting exercise took place in June 1995, when 209 companies were delisted, it happened again in April 1996 (87 companies) and February 1997 (168). In the latest such move by the Bombay Stock Exchange (BSE) in 2004, 885 out of a total of 5,500 listed companies were struck off. While some of these were profit-making companies, others had a healthy book value per share, and so could tap the stock market for funds again. But what about the nearly 10 lakh shareholders who had bought shares in these companies? A majority weren’t even aware of the exercise as the exchange is under no obligation under the Sebi (Delisting of Securities) Guidelines 2003 to tell them when companies delist or are delisted.
“The pathetic monitoring of listed companies, non-enforcement of financial penalties (up to Rs 25 crore) under the Securities Contract (Regulation) Act 1956 and mechanical delisting by BSE has rewarded corporate misgovernance at the cost of small investors,” says Virendra Jain who runs investorhelpline.in. It has received hundreds of complaints against firms delisted in 2004.
Delisting can take place in two ways—voluntary and compulsory. In case of the former, the promoters approach the exchange and are allowed to delist after they fulfill the specified Sebi guidelines. However, it is the compulsory delisting for noncompliance with the terms of the listing agreement that creates most problems for individual investors. The delisting process begins when the exchange issues a notice to the errant company. If it doesn’t respond or comply within a certain timeframe, the company is suspended. If it continues to play rogue for another six months, it can be delisted. But exchanges normally don’t follow the guidelines and give the company 3-5 years to comply before delisting it.The exchanges justify hauling up such firms, saying they are within their rights to ask them to conform to regulations that are meant to promote good investing practices. The companies are even granted a grace period to fall in line, they argue. And as most violations relate to non-payment of annual listing fee, the exchanges say that they are providing a commercial service for which they deserve to be compensated. For instance, the companies with a share capital of up to Rs 5 crore have to cough up an annual listing fee of not more than Rs 10,000. That is small change for any listed company and promoter.
Delisting is the final step in a long, winding tale. The problem for investors begins when an exchange suspends trading in a company’s shares indefinitely. For investors, the implications are the same as delisting— they cannot sell their shares.
Who is to blame?
On the face of it, the primary responsibility appears to lie with the stock exchange concerned as it is the platform where the funds are raised and the only direct link with the companies. So it would seem natural that it should track the companies regularly and ensure compliance with the requirements under the listing agreement, instead of mechanically suspending and delisting them.But, according to the BSE, “Before suspending companies which are non-compliant, we give adequate notice to the market and media (through releases and advertisements). The existing shareholders should track these notices issued by the exchange.”So the responsibility also lies with the investors, who need to play a proactive role by keeping a close tab on the companies they have invested in. As for the notice period, it is often inadequate. At present, exchanges don’t have to forewarn investors about suspensions. In some cases where a notification is issued, the standard 10 days’ period is not enough for the news to trickle down to investors or for them to act. Experts say there should be a longer period to give investors a chance to exit. The counter-argument is that the time doesn’t matter; those who track it will spot it, those who don’t will miss it anyway.
Collateral damage
One problem of holding on to dud stocks is that you cannot claim losses under “capital gains” as it is neither a transfer nor a sale of shares or extinguishment of right. Another problem is in closing the demat account. The depository participant can close your demat account only if you have zero balance and that is impossible as the companies have been delisted and you cannot sell or transfer the shares. It is possible to achieve zero balance if you rematerialise your shares, that is, re-convert to physical shares, but this option is no good either. As there is a high probability that the delisted company has disappeared, who will rematerialise your shares? Which means you have to keep paying for holding on to the stocks and the demat account.
What you can do
Once a company has been delisted, there is nothing much you can do. However, there is hope in case of companies that have been suspended for non-compliance. One, there is a chance that they will comply. Two, you can keep track of such companies and complain to the exchange to trace them and request compliance, especially if it has been suspended for a technical lapse. There is time enough to do so as the company is usually not delisted for a few years. However, once the company is put in the “unknown” (or untraceable companies) list, even that option is lost.
Suspensions can be revoked if a company falls in line, but most don’t and end up being delisted. A company can relist after a cooling-off period of two years and after meeting other requirements, but they rarely do so. Given these worst-case scenarios, try to avoid hitting this dead end.
Buy what you knowDespite being able to buy blue chips in small lots, many investors chase lowpriced stocks in the hope of big returns. Don’t invest in unknown, low-priced stocks unless you understand the associated risks—suspension and delisting being one of them—and are willing to put up with these. If not, stick to known companies that are good, running businesses and whose stock is traded in good numbers every day.
