Two things can be true at the same time. For example, it is true that Engro is one of the most well-managed and responsible companies in Pakistan with professional standards that can possibly even compete on the global scale. At the same time, it is also true that Engro operates in a country that some would consider a regulatory Wild West. As such corporates here, even the good ones, are beholden to the realities of running a business in Pakistan and might not always be above taking benefit of some of the weaker laws and regulations in place.
Just take a look at Engro’s recent dividend issue. On 20th of April 2023, the company announced the financial results for the first quarter ending 31st March 2023. The results brought glad tidings. Engro had announced a massive Rs 23 billion in an interim cash dividend at Rs 40 per share. This would have translated to a return of 15% for investors who had bought the shares only a few days before the announcement. Essentially, Engro had decided to distribute a big chunk of the profits it had accumulated over the years to the shareholders in just this one quarter.
As soon as this massive dividend was announced, the share price went up from Rs. 292 to touch the upper lock at Rs. 314.6. It was obvious that the shareholders were ecstatic.
Except there is a small problem here. You see in the world of stock market trading, a lot of relevance is given to maintaining fairness. That is because the game by its very nature is rigged. A company’s share price responds to decisions that the company makes. Now, people that are on the board of the company or are decision makers at the company have prior knowledge of these decisions. So for example if a company is about to announce a big dividend, the insiders like the CEO, CFO, or board members, will know before any of the other investors. And since these officials can also be shareholders, there are always chances that some of them might try to benefit from this information by buying the shares before the good news is announced to the public. This is called illegal insider trading.
It seems something similar might have happened in the case of Engro’s dividend announcement. Similar, but not the same. For starters, the insider in this case was not an individual, but the company Engro itself. And as per regulations, this type of insider trading is not illegal either. Unfair maybe, but definitely not illegal. So what exactly happened, and how does it reflect on Pakistan’s regulatory framework?
On the 14th of December 2022, months before the massive dividend was announced, Engro had announced its plan to buyback 70 million of its own shares from the market in order to cancel them. This was around 12 percent of all its issued shares. Buybacks are a way for companies to buy some of their own shares and decrease their outstanding shares in the market. This also signals to the markets that the company feels its shares are trading below their true value.
After getting approval from its shareholders, the company started the share buyback process on the 16th of February 2023, and continued to off-and-on buy, till 20th of April 2023. This is the same day when the company had announced the massive dividend.
By the 31st of March 2023, Engro had already bought back 36.75 million out of its intended 70 million shares at an average price of Rs. 294.41 per share. On the 7th of April, Engro told PSX that it will hold its board meeting on the 19th of April to announce the quarterly results. But between these two dates, the company carried out 4 more buyback transactions. On the 17th of April, they bought 1,085,000 shares at Rs. 273.82. On the 18th, they bought 538,236 shares at Rs. 282.98.
On the morning of the 20th of April, the company announced an earning of Rs. 10.63 per share and a dividend of Rs. 40 per share, which was the biggest one time dividend they had given out in their history.
While the meeting was going on over a course of two days, the company was able to buy a further 1,013,526 shares at Rs. 289 per share before the dividend announcement was made and 150,000 shares were bought on the 20th of April at Rs. 299.5 per share on the day of the announcement. After this, no further buying transaction was carried out.
The buyback finally ended on 25th of July after the company had bought back a total of 39,536,762 shares from the market. Everything went by smoothly and without a hitch. Engro followed all of the regulations of the SECP and PSX. However, there is just one problem.
The buyback story and the close period angle
This isn’t really a story about Engro. Profit has already covered the dividend payout in April, detailing how it worried some that the payout might mean Engro was throwing their hands up on the issue of finding suitable investment opportunities in Pakistan.
Instead, this is a story about weak regulation. The problem is that the laws that exist on the books in regards to buyback are contrary to the laws that exist governing trading by company insiders. What do we mean by this? Allow us to explain.
In order to understand the problems that exist in the regulation, first what needs to be understood is what a buyback is. A buyback is a move made by the company when it thinks that it has excess cash flow on hand and can use some of these funds to buyback or cancel some of its shares floating in the market.
Buybacks are also considered a signal in the market that the stock is undervalued as even the company feels that the share price is below compared to what it should be and is buying back its own shares. This allows the company to use some of its funds it has on its books and boost its earnings per share in the future.
If you are still scratching your head on what is actually wrong here, just wait a little longer.
Then comes what is known as the ‘Close Period’.
In order to protect the interest of the shareholders, regulations exist which state that when a board of directors is looking to announce its financial results, it needs to observe a closed period. This closed period ensures that from the time the management and the board get the accounts till the time they release it, they do not get to trade in the shares of the company itself.
This is necessitated due to the fact that the board of directors gets to look at the accounts and approve them before they can announce and distribute these results to its shareholders. As the executives of the company have access to the results and the accounts, regulations place a closed period for the CEO, executives and directors along with their spouses. This makes sure that no inside information is used by the insiders of the company until all the shareholders have had access to internal information.
The purpose of this regulation is that as the management of the company has sensitive information before it is disclosed to the public, they should not be allowed to use this information to trade by themselves. Once the board meeting is carried out and the results are announced, the closed period ends and then anyone can trade in the shares. Such regulations are designed to protect the shareholders and build trust in the market for investors.
Why are companies not subject to this?
The question that arises from this whole situation is the fact that when the management and insider of the company are subject to a closed period, why doesn’t the same apply to the company itself? Let us look at this from a different angle.
On the one hand there are the CEOs, directors and other individual insiders that are subject to a close period. The reason they are made subject to this is so they don’t have an unfair advantage over any other shareholders. By that same logic, a close period should also apply to companies themselves.
No such regulation exists in the PSX for companies carrying out buybacks and the case is the same for SECP and its Buyback regulations. Now look at this from the point of view of an average shareholder. Just days before the big dividend announcement, when Engro would have offered to buy more shares as part of its buyback, the average shareholder would not have known that they planned on releasing a big dividend. So when Engro approaches a shareholder with the offer to buy the share back at around Rs 280, the shareholder wanting to make some money would sell it. At such a time Engro will have known full well what they were planning to do. So when the dividend was announced and the share price rose to Rs 315, Engro was essentially making gains at the expense of the selling shareholders. And since the company is owned by the shareholders that did not sell, which includes the directors/sponsors, these individual insiders would benefit, albeit indirectly, at the expense of the selling shareholders.
Once again, there is nothing illegal or against regulation here. But the selling shareholders might feel shortchanged. The law is being followed but what about the spirit of the law?
When reached for a comment, Engro stated that they had “fulfilled all of its corporate and regulatory obligations in all material respects in relation to the Buyback process.” In simple terms, there are no regulations pertaining to the company following a closed period — something Engro is correct about.
They further went on to say that “Regulation 12(2)(a) of Regulations restrict…..(insiders)…from buying its own shares during a buyback period. However, there is no provision in the said Regulations or under Section 88 of the Companies Act, 2017 which stops the company from buying its own shares during a closed period that happens to fall within the buyback period.”
This is also correct.
The double standard
The regulations that exist on the books state that if any member of the management or the board were going to carry out any transaction in the company during the closed period, the regulator would have stepped in as they were taking unfair advantage. As only a few people had the inside information regarding the results, they should not have the opportunity to gain by themselves while other shareholders were left out in the dark. In such a case, an action by the regulator would have been warranted and expected.
Why is it then that when the company carries out a similar decision, it has no action taken against it? Granted that when the buyback was announced, no such dividend was even on the horizon but when the meeting was announced, shouldn’t the company have similar regulations be imposed on them?
When equal application is not carried out, it can be argued that the company was able to acquire shares from the shareholders when the company had information regarding the results of its first quarter. If the shareholders had any inkling of such a dividend being announced, they might not have sold their shares to Engro in the first place.
The regulators know there are loopholes.
The problem in this case is the fact that the company was able to buyback 2,786,762 shares at a time when the individuals of the company had to adhere to a closed period. This was not applicable to the company itself. SECP needs to look into its regulations and amend them. This will assure that the market is functioning properly and that regulators have an eye on the companies.
The SECP has told Profit that “to address the concerns of buyback during the close period and further rationalise and make it transparent, the SECP has already taken up the matter with the PSX for initiation of respective regulatory amendments in the PSX Rules Book.” This shows that the issue is being considered and that it needs to be regulated in the same manner that individuals are.
This is good news. Here we have a company that is generally known for its responsibility. And they are operating in a market where the government and its appointed regulators are not always the fairest business partners in the world. Still, should the company be expected to not take advantage of lax rules. Maybe, maybe not. Which is why the onus is on the regulators to step up and run a tighter ship.
Story updated with new information on 23rd November 2023