Track your stockIf you can’t resist taking a punt on penny stocks, at least track them. Given their obscure nature, you need to be more involved in this exercise than you would for frontline stocks. If a company doesn’t disclose its results or send you annual reports, or delays dividend payments, it could be headed for trouble. Stock exchange notices that haul up a company for violations are also warning signs. According to a BSE spokesperson, “The Sebi (Delisting of Securities) Guidelines 2003 provide an investor the right to claim compensation from the promoters. However, in their best interests, the investors have to monitor the quality of their investment constantly and take corrective measures before it is too late.”
Check with other stock exchangesIf the shares are delisted, check if they are also delisted from all the stock exchanges where they were initially offered. Usually, delisting first takes place from the optional stock exchanges, not from the regional stock exchanges.
Approach the regulatorAccording to Sebi’s delisting guidelines, promoters of defaulting companies are liable to buy shares from the investors wanting to exit. For this, you have to approach the exchange, which will appoint an arbitrator. After hearing you and the promoter, if present, he will decide the price at which the promoter has to buy your shares. Again, it’s good on paper, but not enforceable, as promoters can’t be tracked down and forced to pay up. Your best option is to avoid a ride with these fly-by-night firms.
Wait for a relistingIf the company is in good financial health and relists, the issue can be taken up again. DLF, for instance, delisted from BSE in 1982 citing an increase in listing fee, and from the DSE in September 2003. There were over 1,300 shareholders who continued to hold its shares. So when the company relisted, it was forced to listen to them and offer compensation.
There is no way of knowing that a company will vanish, but a little homework before investing helps. Barely 50% of investors rely on prospectus before investing, most basing their decisions on past issue performances or hearsay. They must take into account all available information to avoid the nasty surprise of being stuck with dud shares in a delisted company.
What you can do
Once a company has been delisted, there is nothing much you can do. However, there is hope in case of companies that have been suspended for non-compliance. One, there is a chance that they will comply. Two, you can keep track of such companies and complain to the exchange to trace them and request compliance, especially if it has been suspended for a technical lapse. There is time enough to do so as the company is usually not delisted for a few years. However, once the company is put in the “unknown” (or untraceable companies) list, even that option is lost.
Suspensions can be revoked if a company falls in line, but most don’t and end up being delisted. A company can relist after a cooling-off period of two years and after meeting other requirements, but they rarely do so. Given these worst-case scenarios, try to avoid hitting this dead end.
Buy what you knowDespite being able to buy blue chips in small lots, many investors chase lowpriced stocks in the hope of big returns. Don’t invest in unknown, low-priced stocks unless you understand the associated risks—suspension and delisting being one of them—and are willing to put up with these. If not, stick to known companies that are good, running businesses and whose stock is traded in good numbers every day.
Track your stockIf you can’t resist taking a punt on penny stocks, at least track them. Given their obscure nature, you need to be more involved in this exercise than you would for frontline stocks. If a company doesn’t disclose its results or send you annual reports, or delays dividend payments, it could be headed for trouble. Stock exchange notices that haul up a company for violations are also warning signs. According to a BSE spokesperson, “The Sebi (Delisting of Securities) Guidelines 2003 provide an investor the right to claim compensation from the promoters. However, in their best interests, the investors have to monitor the quality of their investment constantly and take corrective measures before it is too late.”
Check with other stock exchangesIf the shares are delisted, check if they are also delisted from all the stock exchanges where they were initially offered. Usually, delisting first takes place from the optional stock exchanges, not from the regional stock exchanges.
Approach the regulatorAccording to Sebi’s delisting guidelines, promoters of defaulting companies are liable to buy shares from the investors wanting to exit. For this, you have to approach the exchange, which will appoint an arbitrator. After hearing you and the promoter, if present, he will decide the price at which the promoter has to buy your shares. Again, it’s good on paper, but not enforceable, as promoters can’t be tracked down and forced to pay up. Your best option is to avoid a ride with these fly-by-night firms.
Wait for a relistingIf the company is in good financial health and relists, the issue can be taken up again. DLF, for instance, delisted from BSE in 1982 citing an increase in listing fee, and from the DSE in September 2003. There were over 1,300 shareholders who continued to hold its shares. So when the company relisted, it was forced to listen to them and offer compensation.
There is no way of knowing that a company will vanish, but a little homework before investing helps. Barely 50% of investors rely on prospectus before investing, most basing their decisions on past issue performances or hearsay. They must take into account all available information to avoid the nasty surprise of being stuck with dud shares in a delisted company.
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